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China Is Playing Hardball With Russia Over Two Massive Gas Pipeline Projects

Despite a rosy outlook offered by Vladimir Putin, industry insiders and analysts tell VICE News that all is not well in Russia-China gas relations.
Photo by Kirill Kudryavtsev/AP

Perhaps Vladimir Putin should be worried when he arrives at the Asia Pacific Economic Conference in Beijing on November 9. Besides a scheduled meeting with Australian Prime Minister Tony Abbott — who said he would use a "shirtfront" rugby tackle on Putin over the deaths of Australians in the downing of MH17 in eastern Ukraine — Putin is also set to discuss yet another mega gas contract with China.

The projected Altai pipeline, also known as the "western route," could bring up to 30 billion cubic meters (bcm) of gas a year to China from Russia, potentially allowing Moscow to play Europe against China for a better gas price. Before his upcoming trip, Putin told the media that Moscow and Beijing had already "reached an understanding in principle concerning the opening of the western route," and had "agreed on many technical and commercial aspects of this project."


But despite Putin's rosy outlook, all is not well in Russia-China gas relations, comments from industry insiders and analysts have revealed. Not only is the "western route" project likely to prove elusive for Putin to nail down in Beijing, but a key detail of the "eastern route" gas pipeline deal that China and Russia signed in May has yet to be worked out. And given the Chinese side's stinginess and the daunting and expensive task of building pipelines through thousands of miles of Siberian wilderness, both projects could prove to be minimally profitable for Russia, which receives half of its budget revenues from oil and gas sales.

"It looks like first contract isn't done, so it could be premature to move on to the second one," Ildar Davletshin, head of oil and gas research at Renaissance Capital, told VICE News.

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In May, Russia signed a $400 billion deal to deliver up to 38 bcm of gas annually to China. Called the "Strength of Siberia," or "eastern route," the project will require the development of the Kovykta and Chayanda fields in the remote Yakutia region in eastern Siberia, as well as the construction of a gas pipeline over 2,500 miles of swamps, mountains, and seismically active areas to China's industrial heartland.

The contract didn't come easy, however, and now it appears the two sides may still have a disagreement over a proposed down payment. The Russian side was in talks with the Chinese, who are notoriously tough negotiators, starting the first day of a visit by Putin to Beijing in May, and continuing through the night. Finally, on the second day, Putin reportedly stepped in and told his negotiators to sign a deal at all costs. Although the amount of gas to be delivered each year and the price China would pay for each thousand cubic meters were not announced, Davletshin said Putin's intervention suggested a "last-minute discount."


The project is on the 'edge of unprofitability' given the likely high costs of developing the gas fields and building the pipeline.

After the initial fanfare, it also came to light that the two sides hadn't agreed on how China would pay Russia the $25 billion stipulated in the contract. In a remark that was little reported in the English-language media, Gazprom deputy CEO Alexander Medvedev said in September that the issue of the advance was "up in the air," although he added that "Gazprom has begun building the pipeline without waiting for a final resolution of this issue."

Moscow has portrayed the $25 billion as a prepayment for the gas to be delivered, while it appears the Chinese thought it should be paid as a loan with interest. Whether it is a prepayment or loan will influence the eventual price Russia gets per thousand cubic meters, which Davletshin predicted would be no higher than $350 per thousand cubic meters with the discount figured in.

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"If it's an advance, China will demand a discount on price, which Gazprom doesn't want to give, but if it's a loan, China will demand the purchase of Chinese products and services, which Gazprom also doesn't want to do," said Vladimir Milov, former deputy energy minister of Russia who is now an opposition-minded energy analyst. He told VICE News that the project is on the "edge of unprofitability" given the likely high costs of developing the gas fields and building the pipeline.


Davletshin said the total return on investment for both the eastern route and the western route could reach the "okay but not great" level of 10 percent — before taking into account likely cost overruns.

According to Putin, Russia will invest $55 billion developing the project. But previous gas pipeline projects have skyrocketed in price once construction actually commenced. Russia's Eastern Siberia-Pacific Ocean oil pipeline, initially estimated to cost $6 billion, ended up costing more than $20 billion.

And, according to a scandalous comment by a Gazprom official, the eventual payoff for the Strength of Siberia project will come later than previously indicated by Russian officials, who stated that the pipeline would deliver up to 38 bcm a year. After Viktor Selin, deputy director of the new Chayanda gas field, told a Russia news agency in September that Gazprom had delayed the start of gas deliveries from this field to the pipeline until 2020, two years later than announced, the company promptly fired him for allegedly giving up business secrets. With the delayed schedule, the volume of gas in the pipeline won't reach the announced 38 bcm until at least 15 years from now, Milov said.

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Despite the many potential problems with the eastern route, it will likely be even harder for Putin to iron out an agreement on the western route. Negotiations between Prime Minister Dmitry Medvedev and Chinese State Council Premier Li Keqiang in Moscow in October ended with a variety of trade deals, but for the western route it produced only a joint working group between Gazprom and Chinese state gas company CNPC, indicating the two sides were still far from agreement. "Another attempt of Moscow to talk the Chinese into accepting the idea of the Altai gas pipeline has failed," the Carnegie Moscow Center wrote at the time.


The Chinese will demand a lower price than with the eastern route, as low as $300 per thousand square meters, since the pipeline would go into sparsely populated northwestern China and would still have to be transported east on Beijing's dime, Davletshin said.

In 2013, China signed an agreement to increase gas deliveries to its northwestern region from the Central Asian country of Turkmenistan to 65 bcm by 2020, greatly reducing Beijing's interest in more expensive Russian gas along a similar route, Milov said. He called Putin's visit to Beijing over the western route a "PR move" to emphasize Moscow's much-publicized turn away from Europe, its current main gas market, which has hit Russia with economic sanctions over its role in aggravating the conflict in eastern Ukraine.

"For Putin, it's important to do this PR move to show that we've come to agreement with China, that we're going to deliver gas by the western route, but I don't think China is that interested because they're already covering these needs with gas from Turkmenistan," Milov said.

But despite the hurdles Putin is likely to encounter in Beijing this week, Russia will likely keep moving toward smoothing out the misunderstandings in the eastern route project and eventually locking down the western route, Davletshin said.

"Russia is more than ever looking at Asia for all types of deals, including financial deals," Davletshin said. "The reason they're looking for this (western route) deal is not just to sell hydrocarbons, but also to get more money out of China now when the western markets are practically shut to Russia, almost impossible to access."

Follow Alec Luhn on Twitter: @ASLuhn