13.10.2006
Neo-Con Plans and the Sober Reality
№4 2006 October/ December



 

Russian
neo-conservatives, presently intoxicated with an influx of
petrodollars, and obsessed with separating Russia from the natural
Euro-Atlantic vector of development, are moving from general
speculation to concrete ideas, which may have practical
implications. One of these ideas involves the expansion of Russia’s
energy cooperation with the youngest “Asian tigers” – China and
India.

 

Needless
to say, there is sound logic behind Russia’s interaction with Asian
countries in the energy sphere. Despite its unique energy
potential, Russia has yet to become a global supplier of energy
resources. Thus far it only plays a regional role: about 95 percent
of its crude oil and 100 percent of its natural gas is exported to
Greater Europe (including Turkey). The European energy market is
almost sated, whereas Russia has no presence on the U.S. or
Asia-Pacific energy markets.

 

For
Russian neo-cons, the idea of entering the energy markets of the
largest Asian powers – China and India – is cast almost as an
economic basis for a global geopolitical revolution: Russia will
restructure its energy supply system away from Europe, leaving it
with an acute energy shortage, while providing economic
underpinnings to the BRIC [a group of emerging world leaders –
Brazil, Russia, India and China] as a global geopolitical
alternative to the West. Sometimes such ideas are embraced not only
by diehard neo-cons, but also by some prominent economists (e.g.,
Mikhail Dmitriev, see p. 120 of this issue) who see Asian markets
as an alternative to Russia’s status as a “European energy
appendage.”

This
reasoning may be naïve, but the question is a potent one: What
is the outlook for Russia’s “economic breakthrough” in the
East?

 

CHINA

 

At first
glance, there are ample grounds for large-scale cooperation between
Russia and China. Russia is a stable net exporter of energy
resources, while China is emerging as a net importer of energy: by
2010, China’s net energy imports may reach an estimated 180 mln to
200 mln tons of oil and 20 bln to 25 bln cu m of natural gas.
Experts were especially impressed by the 2004 figures, when China’s
oil demand rose by 15.8 percent, gas by 19 percent, and coal by
14.6 percent. Many came to the conclusion that the growth trend
will continue and that China has a virtually unlimited potential as
an importer of energy resources.

 

But such a
conclusion would be hasty. Those in favor of greater energy exports
to China should ask: Why has this potential not been realized yet?
Could there be some natural obstacles obstructing such cooperation?
After all, despite its geographic proximity to Russia, China
imports most of its oil from the Middle East, Southeast Asia and
Western Africa (more than 80 percent of its total oil imports).
Meanwhile, China’s energy imports from Russia are negligible:
Russia exports about 15 mln tons of crude oil and petroleum
products to China annually, which is less than 5 percent of its
total exports. At the same time, Russia exports virtually no
natural gas or electricity to China. Why?

 

There are
three intractable problems that cast a dark shadow over the
apparently rosy prospects for a future Russian-Chinese energy
alliance.

 

First, China has traditionally prioritized
the development of its own energy capacity, and presently its only
serious energy shortage involves oil. However, an intergovernmental
agreement on oil supplies from Russia to China has just been signed
(by 2010, Russian oil exports to China are to hit 30 mln tons a
year). This is the only energy agreement between the two countries,
which is not surprising, not only because China heavily depends on
oil imports, but also because oil is a globally traded commodity:
producers (in this case, Russian oil-producing companies) can
always sell oil on any markets, which usually makes buyers
cooperative enough over price arrangements.

 

Concerning
natural gas and electrical power, the situation is fundamentally
different. One of the essential principles of the Chinese Communist
Party’s energy policy is reliance on national energy resources for
“security” considerations. For example, China has just implemented
a 4,000-km gas pipeline project (“West-East”) from the Tarim and
Changqing gas fields in the Xinjiang Province, with proven gas
reserves in the region at a mere 700 bln cu m, to the country’s
main gas consuming areas. At the same time, China refused to sign a
contract with Russia to import gas from the Kovykta deposit in the
Irkutsk Region, arguing that the gas reserves there are purportedly
insufficient (Kovykta’s proven gas reserves are 1.2 trillion cu
m).

 

So China
will continue to place great emphasis on developing its own gas
production and power-generating capacities. Furthermore, since it
has substantial reserves of coal and a large hydroelectric energy
potential, the country is in the position to develop
power-generating capacities that do not depend on gas imports.
China will not have a serious gas shortage in the foreseeable
future, while electricity supplies can be fulfilled in the medium
term.

 

Traditionally, Russia’s gas and power imports to China have
been impeded by price disputes. One key project (Kovykta), which
has the potential to become a main channel for the export of
natural gas from Russia to China, has been effectively frozen due
to price disagreements. The Chinese side has long time refused to
buy Russian gas for more than $30-$35 per 1,000 cu m at point of
delivery on the Russian-Chinese border, although the break-even
level for the Kovykta project is $75 to $120 per 1,000 cu m. China
said it was unreasonable for it to buy gas at prices above $40: at
this level, it would be cheaper to use its own coal as fuel at
electric power stations.

 

In July
2002, the Russian government issued a decree entrusting energy
giant Gazprom with coordinating negotiations on Russian gas exports
to East Asia. Four years have passed since then, but little
progress has been made on the price issue. Gazprom has proposed
various plans for organizing Russian gas exports to China
(deliveries from the Chayanda gas field in Yakutia, for example, or
building a bypass gas pipeline via North and South Korea), but all
of them have proved unviable.

 

Agreements
on gas and electricity supplies, which were signed amid great pomp
in March 2006 during a meeting between Vladimir Putin and Hu
Jintao, are but good intentions on possible delivery volumes. The
agreements make no provision for prices, which remain the main
stumbling block to any progress in this area.

 

The
situation in the power generation sector is equally difficult.
China clearly prioritizes the development of its domestic
generating capacities. By 2010, the aggregate capacity of China’s
power plants is expected to reach about 660 mln KW. To this end, in
the 2004-2010 period, more than 37 mln KW capacities are to be
brought on line each year: that is to say, annual growth in the
country’s generating capacities should average 7.8 percent. By
2025, an additional 171 GW of coal-fired generating capacities will
be built in China (at the start of 2001, such capacities generated
an aggregate of 232 GW). In this context, China’s demand for
electrical power imports from Russia can at best be only temporary.
Not surprisingly, the price issue has also stymied negotiations on
electricity exports from Russia: the Chinese side insists on a
price at or below the cost of energy generation.

 

Second, China’s estimated oil demand should
mislead no one: about one-half of the surging demand for oil in
China, as well as in other Asian countries, was caused by an
electricity shortage (the sluggish power sector usually lags behind
a rapidly growing economy), together with the massive use of diesel
generators. Obviously, the situation will not last forever, and
additional generating capacities (gas, coal or nuclear) will
eventually be built, so there is every reason to expect that
further economic growth in China and other Asian countries will not
be accompanied by an astronomical surge in oil demand. For example,
already in 2005, oil consumption in China rose by a mere 3.1
percent. Clearly, rising demand for coal and electricity will be
met mainly by developing national production capacities: China
accounts for 12.6 percent of the world’s coal reserves and is still
a net exporter of coal.

 

The
third problem involves the uneven economic
development of the Chinese regions. The surge in energy demand is
mainly observed in the industrially developed southeastern parts of
China where deliveries of Russian energy via network infrastructure
(pipelines, power transmission lines) are hindered by large
distances and high costs. These regions will meet their gas demand
mainly through the construction of liquefied natural gas (LNG)
terminals, while this gas will not come from Russia. Future
deliveries from Russia’s only LNG project, Sakhalin-2, have been
fully contracted for the next 20-25 years to Japan, the United
States, and Korea. Apart from Sakhalin-2, Russia is not planning to
further develop LNG production, and even the limited volumes that
may be produced in the Baltic region in a decade will most likely
be sold in Europe.

 

The fact
that China does not have any long-term problems with natural gas
and electricity supplies creates certain difficulties for Russian
exporters on the Chinese market over import prices, while the
availability of gas-substituting energy resources, which can be
used as fuel at electrical power stations (primarily coal), makes
China rather a tough market in terms of price
competition.

 

So the
outlook for energy cooperation between Russia and China is not as
positive as Russia’s policy-obsessed neo-cons suggest. The Chinese
market so far offers far lower delivery prices than Ukraine did
prior to 2005. As for Russian investment in China, it is treated
just as suspiciously as Chinese investment is in Russia: in
addition to the controversy surrounding the privatization of the
Russian oil company Slavneft, I would also like to mention that the
“Chinese factor” was the key factor in the introduction of
limitations on foreign direct investment in Russia’s natural
resources sector (the Law on Production Sharing
Agreements).

 

Incidentally, the first experience with Russian businesses on
China’s energy market – Gazprom’s participation in building a
West-East gas pipeline, and the involvement of Atomstroiexport
[Russia’s nuclear power equipment and service export monopoly] in
building the Tianwan nuclear power plant – has been far from
smooth. In the first instance, Gazprom lost its contract, whereas
in the second, delays in building the nuclear power plant and
providing supplies and equipment affected Russia’s image as a
country that can provide expeditious and good-quality construction
services.

 

INDIA

 

The
situation with India is even more complicated. On the one hand,
India’s dependence on the import of energy resources is also high
and will continue to grow. India itself produces very little oil
(about 40 mln tons a year), and oil production is likely to fall,
whereas demand for oil will grow rapidly, forcing India to import
about 200 mln tons of oil a year by 2020 and about 250 mln tons a
year by 2030 (at present it imports over 80 mln tons a year).
Today, India imports almost 70 percent of oil from the Middle East;
other imports come from Africa and Southeast Asia. As for natural
gas, its domestic production, which currently stands at about 30
bln cu m a year, is expected to rise substantially in the future,
primarily by developing Indian shelf deposits (up to 50 bln cu m by
2020 and 66 bln cu m by 2030), but this will not be enough to meet
its growing domestic demand for natural gas. In this context, net
import is expected to grow from almost zero to 28 bln cu m a year
by 2020 and 44 bln cu m by 2030. Gas will be imported mainly in
liquefied form: India has approved a plan to build 12 new LNG
terminals in the country (Russian companies are not involved in any
of these projects).

 

On the
other hand, there are objective circumstances impeding the
development of Russian-Indian trade in the energy sphere. These
are, above all, infrastructure limitations:

 

– the
continental transportation of oil and natural gas via new oil and
gas pipelines would be virtually impossible due to the
insurmountable physical and political difficulties. Regarding the
former, India and Russia are separated by impassable mountain
ranges; the latter consideration presents equally troubling
problems since sections where oil and gas pipelines could in theory
be built are areas of political and military instability or hotbeds
of unresolved conflicts – Afghanistan, Pakistan, the Caspian with
its unsettled legal status, etc.;

 

– the
limited competitiveness of oil shipments from Russia to India by
sea, compared with the export of Russian oil to Europe, given the
existing structure of Russia’s oil export terminals (problems with
the Suez Canal and the Bab el Mandeb Strait and a lack of capacity
to handle supertankers loaded down with over 200,000 tons at the
Russian ports of Novorossiisk, Tuapse, and Primorsk);
and

 

– Russia’s
lack of capacities to produce enough LNG to be transported by sea,
and the priority that Russian exporters give to other markets for
LNG that is to be produced in a number of new projects (Sakhaliln-2
and the Shtokman field).

 

India,
therefore, is one of the most hard-to-access markets for Russian
energy resources. It is difficult to imagine a sensible businessman
who, given so many opportunities of selling oil in Europe at a very
good profit, would want to risk transporting supplies through Suez
and Bab el Mandeb where he stands the possibility, at the very
least, of losing a lot of money due to tanker delays caused by jams
at these transport bottlenecks. Even if Russia expands oil exports
through Far Eastern ports, the transportation of oil to India will
be the least attractive prospect, compared with its shipment to
China, Japan, Korea and the West Coast of the United States, due to
traffic problems in the Strait of Malacca. So, infrastructure
limitations reduce the possibilities of expanding two-way trade in
energy resources between Russia and India to almost
zero.

 

Furthermore, India, like China, gives priority above all to
its own energy resources. The relatively low levels of oil and gas
consumption growth are mainly due to the availability of
substantial reserves of coal, which is a key source of electricity
production (81 percent, compared with 7 percent for gas and 4
percent for oil). India accounts for 10 percent of the world’s coal
reserves. Based on current production levels, the country has
enough coal for the next 220 years. According to some forecasts,
India could raise coal output from 364 mln tons a year in 2002 to
705 mln tons by 2030, which will make it possible to fully meet
domestic demand for coal.

 

Geopoliticians of course know better: give them a fulcrum, and
they will build a gas pipeline across the Pamir and Hindu Kush. It
is clear, however, that in economic terms, the Chinese and Indian
markets hold little appeal to Russia.

 

EUROPE

 

All of
this only goes to show that in the case of Russia’s energy
strategy, the saying “old friends are best” is highly relevant and
has a very strong pragmatic subtext. Europe is the closest and most
lucrative energy market for Russia. There is a diversified
transport infrastructure for the delivery of Russian energy
resources to Europe (3,000 to 4,000 km, as compared to at least
5,000 to 6,000 km in Asia). Price-wise, this market has always been
the most profitable (concerning oil and LNG, only the U.S. market
is more attractive). While Russia uses European prices as a basis
for making its quasi-market price demands to the post-Soviet
countries, China proposes a price for natural gas that is 60
percent below what Ukraine currently pays for Russian gas.
Throughout the years, Europe has been generously reimbursing us for
our oil and natural gas, and these profits have given us a modicum
of prosperity. Now, Europe is ready to increase the import of
energy resources from Russia in the future on terms that are highly
favorable for Russia.

 

It is true
that there is a certain measure of misunderstanding between Russian
and European politicians. But when you get down to brass tacks,
this has little influence over commercial relations between Russian
and European companies. These relations are developing very, very
successfully, while Russian energy supplies to Europe continue to
grow. Last year, the volume of Russian oil and natural gas
deliveries to the European market hit a record 400 mln tons in oil
equivalent, or one-third of the oil and gas consumption in the
EU-25. Fortunately, the differences between politicians over the
Energy Charter and other virtual things have not as yet transformed
into real bilateral problems.

 

* *
*

 

So, is it
necessary for Russia to turn away from its natural lucrative
partner and – to use a Chinese metaphor – try to catch a black cat
in a dark room where there is no cat? When several years ago, some
people – this author included – called for diversification of
Russian energy exports, we meant something entirely different: the
European market does not provide growth opportunities. Due to the
energy-efficient character of the European economy, there is almost
no growth in energy demand. So if Russia wants to increase its
energy exports (and if it is able to increase them, since the
economic course of the past few years casts doubt on this), it will
simply have to enter new markets.

 

This
applies above all to the United States and Japan, no matter how
blasphemous this might sound to the architects of Russia’s new
geopolitical doctrine. This is where the terms for energy sales are
the best. Exports to China and India may also hold some potential –
or they may not, depending on the situation. Objective economic
interests in this case could happily coincide with Russia’s natural
Euro-Atlantic vector of development.