Russia and China: Too Big for a Natural Gas Deal to Succeed

At first sight, Gazprom's final investment in October to develop the giant Chayanda gas field in east Siberia paves the way to move negotiations forward on gas supplies to China via the so-called eastern route.

But Russia and China have been here before, and it is far from certain that this time the old Cold War enemies will finally resolve their differences.

Even though the world's biggest gas producer shares a border with one of the world's fastest-growing energy markets, politics can still ensure that the deal will fail, if both continue to look for too much from other.

Consequently, what ought to be a marriage made in heaven–since the world's largest gas producer shares a border with one of the world's biggest energy consumers– seems condemned to remain a very long courtship.

A few years ago Moscow and Beijing signed a contract for 30 Bcm/year of gas to be sent to western China from 2015 via the western Altai route, while a 2006 initial agreement also allowed for 38 Bcm/year of additional gas to be piped from eastern Siberia to eastern China. But China's preference has been for gas to be delivered via the eastern route — close to major eastern coastal demand centers — as it would reduce transport costs significantly.

And negotiations led nowhere, as the two had different objectives.

Russia wanted to play off China against Europe through a netback policy that would yield an equivalent price from either market for its western Siberian gas, by delivering gas through the western route via Altai; while China thought that cheap gas in eastern Siberia should be sold cheaply by a pipeline bringing gas to its populated region along the eastern coastline. As a result, the two remain separated by a widely divergent view on the price, perhaps as much as $100/'000 cu m ($2.8/MMBtu).

The latest addition to the Oxford Institute of Energy Studies catalogue of books, Keun-Wook Paik's "Sino-Russian oil and Gas Cooperation," puts forward some reasons why this problem remains unsolved.

First, China has not been given any equity in Russian fields or pipeline projects, denying it any control in the value chain. In Turkmenistan, by contrast, cheap loans have given it the right to produce gas for transport homeward.

Second, Gazprom wants the level of oil indexation to yield a price equivalent to its European sales; third, China has alternative imports from Myanmar, central Asia and LNG. And fourth, there has been a fatal lack of trust between the two former Cold War opponents.

Large amounts of good quality Russian oil, by contrast, has been able to flow to China since the spur from the East Siberia Pacific Ocean pipeline opened in August 2010. This broke the monopoly of the Gulf states, whose crude came with an Asia premium, and created a credible alternative benchmark for Asia.

But when it comes to gas, Russia is simply not a priority, Paik believes. Even Gazprom's ruses–such as planning a pipeline to Korea for eastern Siberian gas instead–has failed to smoke the Chinese out of their bunker: the price was always too high, either because the transportation system was too long, or because Russia was not prepared to sell cheap gas cheaply (Kovykta gas through eastern Siberia).

Paik does not expect Russia to export more than 30 Bcm/year to China by 2020, even if gas demand there is as high as 300 Bcm/year through a single pipeline, with LNG and central Asia making up the difference.

"Gazprom's rigid stance on gas supplies, based on its monopoly status, caused the delay in reaching a gas price compromise and gave China a strong incentive to prioritize the option of gas supply from the central Asian republics, in particular from Turkmenistan," says Paik. A series of west-east pipelines is operating within China, and more are being built, with a fifth on the way, all aimed at bringing in central Asian gas.

The worst scenario for Altai gas is that China decides to allocate WEP-IV to the remaining 35 Bcm/year from the central Asian republics, rejecting Altai gas altogether, he argues.

Generally he is pessimistic about a deal ever materializing. The new leader in Beijing cannot be relied on to change the policy either, he believes, since the country works on a consensual system. "The existing advisors will keep things on track," Paik said, in response to a question about the new premier's views at the launch of the book while nevertheless conceding that it was a very difficult question.

He also said that there was little reason to expect China would pay up for the certainty of direct gas deliveries by pipeline from Russia, rather than simply take its chances with the vagaries of seaborne LNG. "The prospects of Sino-Russian oil co-operation in the next two decades are much more favorable than those of Sino-Russian gas co-operation," his book concludes.

The failure of the two sides to agree has had some surprising side-effects. Central Asian gas is flourishing, with Turkmenistan, Uzbekistan and Kazakhstan now able to choose another buyer than Russia.

But continuing failure to agree would be a loss for both sides and other countries as well. It would deprive both countries' economies of an obvious win, by finding a home for stranded gas reserves, as well as increase future global rivalry in the LNG market, with a knock-on effect on world prices. Indeed, PetroChina's high-price bid for a stake in Browse, the Australian LNG project, does not show much confidence that anything will come of the latest talks.