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Energy

Russian gas pipeline to China links Putin with tough customer

Moscow's energy diplomacy faces headwinds as buyer nations push back

An employee checks a gas valve at the Atamanskaya compressor station, part of Gazprom's Power Of Siberia gas pipeline to China.   © Reuters

TOKYO -- When the first natural gas pipeline from Russia to China was completed last week, the physical link was celebrated by live telecast virtually connecting Russian President Vladimir Putin and his Chinese counterpart Xi Jinping.

At first glance, state-backed utility Gazprom's Power of Siberia pipeline appears to be a win for Putin's energy diplomacy. Russia, the world's top gas exporter, hopes to use the project to strengthen relations with energy-hungry China.

But the achievement comes at a time when energy consumers are driving a harder bargain.

Last Monday's ceremony featured uplifting comments from both sides.

"Energy cooperation between our two countries has entered a new stage," Putin said from Sochi, while Xi in Beijing called stronger relations with Russia "a diplomatic priority" for China.

While their interests may appear to intersect, the two powers occupy contrasting positions, analysts say.

"The Chinese side has recently sent notice of a significant reduction in its gas demand outlook," said Mikhail Krutikhin of Russian consultancy RusEnergy. For China, "Power of Siberia has been positioned as a buffer when imports from other sources falter." 

China's President Xi Jinping, right, and Russian counterpart Vladimir Putin attend a meeting during the BRICS emerging economies summit in Brazil on Nov. 14.   © Reuters

Under the original plan, the supply volume will be increased gradually increased from 5 billion cu. meters in the first year. The outlook for reaching full capacity reportedly remains unclear.

Price is another sticking point. The details have not been disclosed, but Russia appears to be asking for prices comparable with what it charges in Europe, with no final agreement yet.

The Germany-bound Nord Stream undersea pipeline, which started operations in 2011, was partly funded by German companies, as is a second gas link under construction. This gives Germany skin in the game. But for Power of Siberia, the Russian side footed all $68 billion in construction costs, and therefore bears all the investment risk if the flow stops.

If any dispute between Russian and China over the pipeline were brought to international mediation, it would probably take two years to conclude. Given the precariousness of its position, Russia could come under pressure to change the terms of the agreement in the future, observers say.

"There is no commercial prospect for Russia," Krutikhin said.

Russia has had bitter experiences in past negotiations with China. When an oil pipeline was completed in 2010, the price for the output was immediately reduced by a margin that equates to over $300 million a year.

China was highhanded in its reasons. Because it transported the oil to China's main consumption areas, such as Beijing and Shanghai, via its own pipelines, it argued that Russia should discount the price to include those transportation costs. Since the Siberian gas has to travel about 3,000 km to Shanghai via Beijing and other points, China may make similar demands on pricing this time.

China holds another card. It has invested in a liquid natural gas project in Russia's Arctic region and began importing this LNG to Shanghai and other locations. Beijing is now familiar with the cost structure of Russian gas operations and is said to be leveraging this knowledge in negotiations.

China is not the only source of frustration for Russia in its energy ambitions. Changes are also taking place that put Europe in a more dominant negotiating position.

In September, the European Court of Justice ruled that Gazprom was in a monopolistic position and curtailed the Russian group's operations in Europe. As a result, Gazprom faces restrictions in how much volume it can send via the Nord Stream pipeline to Germany.

Gas from such sources as Qatar or Azerbaijan face no such restrictions. The European Commission said this was because Gazprom accounts for 40% of imported gas.

In Asia, Japan seeks to import more oil and LNG from Russian to reduce its reliance on Middle Eastern energy. Moscow could try to use this demand as a bargaining chip in pricing gas bound for China.

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