A Shift from Europe in Russian Energy Policy?

2012-12-04 by Richard Weitz

If Russian energy policy were to shift from Europe as a key market, the obvious focus would be China.  But after many years of false hopes and frustrated deals, China and Russia have made only modest progress in establishing their long-anticipated energy partnership.

But what are the prospects for change in this partnership?  What obstacles have to be overcome for a strategic shift?

The Current State of Play

Notwithstanding China’s efforts at energy supply diversification over the past decade, it was not until 2009 that Russia became China’s fourth largest oil supplier, providing 7.8% of China’s imports in 2009, up from 6.3% in 2008. This figure is now rising further thanks to the opening of the Eastern Siberia–Pacific Ocean oil pipeline on January 1, 2011.

Still, this low figure is surprising because the two countries would appear to be natural energy partners. Furthermore, negotiations over a direct natural gas pipeline remain stalled due to disagreements over what price China will pay for the gas. Russia has carved out only a small share of China’s expanding nuclear energy sector.

Given the geographic proximity between the two countries, that Russia is the world’s largest oil producer, and that China is the world’s largest energy importer and fastest growing economy, Russia and China should have aligned sooner.

The Prospects 

Russia’s oil and natural gas deposits, some of the world’s largest, lie much closer to China than the more distant energy sources of the Persian Gulf and Africa.

Whereas oil and gas from these continents can only reach the PRC through international waters that are vulnerable to interdiction by foreign navies and sea pirates, energy supplied from neighboring Russia can enter Chinese territory directly without having to pass through third-party territories.

Some energy-exporting Central Asian countries also enjoy these advantages, though Chinese policy makers act warily in this region given Moscow’s traditional dominant regional position, which generally guarantees an important role for Russian companies in the exploitation and especially transportation of Central Asian oil and gas.

Despite these advantages and other mutual incentives to increase bilateral energy cooperation, Chinese-Russian energy cooperation has been surprisingly limited.

Technical obstacles, pricing conflicts, inadequate transportation infrastructure, and mutual suspicions have historically kept Chinese purchases of Russian energy at relatively low levels.

Frequent delays in shipments on the part of the Russians and attempts to leverage the competing interests of the Chinese, Asian, and European markets off each other have prevented Chinese policy makers from regarding Russia as a reliable long-term supplier.

Staff members inspect the pipelines and oil storage tanks of China and Russia crude oil pipeline in Mohe in northeast China’s Heilongjiang Province January 2010.

In assessing energy relations between the two countries, it is important to distinguish concrete contracts from mere declarations of intent. Many of the bilateral agreements reached in recent years—often described as memoranda of understanding or framework accords—aim merely to signify interest as well as gain leverage regarding third parties, such as Japan and Europe.

Energy security invariably represents an important agenda item at Russian-Chinese leadership summits. As a result of China’s surging economy, the country has become one of the world largest purchasers of international oil, natural gas, and nuclear technologies.

The gap between China’s stagnant energy production and its fast-growing consumption is projected to expand even further in the next two decades. Domestic resources will not be able to meet China’s growing demand for energy in general, and for oil and natural gas in particular.

The Potential Russian Role in Providing Energy to China 

In principle, Russia should find a natural place within this framework.

Russia is the second-largest oil exporter after Saudi Arabia (and in 2009 produced more oil than the Saudis) and possesses the world’s largest reserves of natural gas.

Many of Russia’s new and untapped oil and gas fields are situated in eastern Siberia and the Russian Far East. These locations lie closer to China than the older fields that now provide energy primarily to consumers in Russia and Europe. In 2007, the Russian Industry and Energy Ministry approved a plan proposed by Gazprom to invest $100 billion through 2030 to create an integrated production, transportation, and supply system involving over 200 billion cubic meters of natural gas in east Siberia and the Russian Far East.

During Putin’s March 2006 visit to Beijing, the two governments signed four energy cooperation agreements envisaging collaboration in oil, gas, electricity, and nuclear energy. Putin’s entourage included the heads of Russia’s major oil, gas, and electricity companies. The Beijing summit provided an opportunity for them to negotiate several cooperation agreements with their Chinese counterparts.

In April 2006, Russia began constructing a massive $12 billion East Siberia-Pacific Ocean (ESPO) oil pipeline. Russia and China subsequently agreed to build a branch oil pipeline from the ESPO that would connect the Russian oil fields of eastern Siberia with the refineries located in northeastern China. Russia will also build another large new pipeline to deliver billions of cubic meters of natural gas annually to East Asia. Chinese and Russian representatives are negotiating to deliver some of this gas to China.

The 21st-century could well see a profound eastward shift in the direction of Russian energy export routes as new supplies flow towards East Asia rather than Europe.

Obstacles to Overcome

But many obstacles will need to be overcome for such a revolution in world energy flows to occur.

Despite these apparent mutual interests in increasing bilateral energy cooperation, Russia’s contribution to China’s oil imports has historically been less than the share provided by some more distant African and Persian Gulf suppliers.

For years, Russia’s consistent delays in shipments, foot-dragging on the issue of pipeline construction, and attempts to play the Chinese, Asian, and European markets against each other have kept PRC policy makers from viewing Russia as a reliable energy security partner.

Until recently, the immediate reason for the small volume of Russian oil and gas sold to China was the underdeveloped transportation infrastructure connecting the two countries. 

For example, most crude oil exported to China from Russia was sent by railway through the Zabaikalsk-Manzhouli border oil reloading terminal on the Chita-Harbin-Vladivostok railroad. This line has limited capacity and is very costly. Not only is rail transport about two and a half to three times as expensive for Russian oil producers as shipments by pipeline, but rail deliveries to China entail the added cost of putting the rail cars on new trucks at the border because of the different gauges of track used by the two countries.

Photo taken during Putin’s visit to China in 2011. 

Chinese, Russian, and other energy experts agree that transporting oil and gas through pipelines would prove much more efficient. For many years, however, the two governments have engaged in contentious negotiations over which pipelines to build, where to locate them, the schedule for their construction, and who will pay to build and maintain them. In particular, the repeated delays on the Russian side to allow for “feasibility” studies and “environmental” assessments have reinforced Chinese suspicions that their Russian interlocutors are using the specter of diverting more energy sales to China to enhance their negotiating leverage with Japan and Europe.

At the time of the March 2007 Hu-Putin summit, China’s chief energy planner, National Development and Reform Commission Vice Minister Zhang Guobao, complained about the Russian approach to the oil transportation issue: “The Sino-Russia pipeline question is one step forward, two steps back. Today is cloudy with a chance for sun while tomorrow is sunny with a chance for clouds. One moment Russia is saying they have made a decision, the next saying that no decision has been made.”

Zhang also faulted Russian policies in the areas of natural gas and electricity: “Even though there have been a lot of promises expressing Russia’s interest in exporting natural gas to China, in truth no real progress has been made. As for Russian electricity exports . . . during all the years we’ve been connected together, Russia has only sent a total of 1 billion kilowatt hours of electricity to China.”

Another complication is that Russia’s unexploited oil and gas deposits are located in areas with challenging geophysical characteristics (e.g., offshore or under frozen tundra). Russian companies need considerable technology and foreign capital to exploit these fields effectively and upgrade the country’s aging energy transportation infrastructure.

Beijing has long wanted Moscow to devote resources into constructing immovable pipelines to China as proof of Russia’s commitment to a long-term energy supply relationship.

Russians appreciate, however, that their ability to attract Western capital could decline if they actually build pipelines committing them to supply primarily the Chinese export market. 

Although Russians have been discussing constructing an oil pipeline to China for over a decade, they continue to entice Japan, Europe, and even the United States with offers of future energy deliveries—encouraging them to offer financial and technical assistance, as well as moderate their policies on other issues (e.g., the Japanese-Russian territorial dispute over the Kuril islands).

Furthermore, despite Russian companies’ expanding control over Central Asian oil and gas resources, many analysts doubt Russia’s ability to satisfy all these expanding energy markets given its stagnant domestic production.

A further difficulty is that the Russian government under Putin has not exempted China from its efforts to limit foreign control of its major Russian energy assets.

According to one estimate, the share of Russian crude oil that is produced by government-controlled energy companies has risen from less than one fifth in 2000 to almost half in 2007, with many of the remaining private firms readily influenced by the Kremlin.

In 2002, the Russian Duma blocked China’s National Petroleum Corporation (CNPC) from acquiring a majority stake in Slavneft, a major Russian oil producer, even though CNPC’s bid was almost twice as high as that of the eventual Russian winner.

In June 2006, the Russian authorities did allow Sinopec to purchase a major stake in Udmurtneft, a major Russian oil producer, but only on the condition that it resold sufficient shares to give the state-owned Russian energy company Rosneft a 51% majority stake in the enterprise.

Russian government officials have since spoken more favorably about attracting foreign direct investment to Russia’s energy sector.

But as long as Russian energy firms remain under state control, Chinese policy makers—aware of Moscow’s treatment of Georgia, Ukraine, and other countries whose governments have antagonized the Kremlin—must worry that relying on them for crucial supplies.

This could leave Beijing vulnerable to politically motivated reductions and cut-offs. 

Credit First Photo:

The Washington Post

http://www.washingtonpost.com/world/china-finds-promise-and-peril-in-pursuit-of-russian-energy/2011/11/27/gIQA1H9hzO_story.html

Credit Second Photo:

http://thediplomat.com/2011/10/22/can-china-russia-close-gas-deal/

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