After 10 Years Russia and China Finally Tie the $400 Billion Natural Gas Knot

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The long-awaited agreement between Russia and China on a $400 billion natural gas pipeline is seen by some as a political triumph for Russian President Vladimir Putin, who is courting partners in Asia as those in Europe and the US seek to isolate him over Moscow’s annexation of Ukraine’s Crimean peninsula, but an argument can be made that this should be seen as a sign of Russia’s weakness.

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That both the timing and eventual details of the deal – the full pricing and terms have yet to be fully agreed, let alone announced – have played in China’s favor with Beijing securing the advantage in a deal that has much to benefit both countries.

What China Wants

For China the supply of up to 38 billion cubic meters of natural gas a year from 2018 onwards – assuming the pipelines and infrastructure are completed on time – will help meet a demand that is anticipated to reach 420 bn cubic meters by the end of the decade according to the Telegraph. The growth potential for natural gas in China is estimated to be double its GDP growth. Not only does the country have a lot of catching up to do, but it’s current energy sources are giving it severe problems.

“Gas accounts only for 4% of China’s primary energy consumption, 19 percentage points below the world average,” according to a Reuters article, while in the rest of Asia, the average is 20%, and even in coal-dominated India it is 8%. Gas accounts for just 2% of China’s power generation, compared with 75% from coal. And therein lies China’s challenge: to wean itself off coal for power generation and, at least in northern states, for heating.

Coal is Strangling China

Coal is literally killing China. Due to a well-meaning but, in hindsight, maybe unfortunate policy during the 1950-1980 period, Beijing established free winter heating of homes and offices mostly via district heating systems, but due to financial restraints this was limited to those 321 northern cities deemed to suffer the harshest winter weather. The dividing line is the old imperial boundary roughly following the 33rd parallel along the Qin Mountains and Huai River, and hence has become known as the Huai River Policy.

This free coal may have kept the northern states warm, but at a cost that is more than financial. As a result of this policy and burning coal for power generation life expectancy in the north is 5.5 years lower than in the south “almost entirely due to an increased incidence of cardio-respiratory mortality,” a joint US/China research team said, according to  Reuters. “Estimates suggest that the 500 million residents of Northern China during the ’90s experienced a loss of more than 2.5 billion life years owing to the Huai River policy,” they concluded.

Pollution due to coal power and heating sources is still a major problem in China and the provision of natural gas as a power source is seen as a key element in reducing what is becoming a source of considerable social dissatisfaction, potentially of unrest. Those living in Japan and the Pacific Northwestern US should also welcome a reduction in acid rain and pollution from the burning of coal in China.

What Russia Wants

For Russia, the deal gives Gazprom an alternative to Europe which is by far Russia’s largest export market but, to keep it in perspective, even at 38 bn cubic meters China will still only be 25% of the exports Russia makes to Europe. This leaves Russia still highly dependent on European demand as that region seeks to diversify its supplies to the Middle East and North Africa, develops domestic hydraulic fracking and even possibly the US if LNG exports are permitted in any volume.

For steel producers, the prospect of gas pipelines running thousands of kilometers from Siberia to meet up with the still underdeveloped but growing Chinese gas network must have them popping the champagne corks. The $55 bn pipeline construction cost is Gazprom’s responsibility and you can bet steel oligarchs are already lobbying the Kremlin for a buy Russia policy. Even if foreign suppliers don’t get a look, Russian mills’ attempt to meet the substantial demand will mean they can’t export as much steel as they currently do, boosting the prospects for European and North American mills who currently face competition from those supply sources.

Who Benefits Most

Likewise, Chinese mills will have a substantial domestic market opened up to them, as the country invests in developing its natural gas transmission network, widely acknowledged to be underdeveloped and in need of extensive investment. Combined with demand from the open cycle gas turbine sector, supplying the still-nascent but expanding fracking market and China’s steel mills could be gainfully employed domestically rather than causing mischief overseas. So, rather than see this deal as a negative development, heralding greater cooperation and alignment of interests between Moscow and Beijing, we should see it as a commercial deal with benefits not just for the two parties but for the wider community.


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