Thursday, October 15, 2009

Price Limit on China's Russian Friendship

Russian Prime Minister Vladimir Putin's visit to China this week is the latest indicator that the rapprochement in Russian-Chinese relations, initiated through the 2001 bilateral "Treaty on Good-Neighborly Relations, Friendship and Cooperation", which provided for increased Russian arms sales to China and the training of Chinese officers at Russian military schools, is developing steadily into closer strategic cooperation.

Burgeoning cooperation in the energy sphere dates from Putin's December 2002 visit to China, as president, when it was agreed that a project for a gas export pipeline to China would be elaborated, with the Kovytka gas field being the most likely candidate for supply.

During his subsequent visit in October 2004, Gazprom and China National Petroleum Corporation (CNPC) signed an agreement on strategic cooperation covering not only promotion of natural gas exports of to China but also exploration of possibilities for joint projects in Siberia and in third countries. At that time a Memorandum of Understanding (MoU) was signed at the level of head of state for development of two pipelines for natural gas. Two years later, another MoU identified their likely routes, one from Western Siberia to be designed to carry 30 billion cubic meters per year (bcm/y) and the one from Eastern Siberia to carry 38 bcm/y.

In 2007, the Russia established the Eastern Gas Program (EGP) as a state program that seeks to create a unified system of gas production and transportation to China and other countries of the Asia-Pacific rim. The EGP was approved that September by the country's Ministry of Industry and Energy, which selected Gazprom to coordinate it.

Meanwhile, earlier this year, the China Development Bank lent US$25 billion at relatively low interest to Russian companies Rosneft and Transneft as part of a deal involving Russian export to China of a minimum of 300,000 barrels of oil per day at a very favorable price and agreement on construction of a spur from off the East Siberia-Pacific Ocean (ESPO) pipeline for that purpose).

Putin's latest visit to Beijing, just concluded, did not arrive at definite further agreement in the gas sphere, as some observers had anticipated it might do, but some progress in negotiations appeared to have occurred.

Halfway through the talks, Deputy Prime Minister Igor Sechin, as quoted by Bloomberg News, told reporters that a contract could be ready by next summer with deliveries to begin in the middle of the next decade either as liquefied natural gas (LNG) delivered by tanker or through new pipelines to be constructed.

Sechin added that China has agreed to construct two new nuclear reactors at its Tianwan power plant, in Jiangsu province, with Russian help, to purchase electricity from the Russian Far East, and to import Russian coal, definite deals altogether worth $3.5 billion without even taking the negotiations over gas into account.

Putin later suggested that the West Siberian gas route could be made operational before the middle of the next decade with a Chinese financial contribution, since the main trunk pipelines already exist and only their extension to China is required. As for the East Siberian route, this might require Chinese capital since the targeted resources in that region are as yet untapped.

Price, in particular, has been a sticking point ever since these deals were first discussed, with Russia seeking a pricing regime like the one it uses in Europe, according to which the cost of gas is set in relation to the price of oil. China has sought a lower-priced scheme. In his last comments before departing Beijing, Putin announced an agreement to set the price of gas in relation to an "Asian oil basket" although details remain to be resolved.

Nevertheless, despite Putin's announcement of a pricing agreement in principle, his final remarks betrayed more conviction that a deal must in principle be done than that it will in practice be done. As quoted by Associated Press, he avowed the necessity "to argue until we lose our voices, up to the last second", while professing faith that "mutual national interest" will enable the two sides to "reach agreement in the end".

Given the fact of the EGP and the fact that Asian markets are the growth markets, it is likely that at least the West Siberian route may be established sometime sooner rather than later. What is clear, however, is that Beijing is driving a hard bargain and is not at present offering concessionary loans of the sort concluded earlier this year in connection with the ESPO oil pipeline. By Robert M Cutler senior research fellow in the Institute of European, Russian and Eurasian Studies, Carleton University, Canada.

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