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RackMultipart20140411-6254-152jjj9Much has been made of the agreement signed by Moscow and Beijing to get gas flowing from western Siberia to China. There is talk of Russia using the deal to offset its isolation from the west and circumventing the sanctions imposed over the Ukraine crisis.

But this deal is a preliminary gas-supply agreement that’s been a long time in the making. It is not something that has suddenly come about since falling out with the West over the Ukraine crisis, nor can Russia simply offset sales to Europe with sales to China.

Just as Russia’s state symbol depicts a double-headed eagle that looks both west and east, so its energy strategy has long sought to develop an eastern pivot to create new markets in Asia to balance trade with Europe. The Russian government’s energy strategy predicts a substantial eastern swing over coming decades, with the share of oil exports going to the Asia-Pacific region rising from 12% now to 23% in 2035, and gas imports increasing from 6% today to 31.5% by 2035.

Looking eastward

Russia’s plans to develop gas exports to Asia are enshrined in Gazprom’s 2007 Eastern Gas Programme. Granted, little progress was made until the US$400 billion pact reached in May 2014, but these long-held plans underwrote the process. An agreement was made to deliver gas from new fields in eastern Siberia and the Far East to northeast China, a region not currently reached by imports of liquefied natural gas (LNG).

But this is not without its problems. Gazprom’s programme also envisages continuing the pipeline to deliver gas to a planned LNG plant at Vladivostok. This extension, however, is now looking doubtful because of the impact of Western sanctions on potential investors and buyers and the prospect of a second deal to deliver a further 30 billion cubic metres (bcm) of pipeline gas from fields in western Siberia via the so-called western or Altai route. There are also ongoing misunderstandings over who is paying for the costs of developing the pipeline, even though Gazprom has started building it.

In terms of the second deal that has just been celebrated at the APEC summit, this is a preliminary arrangement – really an agreement to agree on a firm contract down the line. The Russian government expects to firm up the all-important details in the first half of next year. The final price has yet to be agreed, but China will want a lower one than initially agreed, as the imported gas will have to travel some distance within China to find centres of demand.

It has taken a decade of negotiations to get to the stage where Russia appears to be in the position to seal the deal on the export of 68 bcm. The feed gas for the second pipeline will come from West Siberia and will be easier to develop than the new production for the eastern route. Taken together, the two deals will make China by far the most significant importer of Russian gas, surpassing Germany, which is currently the most important market, bringing in just under 40 bcm in 2013.

In the context of current events in Ukraine and Europe’s determination to limit its future dependence on Russian gas imports, it is easy to see the current deals as a movement away from Europe to Asia. But this is a rather simplistic interpretation when this eastern pivot has long been a goal of Russian energy strategy.

Europe is still crucial

Despite this eastern pivot,Gazprom will not want to see a significant decline in its gas exports to Europe. According to Gazprom’s financial report, in 2013 exports to Europe accounted for 58% of its revenue. It is true that Gazprom has been losing market share in Europe, but it has been increasingly flexible and sales rebounded in 2013.

So, even before the crisis in Ukraine began, it was clear that Europe doesn’t present a growth opportunity for Gazprom. European gas demand is stagnant at best and likely to decline in the face of aggressive climate change policies and growing concerns about security of supply.

That said, European companies remain contractually committed to importing gas from Russia. This is pointed out by the the Oxford Institute for Energy Studies in a recent study. It shows that “up to the mid-2020s, European companies are contractually obliged to import at least 115 bcm/year of Russian gas (approximately 75% of the 2013 import level), a figure which reduces to around 65 bcm by 2030”. Their modelling also suggests that Europe may need as much as 100 bcm of Russian gas into the 2030s.

The final factor to consider is the profitability of these new deals to Gazprom and the Russian state. Most commentators suggest that the price agreed, particularly if oil prices remain low, will only provide a modest return. This means that maintaining revenues from European exports will remain important for Gazprom’s balance sheet and the government’s coffers; especially as income from oil exports is likely to start to fall in the 2020s.

Future growth

Given that all energy projections show that future demand will be concentrated in the Asia Pacific region, it is no surprise that Russia, along everyone in the global LNG industry, sees the region as the locus of future demand growth.

Just how much gas China will consume in the future and how much will be imported remains uncertain. China has already secured significant pipeline imports from Central Asia and Myanmar and has rapidly expanded its LNG import capacity. It also has ambitious, but so far frustrated, plans to develop its substantial shale gas reserves. Russian pipeline exports will not scale up until the early 2020s, but they will potentially impact on China’s appetite for additional LNG supplies now and may serve to establish a benchmark price for new gas supplies in China.

There is no doubting the strategic significance of Russia being able to demonstrate its ability to reorient energy exports away from Europe to new markets in Asia. But these deals have been a long time in the making and some important issues still remain unresolved. Putin would like to be able to threaten to divert Europe’s gas to Asia, but the reality is that Russia needs to swing both ways and cannot afford to turn its back on Europe.

This article was originally published at The Conversation. Read the original article.

Mike Bradshaw is Professor of Global Energy, Warwick Business School at University of Warwick. Mike receives funding from the UK Energy Research Centre (UKERC).

RackMultipart20140411-6254-152jjj9As with the previous Russia-Ukraine gas disputes in 2006 and 2009, how we describe the current stand-off between the two countries is a matter of semantics. Those earlier disputes found solutions based on financial negotiation; this one has an altogether more complex and worrying tone to it.

The bare facts of the dispute look fairly straightforward. Russia’s natural gas exporter Gazprom says that because Ukraine’s Naftogaz has failed to make a down payment on the more than $4 billion debt that is currently outstanding, then under the terms of its contract, Gazprom can insist on prepayment for gas supplies. As no payments have been made, no gas will be delivered to Ukraine. However deliveries to European customers will continue to transit through Ukraine as required by Gazprom’s contract with Ukrtransgaz, the Ukrainian gas transport monopoly.

In 2009, Russia accused Ukraine of withdrawing gas destined for Europe to meet its own domestic needs, the net result being that gas stopped flowing to Europe. Then, as now, Russia has not stopped making deliveries to Europe but it will take some time before we will know if gas is still flowing through Ukraine to meet European demand. So what should Ukraine do now?

Punishment prices

In some ways, you could view Russia’s move as part of a lengthy process of haggling linked to its political priorities for the region.

When Viktor Yanukovych was forced out of power the Kremlin instructed Gazprom to remove the various concessions that had been applied to Ukrainian gas supplies as a reward for turning away from an agreement with the EU. This resulted in a significant price hike from $268.5 per 1,000 cubic metres of gas to $485. Kiev refused to pay this higher price and the gas debt started to grow. The most recent offer made by the Russian president, Vladimir Putin, was that Ukraine should pay a price of $385, achieved by removing export duty and resulting in a price close to the European average, which was $387 in 2013.

Kiev rejected this offer and has taken Gazprom to court to reclaim $6 billion that it claims it has been over-charged by Russia for gas supplies. Gazprom has countered by taking Naftogaz to court to recover the unpaid $4.5 billion. The EU is hoping that it can still broker a compromise price of $385 in winter (when gas prices are always higher) and $300 in the summer months. We must now wait and see if talks will resume.

Ukraine says it has about 14 billion cubic metres (bcm) of gas in storage, enough to keep it going until December. But drawing down on those reserves can only be a short-term solution, as it would leave them vulnerable in the middle of winter. Added to which, Ukraine’s gas storage capacity is important in supplying gas to Europe in the winter months. Europe now has limited reverse-flow capacity from Slovakia and has been sending some gas to Ukraine, but this has an initial flow rate of 2.3 bcm a year and is no alternative to Russian gas given that Ukraine consumes about 55 bcm of gas each year.

Options

If Ukraine does not syphon off gas bound for Europe – and if it uses gas in storage to meet immediate needs – then it will still have time to go back to the negotiating table. Gas storage capacity in Europe is high after a mild winter and this eventuality has been signaled for while. It is also useful that the impasse has arrived as we move into summer, a period of low gas consumption. The problem comes if there is a protracted stand-off that affects the ability of Ukraine and Europe to prepare for the coming winter.

The previous disputes in 2006 and 2009 were largely about payments and price levels – and agreements were eventually reached in a more-or-less business-like fashion. The current situation, which has flared in the wake of Russia’s annexation of Crimea and the on-going conflict in Eastern Ukraine makes it clearer than ever the way in which the Kremlin uses energy exports as a geopolitical lever.

In this context, it is difficult to see how a lasting agreement on gas prices can be brokered without a wider agreement between Ukraine, the EU and Russia on Ukraine’s future and its territorial integrity. The gas dispute is a litmus test of the wider geopolitical crisis and, with no resolution in sight, it promises to be a worrying winter for gas consumers in Europe.

This article was originally published at The Conversation. Read the original article.

Mike Bradshaw is Professor of Global Energy, Warwick Business School at University of Warwick. Tina receives funding from the UK Energy Research Centre (UKERC).