Hammered by the West, Putin Turns East

Right as the West is tightening the screws on Russia’s energy sector, Vladimir Putin is accelerating his own pivot to the east, moving closer to another giant natural gas deal with China.

If consummated this fall, the multibillion-dollar deal would at least partially alleviate Russia’s fears about finding future markets for its gas exports and China’s worries over finding future energy supplies, especially natural gas, for its growing economy and population. By potentially boosting Russia’s leverage with respect to Europe while dealing a blow to other gas exporters’ hopes of leaping into the Chinese market, the deal’s knock-on effects could be felt from Brussels to British Columbia.

But as with another, $400 billion gas deal the two countries signed in May, plenty of questions remain, including whether the two sides can agree on a price for the gas, and whether sanctions-battered Russian firms will be able to finance the billions of dollars needed to build new gas-export infrastructure in western Siberia.

On Wednesday, Gazprom chief Alexei Miller told Putin that the gas giant is ready to sign a 30-year deal to supply China with 30 billion cubic meters of natural gas through the so-called western route, which would snake from western Siberia to sparsely populated areas in western China and then overland to the Chinese coast. The contract could be signed in November.

Miller added that, since talks with Beijing accelerated after the completion of the eastern Siberian gas deal in May, the two sides are considering increasing the western export route to as much as 100 billion cubic meters of gas per year. Today, Gazprom exports about 160 billion cubic meters of gas to all of Europe. But Europe is increasingly casting about for alternatives, especially after last week’s suspicious interruptions of Russian gas deliveries to eastern Europe.

To be sure, China drove a hard bargain on price for the last gas deal. The western route would deliver gas to remote parts of the country, making it even harder for Gazprom to charge a premium. That means that while the western route might be an alternate outlet for Russian gas, it wouldn’t necessarily be a lucrative one.

Russian officials including Putin started talking up the prospects of the western gas route, also known as the Altai route, even before the ink was dry on the other huge gas deal with China. And for an obvious reason: Linking gas fields in western Siberia, which today supply Europe, with China would give Moscow the ability to shift energy supplies west or east as it sees fit.

"This will give us big advantages in rechanneling gas flows, depending on the world market situation," Putin said earlier this month at a groundbreaking ceremony in eastern Siberia.

So what’s changed? Two things: Russia’s energy sector is under greater pressure due to enhanced sanctions because of the Ukraine crisis, and China’s need for Russian gas appears greater now than it did just a few months ago.

The United States and the European Union have steadily increased the pressure on big Russian energy firms with the latest round of sanctions unveiled earlier in September. Those measures would restrict Russia’s ability to tap oil in challenging environments, such as deepwater offshore, the Arctic, and in shale. Congress is currently preparing even stiffer sanctions on Russia that would increase the pressure on its energy sector; legislation winding its way through the Senate this week would take particular aim at Gazprom if gas supplies to Europe are interrupted, for example. The Senate Foreign Relations Committee unanimously passed the bill Thursday.

"The Altai deal will be Putin’s calculated response towards U.S. and EU sanctions against Russia, and the biggest beneficiary will be China," said Keun-Wook Paik, an expert on Sino-Russian energy relations. "Putin looks determined to show that Russia has a very powerful vehicle that can respond to Washington and Brussels’s sanctions policy against Russia in the wake of the Ukraine crisis."

What’s more, the Ukraine crisis seems to have focused Europe on the need to wean off excessive reliance on Russian gas, after a pair of gas-supply crises in the last decade failed to really rouse policymakers. Countries across the continent are seeking alternative sources of gas and, next month, the European Commission will present the results of the stress test it performed to check Europe’s resilience to Russian energy blackmail.

That’s all potentially bad news for Gazprom, which exports most of its gas to Europe and which is now expecting its lowest-ever gas production this year due to the aftermath of the Ukraine mess.

But it takes two to tango. After years of politely brushing aside Russian advances, Beijing may be more willing to dance. And that’s because as China starts to rein in its use of heavily polluting coal, it needs more natural gas. With the world’s most plentiful shale gas resources on paper, China hoped that domestic production would go some way toward meeting its energy needs.

But last month, Chinese officials abruptly cut in half China’s goals for shale gas production in 2020, from about 60 billion cubic meters to just 30 bcm. That’s a reflection that China’s shale deposits are deeper and harder to tap, especially for China’s unwieldy state-owned firms, than similar deposits in the United States.

"They are turning from quite optimistic to more realistic" about shale gas, said Wang Tao, a climate and energy expert at the Carnegie-Tsinghua Center for Global Policy in Beijing.

To make up the shortfall, China can either turn to imported liquefied natural gas, or LNG, which is expensive in Asia, or piped gas from Central Asia and Russia. Perhaps coincidentally, the initial volumes to be exported on the Altai route from Russia match the shortfall in Chinese domestic shale gas production.

And as more, cheaper piped gas makes its way from western Siberia to the Chinese market, that will leave less room for LNG; Paik estimates that the Altai route will "wipe out" about 21 million tons of LNG imports into China per year.

That’s potentially discouraging news for LNG exporters in the United States, Canada, Australia, and Qatar, who are all banking on the Chinese market to gobble up what looks like a flood of liquefied gas rushing onto the global market in the next few years. Australian producers already face questions over their own LNG future; now the issue is whether added supplies from Russia will conspire to drive down LNG prices in Asia.

"It will be a brutal battleground between the pipeline gas from Central Asia and west Siberia, and LNG supplies from Qatar, Australia, Canada, and the United States," said Paik.

"In a sense, China will serve as a collision space for Russia’s own pivot-to-Asia policy and the U.S. and Canadian pivot."