5 Popular Misconceptions about the Sino-Russian Gas Deal

The conclusion of a 30-year, 38 BCM/year Sino-Russian gas deal has gotten considerable attention in the media recently. Not surprisingly, much of the coverage – especially in the western media – was emotionally charged, given that Putin’s visit to China & the deal signing coincided with the unfolding crisis in Ukraine. There was no shortage of rhetoric about Putin “making Russia a resource appendage of China” for “good PR”, as if being a resource appendage of the West is so much better. The tirade of rhetoric against this deal reminds me of the type of propaganda we saw when China started boosting trade and investment in Africa. This post will address some of the biggest misconceptions being propagated in the western (& even Russian) mainstream media, and seek to draw conclusions based on facts, rather than anti-Chinese xenophobia. This is a lengthy post, so for those who are not interested in the details, the bold text will give you an adequate summary.

  1. Putin gave away gas at “bargain prices” for political PR

Highly doubtful, given that Gazprom got virtually everything it asked for during negotiations. The main obstacle that held up these negotiations for ten years was pricing; pricing consisted of two elements – starting price now and pricing formula going forward 30 years. CNPC wanted a starting price comparable to that of Turkmen gas exports to China – $9/MMBtu, whereas Gazprom wanted European-comparable prices, which generally hover between $10.5 and $13 per MMBtu. The finalized starting price is widely estimated to be $10.5/MMBtu. As for pricing formula, CNPC wanted a formula determined by coal prices, whereas Gazprom wanted, and ended up getting, a formula pegged to oil prices – which are obviously much higher than that of coal, especially in China. In addition to getting Europe-comparable prices and oil-based pricing formula, Gazprom also got Chinese financing for much of the upstream and pipeline infrastructure necessary to reach underdeveloped eastern Siberian gas fields, and bring that gas to China and the rest of Asia.

There are people who argue that Gazprom could have gotten higher Asian gas pricing (which fluctuates anywhere between $13 and $20+/MMBtu) by selling LNG to Japan and South Korea instead. Those who make such an argument ignore the logistical factors that make such an alternative unrealizable. First, to sell LNG you have to have the gas available in the first place. Western Siberian gas is mostly dedicated to Europe, and eastern Siberian gas still needs to be piped to the coast, and LNG terminals have to be built or expanded to liquefy the gas. If China is going to fund part of that construction, then it will undoubtedly require a land-based route going directly to China, since avoidance of vulnerable maritime routes is the primary advantage of Russian and Central Asian gas. Second, existing LNG capacities are inadequate for Russia to diversify to Asian markets. Sakhalin, even at its projected max capacity, will produce no more than 15 BCM/year. Moreover, those who argue that Yamal LNG is a viable alternative for Asia-bound exports should look at a map and see where the Yamal terminal is actually located. Finally, this deal with China does not rule out future deals with other Asian partners. In fact, unlocking eastern Siberian gas fields to the Asian market enables Gazprom to export to other partners such as Japan and South Korea, partners with less bargaining power relative to China.

In short, given Gazprom’s (and Russia’s) present circumstances, the pricing in this deal was likely the best they could have realistically gotten.

 

  1. This deal makes Russia a resource appendage of China

Such a statement is completely divorced from reality. Consider the following facts:

Russian gas exports to EU (as of 2013): ~161 BCM; to China: ~0 currently, 38 BCM starting 2018

Russian oil exports to EU (as of 2012): 3mm+ barrels/day; to China: ~0.49mm barrels/day

The painful reality for Russia is that it is a resource appendage of the West (and a rather hostile West I might add), NOT of China. The more painful reality for the Russians is that given its present comparative advantages, its primary exports will be natural resources, regardless of who its main trading partners are. So given that Russia is – at least in the short term – going to remain largely a resource appendage anyway, the most logical course of action for Russia would be to diversify and hedge its bets with as many trading partners as possible. This gas deal represents one of many in the diversification effort.

What a “coincidence” the western media hardly utters a word when Russia used to be an exclusive resource appendage of the West, but acts as if Russia will collapse if it diversifies to China and the rest of Asia.

 

  1. Russia needs this gas deal more than China does

Russia certainly had a sense of urgency, but it was a MUTUAL sense of urgency that finally propelled this deal to completion after ten years of arduous negotiations.

For Russia, there are far greater incentives to diversify to China than the short-term political fallout in Ukraine. One such incentive is European supplier diversification. Europe has traditionally been the cash-cow market for Russia, but this cash-cow is likely to produce diminishing profits in the near future. The emergence of US shale gas, as well as possible shale gas exploration and development in Eastern Europe provides the EU additional bargaining power to reduce Russian gas prices, if not reduce Russian gas volumes altogether. This will be the case REGARDLESS of whether the US decides to export shale gas. EVEN IF the US chooses not to export, it will still cease to be an import market for Canadian and Latin American gas, and those extra volumes and capacity will undoubtedly be looking for alternative markets, such as Europe. Given that Europe will inevitably diversify and provide diminishing returns, the most obvious choice for Russia is to also diversify and seek alternative markets.

China is the most logical alternative market, given that it also has an equal sense of urgency to complete this deal for two main reasons. First, air pollution has reached a critical level in China’s cities, largely as a result of excessive coal consumption. This is one of the rationales China’s doubling of natural gas as a proportion of its energy consumption (from 4-5% to 10% by 2020) under the 12th Five-year Plan. Russian gas helps China meet this target, while mitigating the need for China to develop its own shale gas reserves – which is a water-intensive option with great potential for environmental devastation. Second, land-based gas imports from Russia mitigate China’s dependence on vulnerable maritime transport routes in the South China Sea and the Indian Ocean, and would minimize supply disruptions in case of crisis. This gas deal could not have come at a better time for China, given increased tensions in the South and East China Seas.

  1. China agreed to too high a price for Russian gas?

Given that Gazprom got practically everything it bargained for, and China had an equal sense of urgency to get this deal through, does this mean China paid too high a price for Russian gas? A recent article on Guancha actually pondered this question, and the answer is a very straightforward “NO”. If China did not sign this deal, the other alternative would be to buy more expensive LNG through vulnerable maritime routes. So given the choice between buying $14-20/MMBtu gas, vulnerably shipped by sea, or $10.5-$13/MMBtu gas, safely piped by land – the choice is a no-brainer. Even taking into account previous long-term supply contracts, which brings the weighted average price of Chinese gas imports to around $10.8-10.9/MMBtu, $10.5 is still a more attractive price, given that China’s increasing demand would have pushed that average upwards, if it resorted to increasing LNG exports.

  1. This deal makes China “excessively” dependent on Russian gas

Not true at all; even after this deal is fully implemented around 2018, it will provide only about 1.5% of China’s annual primary energy consumption. The US EIA estimates China’s natural gas demand to reach 7.8 trillion cubic feet (or about 220.9 BCM) by 2020. Assuming a modest 4% annual demand increase, the average annual consumption for the subsequent five years would be around 248-250 BCM. 38 BCM will represent about 15% of China’s total natural gas consumption around the 2020-2025 time frame. Natural gas will account for approximately 10% of China’s total primary energy consumption by that time, so 15% of 10% amounts to a mere 1.5% dependency on Russian gas, which is hardly “excessive” by any standard, especially given that the alternatives are arguably far worse.

In sum, while neither side got their “ideal” bargain, this gas deal was the best possible outcome for both sides, for it satisfies the key objectives of both parties.

About Mister Unknown

At the age of 10, Mr. Unknown immigrated to the US from China with his parents. He has had an unusual combination of experiences ever since - a 4-year enlistment in the US Army after high school, and a business development job in Russia after college. These experiences prompted him to reexamine the political dogmas that are pervasive in modern western societies. Mr. Unknown completed a dual masters program in business and environmental science, and currently works at a tech company. He hopes to advance his career in China and/or the former USSR in the near future.

3 thoughts on “5 Popular Misconceptions about the Sino-Russian Gas Deal

  1. As always, what is not said is louder than what is said, with Western MSM. The spin generally casts Beijing and Moscow as something Dumb & Dumber type of losers, with Russia the bigger bonehead who has sold out to the Yellow Peril, if not the devil himself, with this gas deal that puts the cherry on the two-day flurry of agreements.

    However there is deafening silence from the main media rags over the ramifications of the tightening Russia-China partnership & the squeeze it puts on that wonderful 500-year heritage known as Western hegemony.

    It is an alliance in all but name; an unfinished flourish that gives Putin wriggle room for conciliation with Germany, the leading European state and, similarly, Asean is not forced into choices of us (China ) or them (USA).

    Now India’s bad boy Prime Minister Modi has decided that his first foreign trip will be the Brics summit in July. Russia is not isolated, as Obama claims, while Sino-Indian ties could enter a new era of pragmatism.
    The future of a multi-polar world has come sharper into focus.

  2. This is an excellent post.

    I however want to stress how the deal should be framed. Most of us – especially the West – frame this as a political/geopolitical issue. But I wonder if that is only a secondary issue as far as China is concerned.

    As this post makes wonderfully clear: geopolitics did not change China’s calculation of its best alternative to a negotiated deal (BATNA – a concept critical to understanding negotiations). The price China and Russia settled on eventually to be the upper point China is willing to pay. Similar with Russia, geopolitics may have pushed Russia to getting a deal this year, but it didn’t change its BATNA either. Ultimately both sides got a deal it is able to work with.

    I am surprised that geopolitics has played such a dominant role in the discussion of this deal instead of say environmental protection. China is really trying very hard to reduce its use of coal in a very big way. This is another important concrete step China is taking / has been taking in that direction.

    China has invested much in alternative (wind and solar) energy technologies. It is now investing/cooperating with Russia on developing gas fields – which is considered a much cleaner source of energy. This lays the the foundation for not just China – but also other parts of Asia – including Japan, Koreas, and South East Asia nations to tap into cleaner sources of Energy. The benefits will accrue to other parts of Asia even before Russia builds LNG facilities or other pipelines that spider off in other directions of Asia for it will reduce China’s need to import natural gas.

    This is really a win-win for the world … yet it is seen by some as some sort of subversive deal. Wow…

  3. This should, clinically, be a straightforward deal: China wants gas, at its price, and Russia has an abundance, on which it puts a different price tag. But, in the context of the current turbulence, the geo-political message looms large.
    Putin likely wants the agreement to signal that China is on Russia’s side in the Ukraine crisis – and, imo, President Xi is not discouraging the idea either.
    As for the pipeline to Japan, Shinzo Abe’s sanctions on Moscow and the Northern Islands dispute aren’t going to get in the way, in the long run. John McCain can call Russia a `gas station’ – but the operator sure wields a lot of clout.

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