By Philip Alexander
Demand for oil and gas is surging in North Asia. But efforts to shift supply away from the Middle East and towards the CIS are faltering
In April 2007, Chen Deming, vice-chairman of China’s National Development and Reform Commission, announced plans to build a strategic oil reserve equivalent to 30 days of imports by 2010.
With the Chinese economy sustaining double-digit growth for several years, this is a moving target. The US Energy Information Administration (EIA) forecasts Chinese oil consumption will rise to 8.7 million barrels per day in 2010, an increase of around 55% from 2003 levels. But this is dwarfed by the extraordinary 250% rise in Chinese natural gas demand over the same period, to around 3 trillion cubic feet.
As ever, these eye-catching forecasts raise the question of the sources of supply to meet Chinese demand. Whereas domestic production accounts for around 60% of consumption today, that figure could fall to around 45% in 2010, despite efforts by Chinese oil majors such as China National Petroleum Corporation (CNPC) and China National Offshore Oil Corporation (CNOOC) to step up domestic exploration.
Although these companies have recently made significant investments to increase commodity output in Africa, Helen Henton, commodities economist at Standard Chartered bank in London, emphasizes that the Gulf states will play an ever more dominant role. “Even within five years, and certainly over a 10-year period, the Middle East states will become increasingly important to meet the incremental demand from China. They have the reserves, and are also where the capacity growth is coming from,” she tells Emerging Markets.
The sources of natural gas are more diversified, and yet Korea Gas Corporation (Kogas), the world’s largest importer of liquefied natural gas, reported an increase in dependence on imports from Qatar (already its largest supplier) and Oman in 2006. These two countries accounted for 48% of Kogas’ needs last year, up a percentage point on the previous year, as supplies from Indonesia lost ground. Korea is paying a premium on both production and transport costs to buy from the Gulf states, says Keun-Wook Paik, senior research fellow and specialist on Asian energy supplies at the Oxford Institute for Energy Studies.
The key to reducing this premium is to lower dependence on Middle Eastern markets, and Henton at Standard Chartered notes that China has tried to start this process for oil supplies, tapping the Caspian region in addition to Africa. Paik concurs, estimating that the proportion of oil imports from the Middle East fell to around 45% in 2006, from 47% a year earlier.
CIS success
The much-publicized use of African oil contributed 45 million tons to the total of 145 million tons in 2006, but Paik believes the more remarkable story is the increasing use of oil from the CIS, especially Russia. “Imports from Europe in 2006 were 28 million tons, which is very significant considering that this figure was only 8 million tons as recently as 2003.”
The appeal of CIS oil and gas is obvious enough, given the convenience of land-based pipelines from China’s neighbours. However, Russia’s capacity to use energy supplies as a diplomatic tool is well documented among its CIS neighbours, including Ukraine, Georgia and Belarus, so can China afford to rely on the political whims of the Kremlin? In practice, CNPC has already been a victim of Russian policy-making, because its original partner for importing oil across the border was the ill-fated Yukos.
“CNPC upgraded the existing infrastructure and petrochemicals plant, based on the assumption that they would import 20 million tons of crude oil per year through this Yukos pipeline,” explains Paik. As a result, when the deal collapsed along with Yukos itself in 2004, CNPC was already committed to importing at least 10 million tons per year from Russia through these facilities. The company therefore agreed in early 2005 to pay $6 billion per year over 2006-10 to import this amount from Rosneft, which acquired the Yukos assets. This may secure China’s supplies, but Paik notes that the real winner was Sinopec rather than CNPC, because Rosneft chose Sinopec, which is the largest downstream player in the country, as its partner to penetrate the Chinese distribution market.
As to quantities, the pipeline under construction could be used to transport 30 million tons per year, of which 10 million would be shipped onto the Japanese and Korean markets. Rosneft is hoping to increase supplies beyond this level, but the outcome will depend on the outcome of exploration of fields around Krasnoyarsk, Irkutsk and Sakha. If all these prospects deliver results, Paik projects that Russia could supply as much as 50 million to 80 million tons per year by pipeline to China, if desired.
The prospects for gas supplies to China are much less clear, with Korea also riding on China’s coat tails in increasingly fraught negotiations with Gazprom, Russia’s leading producer. Whereas Rosneft favours reliable supplies to China in response to CNPC’s decision to extend a $6 billion per year cash lifeline at a time when European investors were still condemning the expropriation of Yukos, Gazprom executives in Moscow continue to lobby for energy policy to focus on the European market, says Paik. The key element in the equation is the Sakhalin development off Russia’s Pacific coast. Kogas has an agreement to buy 1.5 million to 2 million tons of liquefied natural gas (LNG) per year from Sakhalin 2, from 2008, but this looks unlikely to be completed on schedule due to ongoing legal disputes. “Beyond Sakhalin 2, the Sakhalin 3, 4, 5 and 6 projects, in which Kogas wants to play a more significant role, are a long way off,” says Paik.
For the much bigger Sakhalin 1 and 2 projects, Kogas is not large enough to partner Gazprom on its own. It is therefore at the mercy of controversies between Gazprom and its existing production partner ExxonMobil. The Russian company has refused to cooperate with a supply agreement that ExxonMobil signed with CNPC, because it was inked without their prior authorization. If Gazprom does not reach a deal with CNPC, this would potentially free up supplies to Kogas, but could also delay the completion of the project still further.
This leaves only TNK-BP’s Kovytka onshore gas project, intended to supply the Chinese market in particular. To date, Gazprom has refused to pay for a 50% plus one share stake in Kovytka, and the Russian authorities could potentially revoke TNK-BP’s production licence unless the sale is agreed at a below-market price. Against this backdrop, the North Asian economies look set to remain dependent on the Middle East, at least in the near term, to meet surging demand for hydrocarbons.