The highlight of President Putin’s visit to Shanghai in May 2014 was the signing of a 30-year accord to supply China with natural gas through a new pipeline from the Russian Far East. It was no spur-of-the-moment agreement in response to Western threats over the Ukrainian crisis, but rather the product of a decade-long negotiation. From the start, the logic was clear: connect the Russian Far East’s large untapped natural gas reserves to China’s voracious appetite for energy.
Until the last half decade, Russia’s entire energy transportation infrastructure had been geared to shipping oil and natural gas westward to Europe, not eastward to Asia. The new accord between China National Petroleum Corporation (CNPC) and Gazprom marked another milestone in Russia’s shift away from Europe and towards Asia. The deal clears the way for the development of the Russian Far East’s giant Chayanda natural gas field and the completion of a pipeline, called the Power of Siberia, which will carry 38 billion cubic metres (bcm) of natural gas per year to China starting in 2018.
Beijing and Moscow have long discussed supplying Russian energy to China. As early as 2000, they had already envisioned potential pipeline routes that would link Russia’s Siberian oil and natural gas fields to China’s Daqing oilfields, from which existing pipelines could then deliver the imported oil and natural gas to the rest of China. In 2006, the two countries held talks to build two natural gas pipelines with a total capacity of 70 bcm. But neither side could agree on a price to be paid for the natural gas. Parallel negotiations over Russian oil exports also were bogged down.
The two countries reached a deal in 2009 under which Russia would export to China 15 million metric tonnes per year (about 300,000 barrels per day) of oil for 20 years in exchange for $25 billion worth of loans from China Development Bank to Rosneft and Gazprom, Russia’s state-run oil and natural gas companies, respectively. Having long underinvested in exploration to replace aging and depleting fields, Russia’s energy companies needed money to develop new oil and natural gas reserves in the Russian Far East. They also used a portion of their newly acquired funds to build a spur pipeline from Russia’s trunk Eastern Siberia-Pacific Ocean (ESPO) pipeline into China.
In late 2010, China Huadian Corporation, a Chinese state-owned enterprise and one of China’s five major power utilities, and Russia’s TGK-2, a regional utility, agreed to develop a joint power project in the Russian city of Yaroslavl. At the same time, CNNC Jiangsu Nuclear Power Corporation contracted with Russia Atomic Energy Corporation to design the third and fourth nuclear reactors at the Tianwan Nuclear Station. The two countries also made headway on the export of Russian energy to China.
The next flurry of energy deals began in 2013. But preparations for it began long before that. In 2003, a collection of Russia’s independent oil companies and British Petroleum (BP) pooled their Russian assets to form a new company TNK-BP. Among its most valuable assets was a 62.8 percent interest in the Russian Far East’s huge Kovykta natural gas field, just west of Lake Baikal. Kovykta’s proven reserves were the best source for natural gas exports to Asia. In 2013, Moscow forced TNK-BP into bankruptcy and Rosneft bought the company’s assets, including Kovykta.
Thus, Rosneft was well positioned to make new deals with China in 2013. Rosneft’s first agreement was to double its shipment of oil to CNPC to 30 million metric tonnes per year (about 600,000 barrels per day). In return, CNPC agreed to prepay Rosneft $60 billion for its future oil deliveries. Those prepaid funds came in handy, because it needed the cash to service its massive debts and to invest in new exploration.
Historically, Russia had been reluctant to permit Chinese companies from taking direct stakes in Russian oil and natural gas fields. But last September, it allowed CNPC to acquire a 20 percent interest in Novatek’s Yamal LNG project in Russia’s Arctic region. In exchange, CNPC agreed to purchase at least 3 million tonnes of LNG from the project. Even more notable, CNPC and Rosneft agreed to form a joint venture to explore for and produce oil in East Siberia, which contains vast deposits extending hundreds of miles north from Lake Baikal. The creation of the joint venture, in which CNPC holds a 49 percent stake, seemed to herald a shift in Russia’s thinking about China.
China may have shifted its energy security strategy from one of self-sufficiency to diversification, but its long-time goal to ensure access to energy resources remains the same.
RUSSIA’S PIVOT TO CHINA: FROM EUROPE TO ASIA
For Moscow, the latest round of energy deals with China seems well timed. Given Russia’s actions in Crimea and Ukraine in 2014, European countries have begun to seriously reconsider their reliance on Russia, particularly for natural gas. In May 2014, representatives from Europe’s biggest economies met in Rome to discuss how they could reduce that dependence. Though they agreed that it would take a long time before that dependence could be truly reduced, the turn in European sentiment away from Russia was clear.
For its part, Russia has long been worried about its reliance on European energy demand and has sought to diversify its customer base. Even before the Ukrainian crisis, stagnant demand and increasing regulatory pressure in Europe had already motivated Russia to seek other outlets for its energy resources. That is why it began discussions with China and Japan in the early 2000s to help finance a new pipeline that could transport the Russian Far East’s oil and natural gas to Asia. A number of different routes were considered. At one point, Japan agreed to help finance the construction of the $11.5 billion pipeline. But when Russia announced its desire to build a spur pipeline into China before it finished the final phase of the trunk line to the coast, Japan balked. Tokyo feared that it would end up paying for a pipeline to China.
Ultimately, Russia built its pipeline and did so in two phases. Begun in 2006, the first phase took three years to complete and connected its Siberian oil fields to Skovorodino. The second phase, which brought the ESPO pipeline to a new terminal near Vladivostok on the Sea of Japan, took another three years to finish. But almost two years before construction on the second phase concluded in December 2012, the spur pipeline to Daqing was already operational. Until then, Russia transported its oil exports to China mainly over rail lines ‘a tedious, inefficient, and sometimes hazardous process.
The second big reason behind Russia’s pivot to China was the rise of new competitors in the global energy market: Australia and the United States. All across Australia’s northern coast, consortia of international energy companies have been developing new offshore natural gas fields to produce LNG. Within the next two years, over 80 bcm of natural gas capacity is slated to come online. That new supply is expected to be followed by similar volumes of natural gas from the United States. American energy companies, exploiting hydraulic fracturing (or fracking) technology, have produced a torrent of natural gas from shale deposits in the United States. That has led those companies to push for government approval to construct LNG terminals so that they can export their output to the world. Clearly, new American and Australian LNG supplies will challenge Russia’s energy ambitions.
CHINA’S PIVOT TO RUSSIA: FROM SELF-SUFFICIENCY TO DIVERSIFICATION
For China, its new energy relationship with Russia has also proved practical. Until the last decade or so, China’s dealings with Russia have largely centered on arms sales and cooperation in international organizations. But with its own rising tensions with Japan and the United States, the expansion of China’s relations with Russia to include trade in energy (and other raw materials) has given China a bit more diplomatic room for manoeuver than it otherwise would have, since the West may be cautious not to push China further into Russia’s arms.
Nevertheless, China has another, more important reason to collaborate with Russia: China’s concern over its access to energy resources. Beijing’s approach to Chinese energy security has long prioritized access to energy resources above all other considerations. That way, China can always count on a reliable energy supply, even in a crisis. For decades, China achieved that goal by being oil self-sufficient. To outsiders, China’s preoccupation with access seemed unwarranted, given the end of the Cold War and the benefits of Pax Americana. But Pax Americana may be precisely why China has felt the need to hedge. Chinese leaders, who came of age in the 1990s’ well remember the volte-face of the West after their crackdown on internal dissent in Tiananmen Square in 1989 and the interference of the United States when they fired missiles into the Taiwan Strait to sway Taiwan’s presidential elections in 1996. That is not to say that fear drives China’s energy security policy, but rather that Beijing appreciates the value of reliable access to energy resources in an unpredictable world.
But by the mid-1990s, China could no longer remain self-sufficient in energy. Its economy was growing too fast for its big state-owned energy companies to keep up. They were too slow to bring new domestic reserves online and reluctant to let foreign energy companies into China’s most-prized oil and natural gas fields. Hence, Beijing directed its state-owned energy companies to seek new energy resources abroad and provided them with low-cost financing to do so. Since then, they have gained access to energy resources all over the globe, particularly in places like Africa, Latin America, and the Middle East.
In other cases, China has been willing to pay a premium for access. One example has been China’s interest in developing a pipeline that extends from Turkmenistan’s southern natural gas fields to China’s eastern coast. The pipeline stretches some 7,000 km (over one-sixth the circumference of the Earth). Construction on a 4,000-km section of it inside China, called the West-East pipeline, began in 2002 and was completed a few years later. Since then, a second span of the West-East pipeline was built in 2011 and a third was begun in 2012. Another 1,300-km segment running through Kazakhstan was finished in 2009. But the pipeline has inherent drawbacks. Because the Turkmenistan-to-China pipeline is actually created from a patchwork of new and existing pipelines, rather than from a single unified design, there is a lot of engineering variability throughout its length. That invariability reduces its reliability and raises its long-term costs. Those higher costs are likely to make shipping natural gas through the entire pipeline unprofitable, especially if China persists in capping natural gas prices in its eastern cities. Yet China seems determined to complete the entire pipeline because the pipeline gives China access to Central Asia’s natural gas over a land route that cannot be interdicted by foreign control of the seas.
By gaining access to energy resources around the world, China has diversified its energy supply base. China may have shifted its energy security strategy from one of self-sufficiency to diversification, but its long-time goal to ensure access to energy resources remains the same. Seen in this light, China’s interest in access to the Russian Far East’s oil and natural gas reserves is a natural extension of its energy diversification.