Looking East Amid a Crisis to the West
Russia's Energy Export Strategies

U.S. and European Union sanctions on Russia in response to its involvement in the ongoing Ukraine crisis have further enhanced Asia’s growing economic and strategic importance to Moscow. To address this important trend, the 2014 Pacific Energy Summit “Charting the Course to a Secure and Cleaner Energy Future,” held in Seoul on June 30–July 1, included a special session on the impact of the Ukraine crisis on Russia’s plans to at least double its oil and gas flows to Asia over the next twenty years.

NBR spoke with Tatiana Mitrova (Energy Research Institute, Russian Academy of Sciences) to continue the discussion. Dr. Mitrova offered insights on the promise for Russian exports to Asian markets, recent developments in Russia’s relations with Asian energy consumers, and the effects of Western sanctions on the country’s energy export prospects.

The massive increase in Asian energy demand, coupled with shrinking demand in Europe, has led Russia to look eastward in recent years. What are the general trends in Russia’s Asia energy strategy? What is needed for Russia to achieve its export goals in Asia?

The unfavorable situation in the core European market and search for new drivers of the country’s economic growth, together with the increasing cooling in relations with the West, are pushing Russia toward stronger energy cooperation with Asia. This is becoming a critical issue for Russian authorities, as the energy sector provides the bulk of the country’s export revenues, budget incomes, and GDP.

According to the State Energy Strategy, which is the basic document setting out Russian energy policy, “creation of oil and gas industrial complexes in the east of the country (which should allow the regions not only to become independent of outside energy and hasten their development but diversify exports flows to Asia-Pacific countries)” is among the most important strategic initiatives of the state in the energy industry. Moreover, according to this document, by 2030 the share of eastern energy markets in Russian energy exports should reach 26%–27%. For oil and oil products, it should grow from the current 6% to 22%–25%, while natural gas exports should grow from 1% to 19%–20%.

In order to achieve these targets a number of new capital-intensive projects should be realized in the upstream and midstream: there should be active exploration and production development in Eastern Siberia and the Russian Far East in order to ensure sufficient supplies; oil and gas processing facilities should be created, and a number of new pipelines and liquefied natural gas (LNG) plants should be built. This means that Russia should attract huge investments and project financing, gain access to the necessary technologies, and also secure final markets for its oil and gas.

In light of the recent announcement of Russia and China’s gas pipeline agreement for Russian exports to China, how do you foresee this project advancing? How will this deal affect Russia’s broader export strategy?

On May 21, 2014, during President Putin’s visit to China, Gazprom and China National Petroleum Corporation (CNPC) signed a 30-year “take-or-pay” contract for Russian pipeline gas to China through the “Power of Siberia” pipeline. The contract stipulates gas supplies of 38 billion cubic meters (bcm) per year. According to Gazprom, gas supplies should start in 2019 and reach a plateau of 38 bcm by 2024. Gazprom has already begun preparation for construction, as the first pipes for the Power of Siberia pipeline were delivered to Lensk, Yakutia, in early August 2014.

This deal was a turning point for Russia’s broader export strategy: the country is becoming more and more China-oriented. Moreover, the recent breakthrough in the Russia-China deal opens opportunities for the new gas export projects. Once the Power of Siberia is built, Russia will be able to supply not only China but also neighboring countries like South Korea, as well as LNG facilities in Vladivostok.

The gas pipeline deal will be conducted using Russian rubles and Chinese renminbi instead of the U.S. dollar. In May, Bank of China and VTB, one of Russia’s largest commercial banks, signed a deal to conduct all transactions in domestic currencies as well. What are the broader effects of these moves away from the U.S. dollar?

So far it is just the first step and mainly a declaration of intentions. But in the longer term, if Russia and China build a normal sustainable system of transactions, it could strongly support the creation of a new trading zone in Eurasia, which would mean an alternative to the U.S. dollar and which would be completely independent from U.S. financial institutions.

The Ukraine crisis has put significant pressure on Russia’s relations with Europe, the longstanding primary recipient of Russian gas exports. How do you think this will affect Russia’s engagement with Asian energy markets? How will the expanded U.S. and European financial sanctions affect Moscow’s ability to attract the necessary investment for new oil and gas supply routes to Asia?

There are several implications of the Ukrainian crisis and the deterioration of Russia’s relationship with the West. The expanded financial sanctions are going to be one of the most serious challenges for the development of Russia’s oil and gas exports. First of all, Russia will be left without several critical technologies (LNG, catalyzers, horizontal drilling, and hydrofracturing), which are also necessary for Asian export development. Another problem is lack of the external financing—Western loans have become unavailable to Russian companies. The Russian financial system and domestic market are not strong enough to cover all of the requirements for Russian companies; if there is no external financing, some companies will even face problems with their debt refinancing. The final effect will largely depend on the willingness of Asian companies and governments to cooperate and to provide loans, technologies, and services to Russian companies.

The shale gas industry in the United States has made dramatic gains over the past few years, leading to decreased import demand from the United States, as well as to increased supply worldwide. Energy-consuming countries in Asia and beyond are seeking to emulate the success of the United States in developing tight gas and oil. How does Russia view these changes and how have these trends affected Russia’s energy policy?

For a period of time, the Russian government and major companies were very skeptical concerning the U.S. shale gas revolution. But in 2012–13 it became obvious that the U.S. shale gas boom, which came as a big surprise to all market participants, is already significantly changing global energy markets, with some immediate results:

• There was an unprecedented drop in the North American gas prices and their decoupling from European and Asian price trends. Gas markets are now more regionalized than ever, despite the expectation that prices would even out over time across regions.
• U.S. domestic gas consumption increased, and gas partially replaced coal for power generation, leading to the reduction of carbon dioxide emissions in North America.
• Significant LNG volumes were redirected to the other markets, namely Europe and Asia. In Europe, this led to a spot price drop, and in Asia it helped mitigate the consequences of Fukushima (otherwise prices would have risen even higher).
• The European gas pricing model changed dramatically in just five years, with the share of spot-indexed gas supplies increasing from 20% in 2007 to 50% in 2012. Gazprom’s contracts have been renegotiated under extreme consumer pressure, and traditional linkage of the gas price to the price of oil products is already regarded by the European Commission as market power abuse.
• Coal exports from the United States undermined gas competitiveness in the European power sector and led gas demand for electricity generation to stagnate (which actually means total demand for gas stagnated), and resulted in low utilization rates, and even the closure of gas-fired power plants in Europe.
• Several large-scale projects in different gas-producing countries, including Russia, Canada, and Qatar, targeted initially at the U.S. gas market, had to urgently seek other buyers, while others were postponed for an unclear period of time (for example, Gazprom’s development of the Shtokman field).
• As Daniel Yergin has mentioned, U.S. shale gas and tight oil are “reducing both Europe’s competitiveness vis-a-vis the U.S. and China’s overall manufacturing competitiveness.” [2] The shale gas boom is giving the United States an unanticipated advantage in energy-intensive industries. Indeed, inexpensive natural gas is fueling a U.S. manufacturing renaissance, as companies build new plants and expand existing facilities. Countries have to reconsider high-cost energy strategies or face weakening competitiveness and the loss of jobs.
• Generally, there was a huge reassessment of the national energy policies in many countries (including Poland, Ukraine, Argentina, and China, etc.)—they felt a new sense of hope. China, for example, seeing the speed and extent of U.S. shale gas development, has placed a high priority on developing its extensive unconventional gas resources.

Overall, the shale revolution provides a new source of resilience for the United States and enhances the U.S. position in the world, while at the same time challenging Russia’s positions in all target markets, including Europe, Asia, and the Commonwealth of Independent States.

Understanding these trends has fostered Russia’s gas sector reform (with LNG liberalization), encouraged a turn toward Asia, and also increased attention to the costs of new projects and their competitiveness.

Are there any other issues you think are important to address for readers?

Russia is one of the major players on the global energy market—it is the third-largest producer and consumer of energy in the world after China and the United States, representing 10% of global production and 5% of global primary energy consumption. Russia is consistently ranked first in the world for gas exports, second for oil exports, and third after Australia and Indonesia for coal exports. In the new geopolitical reality, and because of recent sanctions, it will be extremely difficult to ensure reliable supplies of the increasing volumes of oil and gas from Russia, which could become a painful problem not only for Russia but also for other countries in Europe and Asia. “Sanction wars” do not seem to be a wise way to solve the existing problems—they are more likely to create new ones. I am a strong believer in human rationality and the ability to find solutions to any problem through negotiations, not opposition and wars. The Ukrainian crisis has to be addressed in a constructive way through proper negotiations, not just mutual accusations. Energy markets should not become the victims of politics.

Endnotes

[1] Daniel Yergin, “The Global Impact of US Shale,” Project Syndicate, January 8, 2014, https://www.project-syndicate.org/commentary/daniel-yergin-traces-the-effects-of-america-s-shale-energy-revolution-on-the-balance-of-global-economic-and-political-power.

Tatiana Mitrova is Head of the Oil and Gas Department in the Energy Research Institute of the Russian Academy of Sciences.

This interview was conducted by Laura Schwartz, a Project Associate at NBR.