Power of Siberia Pipeline Strengthens Russia-China Ties

In early December China received its first delivery of Russian natural gas through the Power of Siberia pipeline. The new pipeline crosses 1800 miles of Siberian wilderness from the Arctic to the Chinese border, and is vitally important to both countries. For Russia, the pipeline will be a source of much needed foreign revenue, and a counter to US and European economic sanctions that followed its annexation of Crimea in 2014. China, for its part, gains a new alternative to imports of liquefied natural gas, and improved energy security.

Beyond Power of Siberia’s energy and economic benefits, much has been made its political implications. The pipeline is the latest example of deepening ties between China and Russia at a time when both countries have been at odds with another key player in the global energy market, the United States. 

Kleinman Center Senior Fellows Anna Mikulska and Bill Hederman take a look at what Power of Siberia may reveal about a shift in the global energy market, and the geopolitical influence of key players in that market.

Full Transcript

Andy Stone: In early December, China received its first delivery of Russian natural gas through the Power of Siberia Pipeline. The new pipeline crosses 1,800 miles of Siberian wilderness from the Arctic to the Chinese border, and is vitally important to both countries. For Russia, the pipeline will be a source of much needed foreign revenue, and a counter to U.S. and European economic sanctions that followed its annexation of Crimea in 2014. China, for its part, gains a new alternative to imports of liquefied natural gas and improved energy security.

Beyond Power of Siberia’s energy and economic benefits, much has been made of its political implications. The pipeline is the latest example of deepening ties between China and Russia at a time when both countries have been at odds with another key player in the energy market, the United States. On today’s podcast, we’ll take a look at what Power of Siberia may reveal about a shift in the global energy market, and about the political influence of key players in that market. Today’s guests are Anna Mikulska, a senior fellow here at the Kleinman Center, and a non-resident fellow in energy studies at Rice University’s Baker Institute. Bill Hederman is also a senior fellow at the Kleinman Center, and a former senior advisor within the U.S. Department of Energy. Anna and Bill, welcome back to the podcast.

Bill Hederman: Nice to be here, Andy.

Anna Mikulska: Thank you for having us.

Stone: So Anna, to get us started out, could you tell us about Power of Siberia? How much gas will it deliver, and at what price?

Mikulska: So the Power of Siberia Pipeline is supposed to deliver approximately 38 BCMs to China. So comparing it to current imports or 2018 imports, in 2018 China imported 200 BCMs. So that’s quite a lot, quite a lot of capacity that a pipeline will support. Now going forward, China will increase those imports, so it will become slightly less in terms of the portion of the imports in total. But it is significant. Now the pricing is also very interesting because, first of all, it’s indexed on oil, so depending on oil pricing, the prices of that gas that’s going to be sent are going to be lower or higher. At the time that it was negotiated in 2014, the prices were around $100, so which would come to around nine to ten per billion BTUs, dollars. Which was lower than in Europe, lower than LNG.

So it kind of shows that at this moment China was able to negotiate a very, very favorable pricing for the gas that was supposed to be coming. Now as the time went, the oil prices went down to 30 and so on. So these prices of natural gas plummeted, and it was almost of — it was a concern for gas coming from Russia, that they won’t be able to deliver it at that price that they contracted. But now the price, as the prices have recovered, I think Russia is just fine with what they’ll be getting at at this moment.

Stone: It’s interesting, so it’s about 20% of China’s demand for imported gas is actually going to be served through this pipeline. Quite significant.

Mikulska: Current demand. So when you look going into the future, into 2030, it’s estimated that China will need between 170-340 BCMs of gas.

Stone: So Bill, who operates the pipeline and who’s paying for it?

Hederman: So Gazprom operates at — China as the customer is paying for essentially, Gazprom’s a very highly technically capable gas company. And they learned how to build to western standards when they were serving Western Europe. So there shouldn’t be any concerns about operational risk issues on this, and of course the buyer pays for the gas when you put in a pipeline.

Stone: So Anna, let me ask you this. So Power of Siberia had been in the works for quite some time before Russia and China finally agreed to sign a deal in 2014. Why the delay, and what eventually pushed the deal through?

Mikulska: So yes, it’s been around a decade that the countries have been looking into putting in a natural gas pipeline. But it wasn’t until 2014 that this kind of plans crystallized and materialized. Several things. China has seen an opportunity. At the time it was definitely driven at the time by China, which saw opportunity with Russia being — Russian position globally being weakened due to sanctions that U.S. and Europe imposed after the Ukraine — Russia invaded Ukraine in 2014.

So China saw an opportunity here and saw an ability of negotiating power, and strength. And that’s why it was willing to negotiate at that time. But also China’s position has changed quite substantially. It has definitely become increasingly natural gas dependent, and it has seen, for various reasons including economic but also environmental, that natural gas is going — the natural gas demand is going to increase going forward. While the domestic resources are not enough and they are not developed enough.

And at the same time, developing them would be less cost effective than bringing them in from somewhere else. LNG supplies have also expanded at that time, and China has been using those LNG supplies as one of their — one of the places where natural gas would come. But it’s — China is looking at this as a much bigger kind of general strategy, where diversification of natural gas supply is a key. So one thing that China doesn’t want to do, and — is to get dependent on one specific supplier.

At the time when now in 2014 we see LNG coming in from Qatar, Australia, you know, U.S. also, where China has already gotten contracts with Turkmenistan, potentially later with Myanmar, bringing in natural gas, Russia has become one — yet one another way of diversifying Chinese supply of natural gas, of Chinese imports from natural gas, and making the country more energy secure.

Stone: Now about — Anna, about 75% of Russia’s gas exports actually end up in Europe. And the pipeline offers Russia a possibility to diversify away from that European market, or be less dependent. Why is that important in this day and age?

Mikulska: So yes and no in terms of diversification away from Europe. Russia seems Europe as a very important market, and it wouldn’t be putting a lot of effort, a lot of money, a lot of resources into pipelines such as Nord Stream 1 and 2 now, and Turkey Stream, and wouldn’t be fighting it for so much if it didn’t see Europe as a very important market going forward. However, the geopolitical relationships have been strained recently, because of Russia’s invasion in Ukraine, the European sanctions towards Russia, and also because there is an additional alternative supply that’s coming in not only to Western Europe but also to Eastern Europe via LNG shipments.

So in order to have an ability to diversity its exports, Russia has looked into China. Now, when it started negotiating the Power of Siberia Pipeline, Russia really hoped that it would deliver from its Western Siberia or Altai region. And part of it was, it’s because this is the same region where Russia is bringing in natural gas to Europe. So in a way it would have this arbitrage opportunity, where it could kind of, you know, look between Europe and China and kind of set them both apart and say, “Well, who pays more for my gas?” Or, “Well,” — you know, even geopolitically say, “Well, we’re not going to ship to you. We would just divert our shipments to China, or the other way around.” You can kind of imagine that China didn’t — wasn’t really very happy with this kind of idea.

Also, it already has a pipeline developed from Turkmenistan to deliver to where Russia would deliver to from the Western Siberia region. So negotiating from the position of power, China was able to push for this Power of Siberia to go from Eastern Siberia to Northeast China, to China’s populace demand center. But also Eastern Siberia is basically a market dedicating to China now. There is no other places that Russia could deliver from those resources. So the arbitrage opportunity between Europe and China is not directly there.

Stone: It’s very interesting that China had that power and that negotiation to dictate which source that gas was going to come from, from within Russia.

Hederman: Yeah, I think it’s really important, Andy, on the European side it’s not a purely commercial venture for Russia either. It’s important for a source of funds, but it’s also important as a threat over Western Europe, that they have that supply there. And in my opinion, the former German leader, former Chancellor Schroder who is the CEO of Nord Stream organization just shamelessly was bought out by Russia and helped create this way to lock out Ukraine from the transactions, which of course is important to Russia at this point.

They don’t want Ukraine having any power of transit of their gas. But Western Europe was pretty united in their response of going along with the sanctions related to Crimean invasion. But this — and so I think that’s what gave China a lot of leverage too. Russia was desperate for a deal at that point. And now, interestingly the Nord Stream 2 should be shipping gas in a few weeks as well.

Stone: And Nord Stream 2 went ahead despite all of these sanctions?

Hederman: Yes.

Stone: So Bill, let me ask you about China’s growing demand for gas for a moment, and how the pipeline fits into its gas picture more fully.

Hederman: So China has had domestic natural gas, and it’s during even the nineties they were very aggressively trying to develop coal bed methane. And they just never were able to get their gas supplies to be large enough, and cheaply enough to make economic sense for them. But as Anna mentioned, as coal was growing extremely rapidly, the environmental consequences were coming home to roost. And even in Beijing people were alarmed about the air pollution problems, and they realized that this was not good for their country.

So the idea that they could shift to gas, which was a lot cleaner, and also as part of their complying with their promises at the Paris Agreement, it was a way to basically cut the emissions for the same amount of electricity production in half. It was a win for them in a number of dimensions. And so when they found themselves in a position to be able to negotiate the price as well, and one of my old, my main natural gas expert, when Russia and China signed the deal for roughly nine dollars a billion BTUs —

Stone: For this pipeline?

Hederman: For this pipeline, for delivery. He pulled out a piece of paper and worked forward from the Henry Hub price at the time, and he came up with a price within a dollar of the negotiated price. And I think Russia felt getting the index including oil prices was going to be something to ultimately jack up the prices, but so far it hasn’t worked.

Stone: So the opening of the Power of Siberia Pipeline, Bill, has been interpreted as a sign of growing alignment between Russia and Chinese interests. Can you explain that?

Hederman: Well, President Putin actually said that in the opening ceremonies, that this is a ratcheting up of this strategic alliance between Russia and China. And I didn’t hear China affirming that in response, but that is certainly — any transaction of this size builds connections and interdependency, and so that’s going to build their relationship. They had some major joint military exercises after this deal was cut, both on land and naval. And those are things that are not good news for the Western alliance, and — but I think what’s going to be interesting is Russia may still have a vision of being the senior partner in the relationship, and I think they will learn that that’s not true.

Stone: Well, it sounds like the negotiations over the pricing and where this gas was going to be sourced from, China definitely flexed its muscle.

Hederman: Exactly.

Stone: I want to ask you this question. This pipeline was in the works long before the current trade dispute between the United States and China, and before the whole issue of Crimea ever came to the stage. Could we be overplaying the political impact of this pipeline? Again, it was going to get built anyways, Bill.

Hederman: Well, we always give more attention to the current news than to the historical perspective, right? So yeah, there’s an element to that here. Does steel make sense for commercial reasons? I don’t think that the deal in any way would hinder China working closely with the U.S. when they see it in their interests. Frankly, right now China doesn’t want to bet on their deals with the U.S., and who can blame them.

Stone: Well, U.S. LNG has been pretty much cut out of the Chinese market, is that right?

Hederman: Well, the pricing is not competitive. So the only reason to do it is to build the connective tissue that you could.

Stone: Well, China has levied an import duty on U.S. LNG?

Hederman: Correct, yes. There’s the response tariffs. I don’t know how they’re treated in the recent renegotiation of the tariffs. I haven’t seen anyone mention them specifically. But yeah, it’s a cost forward pricing basis. It’s already non-competitive. So another 25% really makes it out — puts it out of reach.

Stone: And this would make less demand for U.S. gas I would imagine in the future amongst all the options.

Hederman: It’s a global market, and I don’t see that as really material ultimately.

Stone: You know, Anna, Bill mentioned a few minutes ago this idea that the pipeline has been portrayed as a deal among equals. What’s your view on that?

Mikulska: I mean, it’s — as I mentioned before, China was negotiating from the stronger position. Precisely in 2014. And it really — China was what moved the needle on that deal. China’s willingness to start and to commit. Also when you look at the — when you look at the deal was constructed, it was — the pipeline was supposed to start delivering between 2019 and 2021, depending on really what China needed. So we’ve seen as we moved towards 2019, that China needs quite a lot of gas. And you see that the needs of China really pushed that, the pipeline, to start delivering in 2019.

So you see that China’s needs are really kind of dictating the terms of engagement and so on. Although as pricing of the — you know, of oil recovered a little bit, and by that from the thirties to seventies or sixties now, it helps Russia. Also the fact that China has been having issues with U.S. and trading with U.S., kind of encourages China to look more towards Russia for potentially added supply. There is the concern that from China, that potentially U.S. Navy could block some of LNG imports, whether they’re coming from U.S. or not.

So there is additional kind of risk that, you know, any type of increased conflict between U.S. and China will indicate. So you see that there is this kind of move towards Russia from China on that field. And it’s not only with this project. China has been involved in Russian energy projects actually since earlier 2000’s. It has supported Rosneft in buying Yukos in 2005, and then was financing Rosneft’s building of Siberian Pacific Ocean Pipeline, oil pipeline. And when the sanctions were imposed on Russia, and when financing was not available for arctic LNG projects, that’s when China stepped in.

So now actually Chinese companies own almost 30% of the Yamal project, LNG project, and 20% of the Arctic LNG too that’s being developed. And they are highly engaged in financing both of those projects. So we were talking about increased collaboration, that it has definitely been — we’ve seen it on the military front, like Vostok 2018, I think the military exercise, a couple of military exercises. And definitely we’ve seen it in the energy market, in energy policy and energy infrastructure building and financing. And that’s part of the reason — part of the reason for it has been kind of the disagreement between Russia and the West, be it Europe or the U.S.

Stone: So it sounds like in any — when there’s a vacuum created in terms of foreign capital, from the West, or from Western European, United States, etcetera, that might flow into Russia, it sounds like the Chinese have been very happy to come in and fill that void.

Mikulska: Yes, that’s exactly it. And part of this Silk Road project that China is kind of trying to implement, it’s really kind of focusing on the Arctic, that Silk Road on ice. So we’ve seen that kind of —

Hederman: It sounds like a Disney show.

Mikulska: Right. [LAUGHING]

Stone: It does. So let me ask you this, Bill, for a moment. So what larger opportunity does China actually see in Russia? It’s obviously investing heavily. What other opportunities is it looking for?

Hederman: Well, I think through the Paris Agreement, China was envisioning working with the United States as a partner moving forward, and then the election kind of threw a monkey wrench in that. So now they can deal with Russia on a peer to peer basis, and that’s good for China’s self — it’s vision of itself, and it’s also a value to Russia right now. So it’s a win-win for them, and they have their communist legacies that they share. So they have much in common in the way that they try to do things.

But I think ultimately — you mentioned the Arctic. The Arctic is a place where China, as a non-Arctic nation, has exhibited a lot of interest. That’s the place with the most resources that have been untouched, and with the change in the ice cover on the Arctic Ocean there’s going to be more openings there. And Russia tends to have fairly advanced Arctic deep cold technology. And if China can finance activity up there, they’ll have another win-win situation. I also expect that the Arctic Ocean will provide a trade path that will be a much shorter route for cargo ships, etcetera. And Russia has the icebreaker fleet to keep that open as things warm up a little more.

Stone: So Chinese investment in that area gives them a more secure foothold in the Arctic as well it sounds like.

Hederman: Yes, yes. And they — so there is a group known as the Arctic Council, and it’s literally every country who has shoreline facing the Arctic Ocean. But there are several observers, and China has become one of those observers.

Stone: Anna, you know, earlier we spoke — alluded to the fact that obviously China has a strained relationship with the United States at this point. There’s been some positive developments recently, but does the pipeline change the dynamics of the U.S.-China trade conflict more broadly?

Mikulska: I don’t think so really. It’s — the pipeline has been in the making before the trade issues that U.S. and China have been experiencing currently. It provides China with diversity of supply. But then again, U.S. LNG wouldn’t be the only one LNG, or natural gas source where China would depend on it. So as Bill has mentioned, it is — has become a very much globalized market. Very different than it used to be. And you kind of — it’s the supplies, be it contract or by — on spot basis, are there, and countries can access that.

U.S. LNG is — even contracts with the U.S. providers are really interesting and kind of desirable ones, because often they do not include installation [?] clause. [00:23:40] So in that way, Chinese companies possibly would see an interest of having those contracts. Because it doesn’t mean — so when they buy it, they are free on board, they can deliver it to whichever area they want. They don’t necessarily have to bring it in to —

Stone: It’s not necessarily bound to one destination.

Mikulska: Right, exactly. So it gives a lot of flexibility, helps companies. With the conflict between China and U.S. and potential of tariffs, they will be wary of doing this because they don’t know whether they can resell that LNG or on a spot to somebody else.

Stone: Are U.S. gas producers feeling any pain from basically being locked out from the Chinese market, de facto, at this point?

Mikulska: No, I think that’s what Bill was alluding to. It’s a very much globalized market, you will see displacement basically of resources. So you will see more Australian LNG or Qatarian LNG or Russian LNG coming into China. But then as — because that LNG will go to China, it won’t go somewhere else in Asia or Europe or so on. So you will see the market kind of — there is going to be — going forward, while now we see relatively big supply compared to the demand, and you see prices somewhat lower than they used to be, going forward the prediction is their supply is going to be quite larger and the demand — the demand is going to be quite larger, and the supply will kind of be — can be placed depending on the needs.

Stone: Anna and Bill, thanks for talking.

Mikulska: Thanks for having us.

Hederman: You’re very welcome.