A long term gas supply deal with China brings new life to the Power of Siberia 2 pipeline and upgrades Russia’s gas arsenal
In early February 2022, Gazprom made a small but crucial step in upgrading the potency of its natural gas weapon. Gazprom and the China National Petroleum Corporation (CNPC) signed a long term sales and purchase agreement, a deal paving the way for closer Sino-Russian partnership and the realisation of the Power of Siberia 2 pipeline. This pipeline would increase Russia’s ability to easily divert gas volumes destined for Europe to Asia. Russia will acquire even more leverage in using natural gas as a tool for pressuring Europe as its dependence on the European market shrinks. This would further undermine Europe’s energy and climate security and calls for immediate action on boosting diversification efforts.
Exploiting the crisis: Russia is undeniably playing a key role in the energy crisis that has been raging over European markets since mid-2021. By cutting spot natural gas sales to Europe at a time of higher demand and low storage levels, Gazprom is reaping windfall profits from the record-high gas prices, and is filling up state coffers for further military escapades. At the same time, it is pressuring the EU to licence into operation the Nord Stream 2, a pipeline that would help circumvent transit through Ukraine, expand Russia’s market share in Northwestern Europe and solidify its dominance over Central and Eastern Europe, with the added bonus of weakening Ukraine’s economy in the process.
Even without Nord Stream 2, the power that Russia is currently wielding thanks to its dominant position in the European gas market is apparent in the indirect effect it has on the political and even military sphere. The surge in gas prices across Europe, which has filtered through to record-high electricity prices and overall inflation, are contributing to political instability across the EU. National governments are resorting to extreme measures to limit the pain on consumers and the economy and to avoid a social backlash. The situation may worsen further amid the imminent threat of a potential Russian invasion in Ukraine that is closely linked to the risk of a complete halt of Russian gas supplies to Europe. In fact, Russia leverages the threat of a gas supply cut to pressure European governments not to take a firmer stance against Russia in the event of a military conflict.
To reduce the growing security of supply risks, European countries are putting in a strong effort to secure alternative gas supplies, i.e. from LNG imports, which in January 2022 reached a record high of 9.5 million tons, as well as from non-Russian pipelines, coming from into the EU form North Africa and the Caspian Basin. Even with all extraordinary measures, however, a complete halt of Russian gas supplies cannot be fully compensated. Typically, Russian pipeline gas accounts for about 30-40% of European gas consumption. Meanwhile, LNG exports cover around 20% of demand, or less than 100 bcm in 2020. In very simple terms, even if LNG imports remain close to the record high rate from January, this would cover less than half of the potential shortfall from Russia, sending spot gas prices through the roof.
The limits to the Russian gas weapon: Yet paradoxically prices have fallen by half since the record levels of December 2021. One crucial reason is that energy experts and the market itself do not believe that Russia will cut all supplies to Europe – for a very good reason. The true limit of Russia’s gas weapon lies in the fundamental fact that it is a double-edged sword, and the two edges are not made equal. Europe is dependent on Russia for fuel, while Russia is dependent on Europe for revenue. Arguably, diversifying your energy mix is easier than diversifying your economy. For Russia, gas exports to Europe represent more than half of total gas exports. Moreover, these exports are almost exclusively via pipelines and cannot be easily redirected to other markets. Russia’s LNG export capacity is limited, standing at just 40 bcm per year, mainly thanks to Novatek’s Yamal LNG facility. A cut in supply to Europe would not only reduce revenues but more importantly it would undermine Russia’s position as a reliable natural gas supplier leading to a stronger than ever diversification push across Europe.
Power of Siberia 2: A Game Changer: This is exactly why Power of Siberia 2 would be a game changer. Unlike the first line, which is connected to natural gas fields in Eastern Siberia that can only be used to supply China, the second one will be connected to the Yamal field in Western Siberia and the pipeline network that sends gas to Europe. This would not only allow Russia to diversify its export outlets away from its dependence on Europe but also give Gazprom the flexibility to choose between selling to China or to Europe. Unless Europe accelerates its own diversification efforts, the tight interdependence balance will shift in Russia’s favour. Europe’s confidence that Russia would not dare to drastically cut supplies will no longer be justified. Once Power of Siberia 2 reaches maximum capacity, even just a Russian threat to cut supplies to Europe will have a much stronger impact both on European gas markets and on regional geopolitics. And all the sceptics about what the potential effects might be need look no further than what is just going on at Ukraine’s borders when Russia neared the completion of its strategic diversification pipelines – Nord Stream and South/TurkStream.
Gazprom has yet to make the final investment decision on Power of Siberia 2, but the latest deal with CNPC might be a key step in that direction. It will increase Russian pipeline gas supplies to China by only 10 bcm per year, which is just a fifth of the planned capacity of the Power of Siberia’s second phase. Nevertheless, it represents a key breakthrough in the typically tough gas supply talks between Russia and China. The deal for the supply of 38 bcm per year of Russian gas to China, signed at the height of the Crimean crisis in 2014 and, which paved the way for Power of Siberia 1, had stalled for a decade.
The current smaller contract could be part of Gazprom’s strategy to make more incremental steps in the negotiations that may ultimately lead to a faster progress, while giving just enough economic logic for Power of Siberia 2 to move forward. The first line, which came online in 2019, took over 5 years to build. However, Gazprom has already gained experience in the difficult East Siberia terrain, suggesting that it could complete the second phase much faster.
What’s next? The new gas deal between Gazprom and CNPC is also a sign of the closer ties between Russia and China as the two authoritarian countries have deepened their cooperation on a number of economic and political issues. As Chinese demand for Russian and other available gas grows, European buyers will face a tight global market and high prices, with growing uncertainty regarding the stability of Russian pipeline exports.
The Russian-Chinese rapprochement should be a wakeup call for Europe to mobilise its efforts in boosting its energy security. The strong growth of Chinese gas demand is likely to keep the global market tight and prices high. The expansion of Russian gas supply will increase the risk of a Russian gas supply cut-off to Europe. European countries that are excessively dependent on Russian gas will become even more vulnerable to price shocks and gas shortages.
Europe needs to act swiftly in two directions. First, European countries need to accelerate their gas supply diversification efforts by securing alternative gas volumes via LNG and more pipeline imports from North Africa, Iran and the Caspian basin (remember the Nabucco pipeline?). They should also complete the European gas market integration, and seek to eliminate the long-term contracts that have limited competition. Second, Europe needs to reduce its reliance on natural gas in the power and heating sectors by accelerating the uptake of low-carbon technologies, renewables and electrification. There needs to be a stronger focus on storage technologies and demand-side response mechanisms as more sustainable options for ensuring the reliability of supply.
 Rangelova. K., and Vladimirov, M., Beasts from the East and Energy Price Horrors in Europe, Center for the Study of Democracy, Blog, December 2021.
 EU Energy Commissioner, Kadri Simson’s high level visit to Azerbaijan on February 4 2022 is strongly driven by efforts to ensure higher gas supplies to Europe via the TAP pipeline passing through the South Gas Corridor.
 Gas supplies to Europe, Gazprom Export delivery statistics.
 Of these LNG volumes, Russia accounts for a non-negligible share, as a key destination for NOVATEK’s Yamal LNG.
 Exports to Western Europe, at 120bcm in 2020, represented 55% of total exports, at 220 bcm in 2020, according to Gazprom’s 2020 annual report.