A New Russia-China Energy Axis?

A LOT HAS BEEN SAID AND WRITTEN ABOUT THE NEW ENERGY AGREEMENT, WHICH WILL SUPPLY RUSSIAN GAS TO CHINA FOR THE NEXT 30 YEARS. IS THIS AN EARTH-SHAKING EVENT FOR ITALY, EUROPE AND THE WESTERN WORLD, OR DOES IT FIT INTO A LARGER PICTURE?

by Michele Polo, Dept. of Economics, Bocconi
Translated by Richard Greenslade

The agreement signed May 21 between Russia's Gazprom and China National Petroleum Corporation is certainly a major event for the natural gas market in the world and the geopolitical balance. Its impact goes beyond even the significant volume of 38 billion cubic meters a year, almost half of the Italian consumption, and that has led commentators to envisage many scenarios and developments - maybe too simply.

Let's start with the agreement, which allows China to diversify energy sources, still anchored at 60% to coal, to meet the needs of reduction of greenhouse gas emissions and the environmental emergency in many areas of the country. It is an agreement that also seems to pave the way for industrial collaborations across the energy supply chain between the two countries, and that will require the two countries to make a significant investment for the construction of new pipelines linking the gas fields in Siberia to Chinese territory.

That said, it is good idea to clear the field of some of the fears that have been raised in the press and in the political debate in the days following the accord. This agreement does not reasonably lead to a reorientation of Soviet gas flows from Europe to China. Due to the fact that the extraction areas that feed the Russian exports in the two areas are very different and distant from each other, and the fact that Europeans, Germany and Italy in particular, are very good customers with total imports from Russia at 160 billion cubic meters per year, which Gazprom hardly wants to give up. And it appears totally unrealistic in the short term to foresee supply from the U.S. to Europe or to Ukraine in a crisis that has been advancing in recent times. These projects require at least 4 years to become operational, more or less the time horizon within which the Russian-Chinese agreement will provide its first cubic meters of gas.

And yet the feeling of a global impact captures some aspects that we find the recent evolution of the natural gas market, because historically the strategic choices in this sector have overlapped and have supported and influenced foreign policy choices of the big global players. These days, for example, we see a possible showdown in the situation where two major pipeline projects, Nabucco and South Stream, are competing to secure the flow of gas to Europe from the Caucasus while avoiding the Ukrainian bottleneck.

The gas market today is more integrated than before, mainly due to the weight of the liquefied natural gas transported by ship which today allows for much more complex and flexible export flows than those constrained by pipeline networks. The market has also been shaken in recent years by the development of intense extraction of unconventional gas in the United States, which has transformed this country from importer to potential exporter in the near future. And that led to change in the export flows of liquefied natural gas to Europe and Asia. Europe, finally, after 15 years of progressive liberalization and opening up of markets sees a dual supply system, through long-term contracts with producing countries and in the wholesale markets that have developed, especially in England and the Netherlands, where gas is trading at prices that better reflect the state of the market, at times deviating significantly from the price of long-term contracts. In the context of this situation, the new Russian-Chinese agreement becomes one of the many pieces of a complex mosaic, one that may affect Asian markets and most global ones through the law of supply and demand, and through patterns of international politics.