Putin Sees China as a Gas-Hungry Ally

Russian President Vladimir Putin and Chinese President Xi Jinping are likely to find they have more in common than ever as they meet this week, starting today in Shanghai for a Sino-Russian summit and later in St. Petersburg for an economic forum. Both men are coming under sharp criticism from the West: Putin for his annexation of Crimea and Xi for his forays into the contested waters of the South China Sea. For all the fascinating and potentially consequential strategic conversations that may take place between these two men, the one to look out for will be whether they conclude a much-delayed energy deal to pipe huge amounts of Russian natural gas to China starting in 2018.

The two countries have been discussing such a deal for years, and continued today in Shanghai. To outsiders, the energy marriage of the one of the world’s largest producers to one of the world’s largest consumers seems obvious and inevitable. But several issues have kept the two sides from consummation. Most tangible has been the issue of price; China has resisted Russian desires to charge prices comparable to those it gets in Europe, arguing that the benchmark for Russian gas should be the lower rate that China pays for gas piped in from Turkmenistan. Russia has objected, not wanting to signal to Europe — where its long-term contracts are already under pressure — that it is willing to give anyone a discount. This pricing dispute has been compounded by historical mistrust, suspicion over each other’s intentions in Central Asia, and wrangling over the optimal route.

Times have changed, however. As Morena Skalamera, a fellow in myGeopolitics of Energy Project at Harvard, details in an excellent new brief, domestic and international circumstances are upping the odds for the deal to be closed soon. Russia is worried about its European gas market, seeing lackluster European demand and political efforts — intensified since the Ukrainian crisis — to diversify away from Russian gas constraining future sales to the West. At the same time, the shale gas phenomenon, with possible U.S. and Canadian liquid natural gas exports to come, has Moscow concerned about what prices it can hope to attain from the European market. Developing new, potentially lucrative markets in the east seems to be the answer to Russia’s European gas concerns.

China also feels a new impetus for a deal. Despite a slowing of the domestic economy, future demand for energy — the key to both growth and political stability — will be robust. Efforts to develop China’s domestic shale resources are promising, but are unlikely to produce consequential volumes until the next decade. And then there is China’s epic air pollution from coal and other sources, which in the last year has vaulted to the forefront of domestic politics and spurred new ambitions to gasify the economy. Meeting some of this thirst through Russian gas — cheaper than LNG purchased on the Asian market and conveniently piped close to the energy-hungry northeastern provinces — seems ideal. Other factors, such as pressures to lift price controls on natural gas in China, are also making the Russian gas deal feasible when it hasn’t been in the past.

While the final details are still shrouded in secrecy, the general parameters of any gas deal seem apparent. Experts predict that, if the deal is finalized soon, the final price will be close to $10 to $11 per million British thermal units, which is higher than what China is believed to pay Turkmenistan. There is a serious possibility of a Chinese upfront payment of tens of billions of dollars to help Russia pay for infrastructure and other development costs. A big question is whether Russia finally yields to China’s long-standing desire to be allowed to make equity investments in the Russian upstream energy sector. All in all, some estimate the total price tag to be upward of $400 billion.

At the end of the day, whether a deal is inked in the next week or so is really up to China. Not only is Russia ready to sign, but its window is rapidly closing. Large quantities of LNG will flow to Asia beginning next year, as Australia brings more gas online and then the U.S. begins to export. Chinese efforts to develop its own shale plod along, although could be subject to a real boost if price liberalization quickens and smaller companies are allowed more leeway to develop the resources. Time is not on Russia’s side.

What are the global ramifications of a deal? In terms of gas markets, they may be less significant than first meets the eye. Russia has already conceded on its long-held preference for a pipeline route through Altai Mountains, which would have allowed it to divert gas currently earmarked for European markets to head instead to Chinese ones, thereby dramatically weakening the “mutual dependence” argument that provides Europeans some confidence that Russia will not terminate gas sales for political objectives. (Beijing objected to the Altai pipeline as it would have entered in northwestern China, far from the growing population centers of the northeast; the alternate route will depend on the development of new gas fields in eastern Siberia.) And, even as big as this deal would be — 38 billion cubic meters a year to start, with possible expansion to 61 bcm — it would hardly sate Chinese gas demand in the years ahead.

One possible broader effect, however, is that by removing some of the Chinese demand from the Asian LNG market, the deal would place downward pressure on expensive Asian gas prices at the margin. Perhaps counter-intuitively, the finalization of a Sino-Russian gas pipeline may actually make the prospect of Russian LNG projects to Asia more likely. Because such projects rely on the development of expensive fields, guaranteed Chinese demand makes them more economically viable.

For the rest of the world, perhaps, the real question surrounding any gas deal is to what extent it will push Russian-Chinese cooperation beyond energy. Undoubtedly, any deal will add to the global perception that momentum is on the side of powers challenging the Western alliance. Putin has clearly decided to actively take on the international order as it now exists, while Xi may have similar ambitions but a less urgent timeline. An energy deal may well be accompanied by reaching common ground around broader cooperation between Beijing and Moscow in the Far East and Central Asia. While the U.S. and its allies have nothing to fear from a Russian pipeline delivering gas to China, it is these broader understandings to challenge the way the world works today which should give them pause.