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Western conflict with Russia could seal China gas supply deal

Western threats against Russian energy give China the perfect chance to seal a long-term gas supply deal on good terms

As Moscow and the West face off over the crisis in Ukraine, Russia has shown no qualms brandishing what it sees as its most potent weapon in the dispute: natural gas.

Gazprom chief executive Alexei Miller on 7 March threatened to halt supplies to Ukraine if the country didn't settle its $1.9 billion debt and start paying for supplies flowing into the country by 1 April. He warned of "a return to the situation at the start of 2009", when supplies were cut off to Ukraine and as a result much of Europe.

Yet Russia's gas weapon is not as potent as it might seem, largely because Gazprom's failure over the past decade to break into Asia's booming markets has left Russia almost completely reliant on Europe markets. Russia is the world's largest gas exporter, but it has almost no presence in the world's fastest growing and most lucrative market.

Russian president Vladimir Putin could no doubt inflict significant short-term economic damage on Europe by turning off the taps. Europe, which gets about 30% of its natural gas from Russia, would have to draw on strategic reserves, turn to Norway and other international suppliers for more expensive liquefied natural gas (LNG) imports and likely start burning more coal. Prices would rise and shortages would be likely. The pain would be particularly acute in Eastern European countries, which rely heavily on Russian supplies.

But the pain would go both ways. Gazprom's gas exports, of which more than 90% go to Europe, bring in about $66bn, accounting for around 15% of Russia's total import revenue. The loss of those revenues, even for a short period of time, would be felt deeply across the Russian economy. It is mutually assured destruction.

Putin's path out of this uncomfortable embrace with Europe leads to the East. For more than a decade, Gazprom has been in negotiations with state-run China National Petroleum Corporation (CNPC) over a multi-billion dollar gas supply deal that would finally give Russia a major foothold in Asia.  That deal is now more important than ever for Moscow and will be in the spotlight over the coming months ahead of Putin's visit to Beijing in May.

If a Russia-China deal had been signed in the mid-2000s as envisioned by Moscow, today's standoff could have looked very different, and potentially a whole lot worse for Europe. Under the terms initially put forward by Gazprom, Russia would have supplied the Chinese market from the same fields and infrastructure in Western Siberia it uses to ship gas to Europe. This would have involved building a pipeline through western China - known as the Altai Route - into China's economic heartland on the east coast.

This would have given Russia a much stronger hand to play in its energy diplomacy with both Europe and China. It would have pitted the two sides against each other for supplies, making Russia a swing supplier. And in disputes with Europe such as today or in 2009, it could have diverted supplies to China, blunting the risk to its own revenues.

But China had little interest in the proposal. Beijing has never wanted to sign on to a long-term deal at the same high prices Europe pays for gas, and after it signed deals with Russia's former-Soviet Central Asian neighbours for cheaper supplies, it didn't need extra piped gas running through its sparsely populated Western provinces.

After years of unfruitful talks, though, the sides finally agreed in principle last year on the alternative eastern supply route, long favoured by Beijing. The plan calls for the development of Russia's huge but remote eastern Siberia gas fields to supply the Chinese market via a new pipeline called the 'Power of Siberia' that would cross the Russia-China border east of Mongolia. China agreed, in principle, to buy 38 billion cubic metres of gas a year from Russia, more than Germany, Russia's largest European customer.

The China deal is central to Russia's larger Asian gas strategy. It also hopes to supply Japan, South Korea and other Asian markets via a proposed LNG plant on the Pacific coast at Vladivostok from the same eastern Siberia gasfields. It is a hugely ambitious scheme that has been estimated to cost as much as $90bn and is seen by Moscow as the future of Russia's natural gas industry.

Gazprom has been unable to seal a deal with CNPC, though, as the sides have not agreed pricing. Gazprom has long insisted that CNPC will have to pay a similar price to its European customers, but the Chinese side has refused, saying it wants prices more competitive with its other pipeline supplies from Central Asia and Myanmar.

Russia's standoff with the West makes the deal all the more urgent for Moscow. Although gas wouldn't start flowing until at least the end of the decade, signing the deal during Putin's Beijing visit would hand the Kremlin a major symbolic victory. And with new markets opening in the East, it could embolden Putin to play his energy hand more aggressively if the standoff escalates.

Moreover, European leaders have already started to talk about ways to cut their long-term reliance on Russian gas. The EU could, for example, hold up new pipeline projects such as South Stream or push legal challenges to open access to Gazprom's existing pipeline infrastructure in Europe to third parties. Russia would have to respond by finding new markets of its own.

"Isolation from the EU means Russia needs to focus on this new market in Asia. The chances of a deal in May are now even higher," Keun-Wook Paik, an expert on northeast Asia energy issues at the Oxford Institute for Energy Studies, told Petroleum Economist.

If Moscow and Gazprom were ever going to bend on prices and terms to secure a deal with the Chinese, it would be now. In recent rounds of negotiations CNPC has pressed for increased access to Russian oil and gasfields as part of the broader supply deal. That could now be on the table. "A very miserable situation for the EU could be a blessing for China," said Paik.

At the same time, domestic factors could be pushing CNPC towards a deal. Beijing is pressing the company to sign it in May to help increase natural gas supplies as the country combats its coal-fired pollution problem. It would also help shield the economy from higher cost LNG imports, said Paik.

But the diplomatic standoff between Russia and the West puts China in an awkward position. Beijing has hinted that it backs Russia, and Moscow has been quick to claim Beijing's support. But China has been reluctant to stake out a clear position on the issue beyond its default position in all international crises of calling for dialogue.

That is because the dispute brings key elements of China's foreign policy into direct confrontation. The Communist Party fears the kind of Western-backed uprising that ousted Viktor Yanukovich's pro-Russian government. But it is also uneasy about the precedent set by Russia's effective annexation of the Crimean peninsula, as it fears one of its own rogue provinces may one day try to break away. 

With Putin coming to Beijing in May, China's leaders are likely to find themselves under intense pressure from both Russia and the US and Europe over the deal in the coming months. Punting on the agreement once again would be a major setback for Putin's petro-diplomacy, while signing would hand him a well-timed victory. Whether it wants to or not, Beijing will have to take a stand.

Map 1: Possible pipeline routes
Map 1: Possible pipeline routes



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