Oil and Gas in the Capitals

Recent events have cast a shadow on the Kremlin’s goal to reroute part of its oil and gas production to the east.

Do you remember where the situation stood at the end of last spring? By then, we were in the middle of the post-Fukushima trauma. Nuclear energy was seen, at best, as a diminishing option in several countries, even excluded totally by some. Power shortages were a problem in Japan, and more were expected to come. In that context, it was logical to look at other options, among them development of Russian natural gas exports to the region. This was the starting point in low-key cooperation among some regional countries and Russia to look at the future.

Russia’s interest has clearly been to expand its reach toward East Asia for a number of reasons. The first was a classical rebalancing of its potential customer portfolio to diminish its dependency toward Europe. The second one, which received a stark confirmation by Fall 2011, was the coming recession, or even depression, in the Euro Zone. With the accumulation of so-called “austerity plans” in nearly every country for the sake of fighting the European Monetary Union crisis, the zone’s economy would suffer. By November, OECD had forecast GDP growth of 0.3% for 2012, confirming the recession. As the situation now develops, this view could be seen as optimistic.

The third reason was the growing and seemingly endless Chinese appetite for energy, and the fact that reliance on coal was beginning to be questioned in China on the face of its effect on the environment. Fourth, ideological reasons had to be factored into the situation.  The Moscow government’s growing uneasiness with Washington was clearly pushing Russia to renew its links with China. The current situation in Moscow after legislative elections is even adding some water to the pro-Chinese river, despite whatever problems remain between both countries.

For all these reasons, since publication of the long-term energy strategy, a switch toward East Asia was unmistakable in Russian diplomacy. It fit very well with Putin’s own authoritarian overhaul in the face of a weakening of then-President Medvedev’s liberal modernization.

The very fact that some East Asian countries could invest capital and technologies in the hydrocarbon sector was also seen as an important, potential development factor. Some negotiations took place last summer with Japanese and Korean firms to improve infrastructure in Sakhalin and to build a new LNG facility intended to supply both Japan and Korea.

There is no doubt that all these reasons still have strong validity. The informal contacts maintained between Russia, China, Japan and Korea are certainly a good omen. However, their short-term relevance could become less obvious.

First, there is to be a large revision of Korea’s energy strategy with the publication of a major document by next spring. This is clear, when one hears from officials that the post-Fukushima trauma is now overtaken. The current mix of coal and nuclear power could be vindicated again. Of course, one has to expect some public reaction, where anti-nuclear feeling is still very strong. But this would, at best, prevent a revision of current policy until Spring 2012 and new elections.

Second, China is less hurried to come to an agreement with Russia on natural gas, as it ponders the possibility of developing its own shale gas resources. Here again, shale gas should not be seen as a panacea. Its environmental impact is now better assessed. But the fact that Chinese resources in this field are in a process of re-evaluation is making a wait-and-see policy an option, at least in the short term. Quite obviously, Chinese officials would try to obtain major Russian concessions, as far as gas prices are concerned. Also, the slowing down of Chinese growth and the very possibility of a hard landing for China’s economy is adding weight to this policy.

This still does not answer the Japanese question. Here, the anti-nuclear feeling is very strong, the TEPCO company has lost its credibility, and some exit from nuclear energy is inescapable. This raises, of course, the issue of which energy source could replace nuclear power, if necessary.

Another question left unanswered is how to stabilize the political situation on the Korean peninsula. One hidden advantage of increasing the natural gas share of South Korean energy consumption would be the economic and political consequences of building a gas pipeline from Manchuria through the peninsula. Whatever the rhetoric of the South Korean government, the idea of disciplining the maverick North Korean regime with a stick-and-carrot policy is still a priority for all neighboring countries, including China and Russia. But, on the other hand, is it a priority of the South Korean government?

This leaves Russia “undressed,” if not “naked,” at the worst possible moment. Forecasts of European demand for oil and gas are now very gloomy and not expected to improve before two or three years.

Thus, Russian officials have the incentive to advance quickly in East Asia, if they really want to enter that market and develop the Sakhalin-Vladivostok region. But, the only negotiating chip they hold is gas prices. If Russia makes important concessions in this matter, it could probably persuade the Chinese to enter the strategic game that Moscow is eager to play.

The question now on the table is to what extent diminishing European demand will drive down prices, so that Russian concessions to China would be more acceptable to Moscow leaders in the global context of diminishing prices. The answer to this question will probably be known by early Spring 2012. When we hear it, we will know whether Russia will actually switch to Asia, at least partly.  WO