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China Turning The Screws On Russia? Gazprom Might Be The Next Target Of Beijing

December 11, 2008

Is China Turning The Screws On Russia? Gazprom Might Be The Next Target Of Beijing Martin McCauley writes: A leading Russian academic predicted some time ago that Russia would eventually push out the United States to become China’s number one trading partner. He even thought Moscow could become Beijing ‘quasi-ally’. The man was obviously living in cloud cuckoo land. Recent setbacks for Russia’s economy reveal a different reality.

In October a deal was struck between Russim and china to supply oil to China through the East Siberian Pacific Ocean Pipeline (ESPO). China agreed to lend Rosneft, the Russian state oil company, $15 billion and Transneft, the Russian state oil pipeline corporation,  another $10 billion to facilitate the project. However, there were strings attached: the Russians had to build the pipeline and start pumping 15 million tonnes of oil a year to China by 2011.

One of the reasons why China imposed strict conditions on the deal was that Russia had an irritating habit of not fulfilling contracts on time.

Prime Minister Vladimir Putin now welcomes Chinese investment. This is in marked contrast to 2002 when Moscow turned away Chinese investment in the oil company Slavneft. Oleg Safonov, the presidential envoy to the Russian Far East, is now asking for Chinese money to be invested into timber processing, aircraft construction, development of nanotechnology and energy.

In January 2008, Russian foreign direct investment (FDI) in China only amounted to $14 million while Chinese FDI in Russia totalled $415 million. Compare this with the billions of dollars of FDI poured in by the United States over the last 30 years. China at present holds about $1 trillion of US state bonds.

The Russians admit that the Far East cannot be developed without direct foreign investment. Chinese engineering companies are building coal-fired turbines there to generate electricity. Hence Russia is becoming dependent on China for the development of infrastructure in this strategically important area.

But back to ill-fated ESPO: Russia thought that China had agreed to an interest rate of 7 per cent for the loans. However, the Chinese then insisted in increasing rate. The talks collapsed in mid-November. They have resumed since then, but so far no agreement is in sight. ESPO may not even be built at all. An even more thorny question – the price of the oil itself – has yet to be agreed.

Russian oil deliveries, by rail, to China fell by 10 per cent in 2007. Even worse, Gazprom has not been able to supply any oil to China this year because of a dispute with Kazakhstan.

Gazprom is also trying to wriggle out of commitments to deliver gas to China. There will be no gas pipeline to China from the Sakhalin-1 project because Gazprom cannot even meet its contractual agreements in full to supply gas to its Russian, European and Asian customers. Originally China tried to avoid dealing with Gazprom by signing a memorandum of understanding with Exxon-Mobil that controlled the Sakhalin-1 project in 2006. Since then Gazprom has taken a controlling stake over the project and the Chinese have to negotiate now with Gazprom.

More bad news for China is that Gazprom is planning to supply gas from the Sakhalin-2 project to Japan through a new pipeline under the Sea of Japan. Beijing is now demanding that Russia provides China with the latest nuclear technology to permit the construction of more nuclear power plants.

Gazprom has already cancelled a proposed gas pipeline from Altai to China because it would not have been cost effective. Beijing will not commit itself to long term pricing because alternative gas supplies from Turkmenistan may become available soon. The Central Asian state has huge reserves and when a proposed pipeline is built, going though Uzbekistan, the gas price could be set much lower than the one that is being offered by Gazprom.

At present almost all the gas delivered by Gazprom to Ukraine and Europe comes from Central Asia. If Turkmenistan decides that China is a more lucrative market than Russia, where will the gas for Ukraine and Europe come from? Gazprom production this year is down on last year. Fortunately the winter so far in Russia is classified as ‘warm’ so domestic demand is down as well.

The downturn in the world economy makes Gazprom a high cost producer. Already it needs help from the Central Bank of Russia to survive. It has ambitious plans to exploit the huge Shtokman field in the Barents Sea. The gas would be turned into liquefied natural gas on shore and shipped to the US and Europe. These will remain a pipe dream for the present.

China needs energy but finds Gazprom an inefficient, unreliable supplier. Is the solution for the Chinese to take a stake in Gazprom and run it more efficiently? It is beginning to look like a likely option.

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