China: Dancing with the Russian bear

Prime Minister Wen Jiabao has recently returned from a visit to Russia during which he discussed with his counterparts in the Russian government the issue of energy cooperation. Russia has the largest reserves of gas in the world and the seventh largest reserves of oil. China is the second largest consumer of energy and is a growing importer of oil and gas. But, as we know in Europe, energy relations with Russia (or with the former Soviet Union) have a habit of throwing up surprises, both good and bad ones. The energy relationship between China and Russia should be a “marriage made in heaven”, but it may prove to be more a case of “the course of true love never did run smooth”.


Energy has played an important role in Sino-Russian relations since Liberation in 1949. In the 1950s Soviet technical advisers and Soviet technology helped China to establish the beginnings of an oil industry. But the break in relations in the early 1960s left the country with an oil output of only five million tonnes per year and few skilled engineers. The Chinese were able to harness revolutionary ardour with the legacy of Soviet technology and Soviet technical training and, through the development of the Daqing and other major fields, to raise output to more than 50 million tonnes by 1973 and 100 million tonnes by 1978. The remaining hold of the Soviet Union over China’s oil industry began to crumble from 1980 as foreign oil companies and contractors were invited to participate  in China’s oil industry.


The break-up of the Soviet Union allowed foreign oil companies to assess Russia’s oil and gas reserves for the first time. It had long been speculated that significant accumulations of oil and gas might exist in Eastern Siberia and the Russian Far East. Indeed Japan entered into discussions with the Soviet Union in the 1970s to attempt to secure exports. But there was no firm evidence of the scale of the reserves. By the early 1990s, exploration and appraisal work by foreign oil companies had started to demonstrate the probable large scale of reserves in areas adjacent to China. Though the fields in the Far East might well be suited to export by sea, those inland, to the north of Mongolia, were clearly possible sources of export to China which by then had become a net importer of oil and was also seeking to increase the proportion of natural gas in its energy mix. Indeed from this time, energy was seen by both governments to be a key potential component of a deepening relationship, culminating in the Treaty of Friendship and Cooperation signed in July 2001.


Despite this rhetoric, energy flows from Russia to China have been limited to oil carried by rail and a small amount of electricity. No pipeline has been completed. A feasibility study has been completed for a branch which would run south into China from the Eastern Siberia – Pacific Ocean oil pipeline. On the topic of gas exports, Russia’s First Deputy Prime Minister Dmitry Medvedev said “We hope to come up with a practical cooperation model for gas deliveries in the next few years”.


From the Chinese perspective most of these delays have their origins in Russia. The plans for an oil pipeline from Irkutsk was disrupted by the enforced break-up of Yukos, the Russian private oil company which had proposed the project and had reached a deal with China. A further complication was added when Japan suggested that rather than build a modest-sized pipeline to China, Russia should build a large pipeline to the Pacific coast, and that Japan would finance it. This option has the advantage to Russia of reducing dependence on a single export market and to Japan of bringing a major supply of oil into the East Asian market and possibly undermining the “Asian premium” charged by Middle East suppliers.


Everything was then laid wide open when Russian and international environmentalists drew attention to the danger that the pipeline posed to Lake Baikal, a World Heritage site. Only recently has the Russian government made the decision to build the pipeline to the coast and as well as a branch southwards to China. Despite the delay in this decision, Russia has been steadily raising the amount of oil sent to China by train. This is likely to reach fifteen million tonnes in 2007, some 7% of China’s total oil imports.


The gas story is more complicated. The prime field for potential exports to China has long been recognised to be the Kovytke filed, near Irkutsk, on account of its location and its large size. However, the licence was held by TNK-BP, which not only is partly foreign-owned, but did not include participation by the Russian gas giant, Gazprom. Very late in the day Gazprom realised that it needed to be part of this consortium and used its recently-created monopoly power over gas exports as a negotiating lever to force its way into the project. Further, the Russian government had entered a prolonged period of internal debate over the path of future national energy policy. Particular areas of concern were which resources would be reserved for Russian companies, which resources should be used to supply domestic energy needs, and which resources should supply foreign energy markets respectively to the west and to the east. Though the government appears keen to export gas to China, this gas could come from West Siberia, East Siberia, the Sakha Republic or the Russian Far East.


This policy debate continues. In the meantime investment in Russia’s gas reserves is at a frighteningly low level – at least it is frightening to those in mainland Europe who depend on Russian gas supplies to heat their homes and run their industries. So, the Chinese will just have to join the queue of those waiting for a clear gas policy from Russia and for an acceleration in their investment in field appraisal and development and in pipeline construction.


That being said, the Russians cannot be blamed for everything. Until recently China was driving a very hard bargain on the price it was prepared to pay for Russian gas. This was based on the very low price they secured for their first LNG import plant in Guangdong and on the ability of customers in north-east China to pay for gas from Kovytke. China’s willingness and ability to pay a higher price for gas has grown in recent years on account of its rising wealth, the expanding need for clean energy, and the growing realisation that all international gas supplies are likely to be expensive.


Prime Minister Wen Jiabao’s recent tour has served only to emphasise the uncertainties underpinning China’s hopes for large scale energy imports from Russia. Where were the most optimistic statements on gas pipelines? In Kazakhstan and Turkmenistan. As in 2003, when China gave up waiting for an oil pipeline from Russia and signed an agreement to build one from Kazakhstan which was put into operation in 2005, so China now appears to be pressing ahead to secure supplies of gas from central Asia, rather than wait for the Russians to make up their minds.

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