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Analytics // Projects

The status of Chinese–Russian energy cooperation in the Arctic

15 May 2017 , 00:03Ekaterina KlimenkoNeftegaz.RU576



The Arctic is estimated to contain 30 % of the world's undiscovered oil and gas reserves. Climate change has accelerated the melting of the Arctic ice, making these resources more available. This backgrounder looks at the status of Chinese-Russian energy cooperation in the Arctic.

In the past decade, Russia has been actively developing Arctic resources and shipping routes, while boosting its military presence in the region.

While Russia has primarily worked with European countries to develop its energy resources, including in the Arctic, a number of factors have led Russia to reconsider and look even more to Asia for potential investors and technology partners, and as a key consumer market.

China is increasingly highlighted as an important partner for Russia in developing the Russian Arctic.
China has increased its focus on and engagement in the Arctic over the past decade.

From a Chinese perspective, cooperation with Russia on Arctic resources and shipping routes also helps facilitate a greater Chinese role and influence in the region and gradually gain respect and acceptance for China as a legitimate Arctic stakeholder.


Interests in the Arctic
Russia's Arctic strategy identifies the following core national interests: (a) use of the Arctic Zone of the Russian Federation as a strategic resource base; (b) safe-guarding the Arctic as a zone of peace and cooperation; and (c) use of the Northern Sea Route as a national integrated transport-communication system for Russia in the Arctic.

Among these goals, the development of offshore and onshore oil and gas resources is a top priority.

The Russian economy is largely dependent on revenues from oil and gas.
At least 50 % of federal budget revenue is generated from exports of energy resources.

Most of Russia's oil and gas production is concentrated in the traditional areas of western Siberia.
However, their depletion over the past decade means that the geography of production has been shifting to new regions to the north of western Siberia, including the Yamal Peninsula and the Arctic seas.

To date, China's focus and activities in the Arctic region have been primarily concentrated on its scientific interests, particularly those that relate to how the melting ice and changing climate in the Arctic will affect China.
However, over the past decade, China's activities have begun to concentrate more on economic interests and concerns about securing and diversifying China's supply of energy resources and minerals.

China has also developed a growing interest in the Arctic shipping routes, which could provide it with alternatives to the longer and strategically vulnerable routes currently in use.
Furthermore, China is interested in securing a voice in the evolving Arctic governance regime, which is related to its importance and potential implications for wider global and regional governance.

As a result, China seeks to diversify and strengthen its bilateral relations with all the Arctic states by establishing stronger diplomatic ties, scientific cooperation, and economic partnerships.

Drivers of Chinese-Russian energy cooperation in the Arctic

Russia
Major shifts in world energy markets have significantly affected the development of Russia's Arctic shelf resources and the expansion of the current onshore resources of the Yamal Peninsula.
At least 3 key factors have led to a significant overproduction of natural gas in Russia and hence delayed the development of gas resources on the Arctic shelf: (a) EU plans to prioritize the diversification of gas suppliers in the

European market; (b) difficult relations with Ukraine, which is the 3rd largest consumer of Russian gas; and (c) shale gas revolution has also resulted in the loss of other potential markets.

In relation to oil, estimates suggest that the fall in oil prices has made the development of the Arctic shelf oilfields unprofitable.
This will continue to be the case while the price of oil stays below $100 per barrel.

However, the decisive factor in the need for Russian companies to diversify their partnerships has been the geopolitical tensions between Russia and the West in the wake of the crisis in Ukraine.

The USA and the EU introduced sanctions against Russia in 2014 after Russia's annexation of Crimea.
Among these sanctions, the 3rd package, which was introduced in July 2014, has had significant implications because it concerns the transfer of technologies.

The USA and EU sanctions include a ban on the transfer of equipment and technology for deep drilling below 150-152 metres, as well as on exploration and development of Arctic shelf shale oil reserves.

These sanctions forced ExxonMobil, Statoil and other Western companies to suspend their cooperation with Russia in the Arctic.
The 3rd package of sanctions also introduced strict financial restrictions, applied to loans of longer than 30 days.

The largest Russian banks and corporations in Russia, such as Rosneft, Transneft, Gazpromneft, Gazprom, Novatek, Lukoil and Surgutneftegaz, remain under sanctions.
This has made it difficult to seek financing for Arctic projects in Western financial markets.

China
Seen from Beijing, Russia, as the biggest Arctic state, stands as an important gatekeeper and 'necessary partner' for non-Arctic states such as China.
China knows that in many ways it is dependent on Russia - for example, for Russian goodwill and support - if China is to increase its activities and consolidate its role as a legitimate stakeholder in the region.

Consequently, in a Chinese analysis, there is no way to avoid dealing and getting along with Russia in the Arctic.

Despite the lower growth rate of the Chinese economy in recent years, its demand for energy and resources continues to grow and its state-owned enterprises are continuously encouraged to identify and establish new areas for exploration and extraction.

China sees the Russian Far East, Siberia and the Russian Arctic as increasingly important due to their potential in relation to energy resources, export markets and new shipping and trading routes.
It also sees these regions as recipients of and partners in Chinese-led infrastructure and other development projects.

These activities have synergies with China's high-profile 'One Belt, One Road' initiative, through which China is seeking access to vital European markets through Central Asia and Russia.

China also seeks to take advantage of current Russian geostrategic and geo-economic vulnerabilities and of Russia's need for China as a partner to gradually strengthen its presence and relationships in the Arctic.

Concrete steps towards Chinese-Russian cooperation on the development of the Arctic shelf
In February and March 2013, during a round of oil delivery negotiations, Rosneft and the China National Petroleum Corporation (CNPC) discussed opportunities for cooperation on shelf projects in the Arctic Barents Sea and Pechora Sea, with a particular focus on the Zapadno-Prinovozemelsky, Yuzhno Russky, Medyskoe Sea and Varandeyskoe Sea deposits.

Among these, the Medyskoe Sea and Varandeyskoe Sea are the most promising, containing an estimated 3.9 million and 5.5 million tonnes of oil per year, respectively.
Although the head of Rosneft, Igor Sechin, confirmed a commitment to work with China on the Arctic shelf early in 2014, however, no official confirmation or details have yet to emerge.

In late 2015, Russia's Deputy Energy Minister reiterated that Rosneft was still 'negotiating' and 'discussing' its participation in Arctic shelf energy and extraction projects with China.
The relative lack of progress over nearly 2 years could indicate that China is either reluctant to invest or trying to get a better deal.

Moreover, the fact that China did not invest in the Vankor deposit in East Siberia and did not buy Rosneft's shares could demonstrate that its interest in the Russian upstream has decreased, or that it cannot accept Rosneft's conditions.

It could also be argued that the Russian oil and gas delivery deals that China secured in 2013 and 2014 have reduced its overall interest in the Russian upstream, including in the Arctic.
Nonetheless, analysts continue to claim that China wants not just to be part of, but to have a managerial stake, in these Arctic projects.

Another unanswered question is the extent to which Chinese companies can replace the work of Western partners on the Arctic shelf, particularly their technological assistance.
Despite such concerns, Russia and China have increased their technological cooperation in the oil and gas sectors since the imposition of sanctions.

In September 2015, for example, China Oilfield Services Limited (COSL) signed deals with Rosneft and Norwegian Statoil to drill 2 exploration wells in the Sea of Okhotsk, which has similar conditions to the Arctic.
Igor Sechin noted that the agreements unlocked new potential for cooperation on oil and gas resource exploration by industry leaders in Russia, Norway and China.

The extent to which this potential will affect the Arctic remains to be seen.

Emerging Chinese-Russian cooperation on the Yamal Peninsula
If offshore projects remain a question for the future, onshore cooperation in the Arctic is already advancing.
In February 2013, the head of Novatek visited China as part of an official Russian delegation to discuss opportunities for cooperation on its main Arctic project, Yamal liquefied natural gas (LNG).

As a result of this visit and several subsequent rounds of negotiations, on 5 September 2013, Novatek and CNPC signed a contract for the sale of a 20 % stake in Yamal LNG.

The agreement includes a long-term contract for the supply of not less than 3 million tonnes of LNG per year to China, which is 18 % of total capacity.
The deal was approved by the Russian Government in November 2013 and signed in January 2014.

Following the breakout of the crisis in Ukraine, Novatek became the target of sanctions and Yamal LNG faced further financial difficulties.
Novatek was forced to seek further engagement with foreign partners and China was among the few remaining alternatives.

In September 2015, Novatek sold the Silk Road Fund, a Chinese sovereign fund, a further 9.9 % of Yamal LNG for approximately EUR €1.09 billion.
In December 2015, as part of the deal, Novatek received a loan from the Silk Road Fund of EUR €730 million for a period of 15 years to finance the project.

As a follow-up to these advances, on 29 April 2016 Yamal LNG announced the signing of agreements with the Export-Import Bank of China and the China Development Bank on two 15-year credit facilities of a total amount of EUR €9.3 billion to finance the project.

China will therefore provide up to 60 % of the necessary capital to implement the project.

Despite this impressive track record of cooperation on Yamal LNG, two problems reveal the limits of possible Chinese-Russian energy cooperation.
1st, Novatek had serious difficulties in securing Chinese financing for the project.

The deal was only concluded after numerous delays and negotiations.
2nd, China also received huge benefits from the deal, since up to 80 % of the equipment for Yamal LNG will be produced in Chinese shipyards.

This shows that, despite China's interest in energy projects in the Arctic and Russia's eagerness to obtain Chinese partnerships, there are a lot of difficulties ahead.
Chinese companies will work on projects that they are interested in only under conditions that they find acceptable.

Thus, Russia will have to offer good conditions to attract the Chinese and develop Chinese-Russian energy cooperation.


Looking forward
Despite the stream of positive adjectives flowing from both Russia and China in recent months about partnership and friendship, cooperation in the Arctic has not progressed much.
Except for cooperation on the Yamal Peninsula, Russian and Chinese companies have not yet found further mutual ground for energy cooperation in the Arctic.

On the one hand, Russian companies need and welcome Chinese investments and loans; on the other hand, they are not entirely comfortable allowing Chinese companies to play too big a role in Russian energy projects, including those in the Arctic.

Chinese companies, in contrast, are in a very strong position at the moment and would not agree to anything less than a significant controlling and management role.

As a result, there is a degree of disappointment in Russia that energy cooperation with China has not developed as anticipated and thus has not mitigated the crisis with the West to the desired degree.
Seen from Russia, China has taken advantage of the situation, for example to extract especially favourable terms on energy deals and to insist on high interest rates on major Chinese loans.

That is, China has not shown the expected goodwill, which is why using the Chinese-Russian partnership as leverage against the West has not worked.


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