The long road to the China-Russian gas pipeline deal: the end of the beginning

Putin_Xi.2014On 21st May 2014 CNPC and Gazprom finally signed the deal that commits Gazprom to export by pipeline to China 38 billion cubic metres of gas per year for 30 years. At a total contract value of US$ 400 billion, the estimated price is about US$ 10 per million British thermal units. This gas will be produced from the long-established Kovytke field and new fields in the Yakutia region.  Despite more than 10 years of negotiation the likelihood that the deal would be concluded remained uncertain right up to the last minute. In the end, it was probably pressure from the political leaders that persuaded the companies to sign. It is not known whether the deal requires China to give Russia a multi-billion dollar loan, which was the case with the earlier oil pipeline agreement.


The story of this pipeline dates back to the early 1990s. The Kovytke field near Irkutsk was discovered in 1987. By 1993 the rights to this gas field were held by Rusia Petroleum whose main shareholder was Sidanko. At this time the gas reserves of Kovytke stood at 870 billion cubic meters. In 1994, CNPC and Russia’s Ministry of Fuel and Energy signed a Memorandum of Understanding to export gas from Kovytke to China by pipeline and in 1997 this was reinforced by an inter-governmental agreement.

In late 1997, BP, bought a 10% share of Sidanco with the specific objective of gaining access to Rusia Petroleum’s oil and gas exports to China. In 1999, Rusia Petroleum and CNPC began to prepare a feasibility study for the proposed gas pipeline. They were joined by Korea’s KOGAS in 2000. At this stage, three options for a pipeline route were being considered: a direct route through Mongolia, a route eastwards to South Korea traversing North Korea, and a route to South Korea which passed under the Yellow Sea, thus avoiding North Korea.

The final feasibility report was published in 2003 and it favoured the third option on the basis that it avoided the perceived transit risks associated with Mongolia and North Korea. By this time the proven reserves of the Kovytke field had risen to 2.13 trillion cubic metres. The project was planned to deliver 4 billion cubic metres per year to local markets in Eastern Siberia, 20 billion cubic metres per year to China and 10 billion cubic metres per year to South Korea.

In addition to supplying a significant quantity of gas to China, the project would also provide much needed energy to the Irkutsk region as well as stimulating local economic development and generating export revenues. The key risk was perceived to be the ability and willingness of customers in China to pay a price for the gas which was acceptable to the Russian suppliers. It was for this reason that an extension to Korea was included in the final feasibility report.

When Vladimir Putin took power as President in 2000, the Russian oil and gas sector was in a parlous state. The new government began to take steps to re-establish control over the sector through centralising authority over the allocation of rights to exploit resources, raising tax revenues, increasing state control over the oil and gas companies, enhancing control over export networks, and more careful consideration of the domestic energy needs of the country.

These new policies and structures had immediate implications for the existing plans for cooperation between Russia and China. Though Russia’s government appeared to remain keen to export gas to China, the new policies required that projects be under tight state control and be managed by one of the major state-owned enterprises. It was also necessary that Russia’s own energy needs be placed above the desire to export and that a wide range of export options be evaluated before final commitments were made. 

The Kovytke gas project, which by 2004 was controlled by TNK-BP, became a victim of these new policies. Gazprom wanted the gas pipeline from the Kovykte deposit to be constructed not to the east for export but to the west in order to create a unified system of gas supply in Russia. Simultaneously Gazprom was preparing its own plans for the gasification of eastern regions of the country drawing on gas reserves in other fields. The company also sought to gain control over the Kovytke field. As a result, the export plans were suspended and the government threatened to withdraw TNK-BP’s license for Kovykte, as terms of the license were not being fulfilled. Eventually BP was forced to relinquish its interest in the field to Gazprom.

As a consequence of this delay, China turned to the vast gas resources of Turkmenistan. An agreement was signed in 2007 and by the end of 2009 gas was flowing from Turkmenistan to Shanghai. In 2013, China imported 27 billion cubic metres of gas from Turkmenistan and other central Asian states, comprising just over 50% of the country’s total gas imports. Most of the balance was imported by sea as liquefied natural gas (LNG). The third pipeline from Central Asia was commissioned at the end of May 2014 and a fourth one is planned. By 2020, the capacity of these pipelines will have reached 80 billion cubic metres.

So Russia is a latecomer to China’s growing gas market, and it is possible that the deal may not have been concluded this year had it not been for the reaction of the European Union to events in Ukraine that put pressure of Russia to accelerate its search for Asian markets. China has gained a new source of gas imports which further diversifies its supplies as well as avoiding the increasingly contentious East Asian sealanes. China’s national oil companies will be satisfied because the price of this new gas is significantly lower than current LNG prices.

In the short-term, the main uncertainty will be whether or not the pipeline can be constructed and reach capacity on schedule. In the longer term, both sides will be hoping that the pipeline strengthens bi-lateral relations rather than undermines them, as has been the case in Europe.  These uncertainties relate not only to the potential for physical disruptions of gas supply but also to possible disagreements over the pricing formula should markets undergo a radical shift, as happened with the Russia-China oil pipeline a few years ago.

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