The 2009 Sino-Russian Gas Deals: Cementing a Strategic Partnership?

The pressures of the financial and economic crisis have lead to a slump in Europe’s natural gas demand. This has caused a sizeable reduction in Russian gas imports – up to 50 billion cubic meters (bcm) in Western Europe alone – with Germany’s and Italy’s purchase reduction rates (44% and 34% respectively) being responsible for nearly half that drop. The loss in exports is significantly affecting Gazprom’s balance sheet and in conjunction with reduced Russian domestic consumption leading to excess capacity, forcing the gas major to reconsider its export dependency on the European gas market.

Unsurprisingly, the Russian gas monopoly has lately turned its attention towards the major emerging natural gas consumer China, as Prime Minister Putin’s 2008 visit to Beijing brought forth another round of negotiations on a long-awaited gas deal. Besides the conclusion of numerous commercial deals worth up to $3.5 billion signed between Russian and Chinese companies, Gazprom and China National Petroleum Corporation (CNPC) agreed to a strategic framework agreement on gas supplies, which would open the way for Russia to supply up to 70 bcm per annum by 2014-2015 through two new pipelines.

The first, known as the Altai pipeline, would cost roughly $10 billion and provide up to 30 bcm of Yamal gas running 6,700 km from Russia’s Altai region to Xinjiang where it would connect to China’s West-East pipeline. The second, using gas from Sakhalin or the Kovykta field would have a capacity of 40 bcm and would run from Eastern Siberia to Beijing.

This gas agreement would cement an increasingly important relationship between Russia, the largest energy exporter, and China, the largest energy consumer behind the United States. With the Russian Federation being as abundant in natural resources as the People’s Republic in cheap labor and manufacturing, there is indeed a vast complementary between both actors.

However, despite the actual benefits a closer Russian-China energy relationship might bring as well as the positive rhetoric surrounding the latest framework agreement signed on 13 October 2009, one should treat this so-called protocol of intentions with some skepticism as it represents a mere continuation of a discussion that has been running since early 2004. Commercial negotiations were already supposed to finish back in 2005 with deliveries destined to reach China in 2008 but disagreements on pricing, with China insisting on $70 per thousand cubic meters (mcm) and drawing comparisons to the discount prices offered by Russia to post-Soviet states such as Ukraine and Belarus, broke down efforts to clinch a deal. In March 2006 another preliminary agreement was drafted – this time for 68 bcm by 2011 – which faced similar obstacles as China obstinately refused to pay more than $100/mcm.

Consequently, the numerous memoranda of understanding and framework agreements have so far struggled to turn themselves into viable commercial contracts. While Moscow wishes to set the export price in accordance with the European pricing formula, which is linked to the oil price, Beijing insists that the gas price should be either fixed or linked to the local price for coal since Russian natural gas supplies would substitute coal in power generation.

The current economic dynamics, particularly in the oil and natural gas markets, are however increasing the chances of Moscow and Beijing actually striking an agreement. This is due to four fundamental factors.