Wednesday, January 11, 2012

China Russia Energy Cooperation Moving Slowly

You would think that the most natural thing in the world would be for a large energy producer to partner with a large energy consumer, but in the case of China and Russia logic does not always prevail. The Washington Post quotes a Western energy executive who said, "They look like the perfect partners, but this is a marriage made in hell." He added the two sides were so afraid of being outdone by the other that negotiations tend toward all-or-nothing combat. The issue, whether discussing gas or crude oil, is the relationship between price and transportation distance.

In the case of oil, in October 2008 Russia and China signed an agreement in which the China Development Bank lent Transneft the funds to build an extension of the East Siberia-Pacific Ocean (ESPO) so that Russian crude could be delivered to the Chinese city of Daqing. The loan was to be repaid by supplying China with 300,000 barrels per day of crude for twenty years. Everything appeared on track, and on December 31, 2010, the first Russian oil crossed the Chinese border.

In April, Transneft reported that it was losing $20 million a month in the oil deliveries, because China had unilaterally decided that they were paying too much and reduced payments. Russia threatened to take the Chinese National Petroleum Corporation (CNPC) to the London Arbitration Court. China wanted a discount, because the oil they were purchasing traveled less than oil destined for Japan. according to Transneft spokesman Igor Dyomin, "There is no price difference for oil companies as to where they enter ESPO and where they exit...Russia is long out of socialism--we want fair market pricing."

Chinese Foreign Ministry spokesman Hong Lei was sanguine about the dispute. Reuters reported his comments that, "As for some concrete problems encountered during cooperation, we believe both sides can fully resolve this in a positive way via friendly negotiations and on a mutually beneficial, win-win basis."

Some progress was made in late May 2011, when China paid about three-fourths of the money the Russians claimed they were owed. Shortly thereafter, China resumed discounting its payments. After talks in early June, a Russian Energy Ministry spokesman said that the pricing formula would remain unchanged. "The price formula will be kept unchanged, we have agreed on that and China is ready to make payments according to it," quoted RIA Novosti. The Russians were overly optimistic, however. "They actually went back to the level of negotations which we had prior to the signing of the contract," Pravda quoted Transneft officials.

A Russian source stated anonymously that if the Chinese did not pay for the oil in full, that the dispute would go to the arbitration court, and that Transneft was prepared to repay its 20 year loan ahead of schedule, according to With the loan repaid, Transneft could cease oil deliveries. China then moved the dispute from the state-owned company level, to the governmental level.

Russia's Deputy Prime Minister, Igor Sechin, tried to calm the situation. He said he did not see any problems that could not be solved, and that not all opportunities had been exhausted, according to RIA Novosti. Finally, in October, Premiers Wen Jia Bao and Vladimir Putin jointly announced a breakthrough. "The two countries agreed on crude oil prices and decided to actively push forward cooperation on oil and gas," China Daily quoted Wen. No details of the agreement were released but anonymous sources told that Russia, who had claimed China was underpaying by $3 per barrel, had agreed to a $1.50 discount.

At least a compromise had been reached. Natural gas is a different story. Currently, China consumes about 150 billion cubic meters (bcm) of natural gas per annum, approximately 4% of its energy mix. This amount is expected to double by 2020, according to a report in the People's Daily. Russia and China signed an agreement in 2006 to build two natural gas pipelines. Russia would then send 70 billion cubic meters annually to China. In 2011, despite numerous positive remarks by both Chinese and Russian officials, there is no pipeline construction.

Denis Borisov, an oil analyst at the Bank of Moscow, believes that Russia badly needs a gas deal with China, to diversity its exports away from saturated European gas markets. "Talks may last long but the gas deal won't be sacrificed..I think gas cooperation is a top priority for Russia," he told Reuters. This optimism was echoed by a Chinese source close to the Chinese-Russian talks,. "Our positions have gotten closer," he said about the possibility of a Chinese loan to build the pipeline.

In April, Chinese President Hu Jintao met with Dmitry Medvedev in the Chinese resort town of Sanya. The leaders announced they would pursue cooperation on major energy projects, such as the west natural gas pipeline from West Siberia to China, according to the Xinhua news agency. Despite the positive pronouncements, Interfax China reported that Gazprom and CNPC were involved in tough negotiations over price that did not appear to be progressing.

Everything looked better in May. Russian Deputy Prime Minister Igor Sechin reported that, after many years of fruitless negotiations, Russia and China had coordinated the key terms of a long-term gas contract. "We are considering two gas supply routes for the next 30 years. The western route will provide China with 30 bcm of gas, the eastern one with 38 billion,' he said. He also said there would be no problem with financing, according to the Voice of Russia. Sechin cautioned, however, that the two sides had not reached a final agreement on price--leaving that detail to Gazprom and CNPC, according to Chinese Assistant Foreign Minister Cheng Guoping was pleased: "Personally, I'm confident that if progress is smooth, then it's quite likely that in the near future..both sides will achieve a major breakthrough in cooperating over natural gas," he told a news conference. Xing Guangcheng, an expert on Russian studies at the Chinese Academy of Social Sciences, commented, "The deal is not an ordinary project between just two companies. It is a project of bilateral strategic importance, and it needs the determination of the leadership from both sides," according to China Daily.

It was not to be. President Medvedev announced that documents were being finalized, and Premier Hu Juntao said both sides ere willing to push forward, but price remained a stumbling block. "We are not going to sign anything this time," Medvedev concluded the negotiations, according to New Europe. Russian Energy Minister Sergei Shmatko commented, "This is not some simple bazaar deal; we can't hurry on this."

The disagreement was outlined in China Daily. Andrew Neff, an analyst who specializes in Russia and the Commonwealth of Independent States at IHS Global Insight, explained the Russian position: "Gazprom is focused on achieving a price agreement in line with that of its long-term, oil-indexed contracts for pipeline supplies to its European customers." But China disagreed. Pang Changwei, Director of the Institute for International Oil Politics at China University of Petroleum said it was unrealistic to base the price on the European market because the distance between China and Russia was much less than that between Russia and Western Europe. He reasoned that because transportation costs should be lower, so should the price. It was the same Chinese argument that disrupted oil deliveries through ESPO.

Some analysts believe that Russia has no intention to actually build a gas line, and that the lengthy negotiations are a ruse. RusEnergy partner Mikhail Krutikhin opined that clearly no gas agreement would be reached. "Russia is trying to scare Europe with threats of redirecting its gas to China, but China is not ready to pay $220-$230 per 1,000 cubic meters," he said according to Nezavisimaya Gazeta. Robert Cutler cited a Chinese press leak that the two sides were as much as $100 per thousand cubic meters apart on price.

In the end, price differences could be negotiated, but the heart of the matter is a lack of trust between the two sides. "China looks very seductive, but" said former Russian deputy energy minister Vladimir Milov. "there is a deep lack of trust behind the facade," quoted the Washington Post. This lack of trust could be generated by geopolitical rivalry between the two sides, according to analyst Alexandros Petersen. The Chinese officially reject such an analysis as an "inaccurate Western perspective," but Petersen quotes a Sinopec analyst saying, "Our interests and the interests of our government are to see stable governments in the region...The result is soft geopolitical competition between China and Russia. And it is spreading."

All that's left is to see what is more important: access to energy, price or geopolitics.