Why Russia Isn't Abandoning Europe for Chinese Gas Revenue

Much has been made of the agreement signed by Moscow and Beijing to get gas flowing from western Siberia to China. There is talk of Russia using the deal to offset its isolation from the west and circumventing the sanctions imposed over the Ukraine crisis.
Why Russia Isn't Abandoning Europe for Chinese Gas Revenue
Russian Prime Minister Dmitry Medvedev (2L) accompanied by Dmitry Pumpyansky (L) head of TMK, Russia's largest maker of steel pipes for the oil and gas industry, visit the Seversky Tube Works in the town of Polevskoy, outside Yekaterinburg, Urals, on Oct. 24, 2014. (Ivan Sekretarev/AFP/Getty Images)

Much has been made of the agreement signed by Moscow and Beijing to get gas flowing from western Siberia to China. There is talk of Russia using the deal to offset its isolation from the west and circumventing the sanctions imposed over the Ukraine crisis.

But this deal is a preliminary gas-supply agreement that's been a long time in the making. It is not something that has suddenly come about since falling out with the West over the Ukraine crisis, nor can Russia simply offset sales to Europe with sales to China.

Just as Russia's state symbol depicts a double-headed eagle that looks both west and east, so its energy strategy has long sought to develop an eastern pivot to create new markets in Asia to balance trade with Europe. The Russian government's energy strategy predicts a substantial eastern swing over coming decades, with the share of oil exports going to the Asia-Pacific region rising from 12% now to 23% in 2035, and gas imports increasing from 6% today to 31.5% by 2035.

Looking Eastward

Russia's plans to develop gas exports to Asia are enshrined in Gazprom's 2007 Eastern Gas Programme. Granted, little progress was made until the US$400 billion pact reached in May 2014, but these long-held plans underwrote the process. An agreement was made to deliver gas from new fields in eastern Siberia and the Far East to northeast China, a region not currently reached by imports of liquefied natural gas (LNG).

But this is not without its problems. Gazprom's programme also envisages continuing the pipeline to deliver gas to a planned LNG plant at Vladivostok. This extension, however, is now looking doubtful because of the impact of Western sanctions on potential investors and buyers and the prospect of a second deal to deliver a further 30 billion cubic metres (bcm) of pipeline gas from fields in western Siberia via the so-called western or Altai route. There are also ongoing misunderstandings over who is paying for the costs of developing the pipeline, even though Gazprom has started building it.

In terms of the second deal that has just been celebrated at the APEC summit, this is a preliminary arrangement – really an agreement to agree on a firm contract down the line. The Russian government expects to firm up the all-important details in the first half of next year. The final price has yet to be agreed, but China will want a lower one than initially agreed, as the imported gas will have to travel some distance within China to find centres of demand.

It has taken a decade of negotiations to get to the stage where Russia appears to be in the position to seal the deal on the export of 68 bcm. The feed gas for the second pipeline will come from West Siberia and will be easier to develop than the new production for the eastern route. Taken together, the two deals will make China by far the most significant importer of Russian gas, surpassing Germany, which is currently the most important market, bringing in just under 40 bcm in 2013.

In the context of current events in Ukraine and Europe's determination to limit its future dependence on Russian gas imports, it is easy to see the current deals as a movement away from Europe to Asia. But this is a rather simplistic interpretation when this eastern pivot has long been a goal of Russian energy strategy.

Europe is Still Crucial

Despite this eastern pivot, Gazprom will not want to see a significant decline in its gas exports to Europe. According to Gazprom's financial report, in 2013 exports to Europe accounted for 58% of its revenue. It is true that Gazprom has been losing market share in Europe, but it has been increasingly flexible and sales rebounded in 2013.

So, even before the crisis in Ukraine began, it was clear that Europe doesn't present a growth opportunity for Gazprom. European gas demand is stagnant at best and likely to decline in the face of aggressive climate change policies and growing concerns about security of supply.

That said, European companies remain contractually committed to importing gas from Russia. This is pointed out by the the Oxford Institute for Energy Studies in a recent study. It shows that "up to the mid-2020s, European companies are contractually obliged to import at least 115 bcm/year of Russian gas (approximately 75% of the 2013 import level), a figure which reduces to around 65 bcm by 2030". Their modelling also suggests that Europe may need as much as 100 bcm of Russian gas into the 2030s.

The final factor to consider is the profitability of these new deals to Gazprom and the Russian state. Most commentators suggest that the price agreed, particularly if oil prices remain low, will only provide a modest return. This means that maintaining revenues from European exports will remain important for Gazprom's balance sheet and the government's coffers; especially as income from oil exports is likely to start to fall in the 2020s.

Future Growth

Given that all energy projections show that future demand will be concentrated in the Asia Pacific region, it is no surprise that Russia, along everyone in the global LNG industry, sees the region as the locus of future demand growth.

Just how much gas China will consume in the future and how much will be imported remains uncertain. China has already secured significant pipeline imports from Central Asia and Myanmar and has rapidly expanded its LNG import capacity. It also has ambitious, but so far frustrated, plans to develop its substantial shale gas reserves. Russian pipeline exports will not scale up until the early 2020s, but they will potentially impact on China's appetite for additional LNG supplies now and may serve to establish a benchmark price for new gas supplies in China.

There is no doubting the strategic significance of Russia being able to demonstrate its ability to reorient energy exports away from Europe to new markets in Asia. But these deals have been a long time in the making and some important issues still remain unresolved. Putin would like to be able to threaten to divert Europe's gas to Asia, but the reality is that Russia needs to swing both ways and cannot afford to turn its back on Europe.

Michael Bradshaw receives funding from the UK Energy Research Centre (UKERC). This article was originally published on The Conversation. Read the original article.