CENTRAL ASIAN ENERGY: The turning point

02/05/2010 | Simon Pirani

A major dilemma for central Asia’s economic development is how the region can avoid being reduced to the role of a raw materials supplier to China

China is setting the pace economically in central Asia, as a gluttonous consumer of raw materials, a provider of capital and an exporter of consumer goods.

Natural gas deliveries through the new Turkmenistan-China pipeline, which are this spring being ramped up from small test volumes to around 25 million cubic metres daily, amount to extra proof that the economic balance of power has shifted away from Russia, eastwards.

Until now, Turkmenistan relied on Soviet-built pipeline systems, and had to export almost all its gas to or through Russia, plus a small quantity to Iran. Now it has another big, hungry customer, which may buy up to half its output within a few years – and is providing billions of dollars in soft loans for capital investment. The pipeline, commissioned in December, passes through Uzbekistan and Kazakhstan. It will also supply China with gas.

China’s gas market breakthrough follows its success in securing a significant equity in Kazakh’s oil production, and a sizeable share of exports. The Kazakh-Chinese oil pipeline, after last year’s upgrade, is expected to take nearly one-third of Kazakhstan’s current exports. Uzbek and Kazakh metals resources, too, are on the Chinese finance-and-buy list.

Russia has lost its near-monopsony – a market where there is one buyer but many sellers – on Turkmen gas, and its predominance over Kazakh oil. It will have to amend its plans to expand its own raw materials exports eastwards to take account of central Asian competition. Supplying raw materials to China and Europe, rather than to Russia, looks increasingly like the predominant factor in central Asia’s economic destiny.

MONEY TALKS

In the 18 months since the US financial meltdown, China has had an abundance of capital at a time of scarcity – and has seized the opportunity to tie long-term export agreements either directly or indirectly to generous loans.

It has financed the pipeline from Turkmenistan, and last year extended a $4 billion Chinese Development Bank loan to Turkmengaz to develop the Yolotan-South Osman gas field, one of the world’s biggest. More cash should follow, possibly to be repaid with gas.

China also provided $10 billion of loans to Kazakhstan last year, including a $5 billion deal for Kazmunaigaz, the state-owned national oil and gas company, to finance purchase of a competitor, and $5 billion to the state-owned Development Bank of Kazakhstan (DBK). Kazakhmys, the London-listed copper producer, was another beneficiary: in December it secured a $2.7 billion loan from the Chinese Development Bank and SamrukKazyna, the Kazakh sovereign wealth fund, mostly to invest in the Boschekul copper project, which will serve sharply increasing Chinese copper demand.

Central Asia is not China’s only investment-for-resources target. Last year it lent $25 billion to the Russian state oil companies Rosneft and Transneft in return for long-term offtake contracts, and did similar deals in Australasia and Africa.

Aleksandra Evtifyeva, senior economist at VTB Capital in Moscow, says China’s export strategy, as well as its need to secure raw materials, drives such deals. “China has adopted this strategy in central Asia and beyond. The loan capital is not only to secure natural resources but also to underpin purchases of Chinese goods and services.”

A direct consequence of the loan spree – for which interest rates are about 6% annually – is that some of central Asia’s best credits will return to financial markets more slowly. Arman Kassenov, DBK managing director, said last month that plans to issue a $500 million Eurobond will likely be cancelled, “as we have enough liquidity for this year at least” after taking the Chinese credit lines.

Jeffrey Woodruff, senior director at Fitch Ratings, says that China’s aggressive lending spree would reduce demand for debt from central Asian and Russian companies. “China wants the energy supplies, has a huge capital base to help secure them, and may be able to offer better rates than western lenders for some time going forward,” he says.

Tatyana Kalachova, oil and gas analyst at Renaissance Capital in Almaty, says that China lends in line with strategic economic objectives. “This money is offered to large state-owned companies in central Asia – not to small private ones – and the deals are arranged at political level.”

GAS VOLUMES

For Turkmenistan, the completion in December of the gas pipeline to China, through which it will export 30 billion cubic metres (bcm) of gas per year from 2013, is probably the most important economic turning-point since the collapse of the Soviet Union.

Russia has always used Turkmenistan’s lack of alternative export routes to keep gas export prices down. Only in January last year did Russia, aware that its monopsony was about to be broken, offer for the first time to pay European-linked prices (above $300 per thousand cubic metres) for Turkmen gas. But that was also the moment when gas demand in Europe, and in Russia itself, plunged as a result of the economic crisis.

In April last year the main Turkmen gas pipeline to Russia was damaged by an explosion, for which each side blamed the other. Although it was fixed in three days, Russia then announced it would not start buying Turkmen gas again unless prices were lowered.

Russian exports did not restart until January, and are expected to be about 10 bcm/year, one fifth of their previous level, at least for the medium term. So the Chinese pipeline came none too soon.

It is part of a wider relationship: when in December Turkmenistan awarded $9.7 billion of contracts to develop the South Yolotan field, China National Petroleum Company was the lead player with $3.1 billion-worth.

Turkmenistan, which last December also completed a pipeline to raise exports to Iran, is expected within the next three years to move from almost total dependence on gas exports to a single customer, Russia, to three-way diversification.

Bobo Lo, a London-based academic expert on Russo-Chinese relations and author of Axis of Convenience, says China’s Turkmen gas deals will make life difficult for Russia as a would-be gas exporter to China. “Prime minister Vladimir Putin has promised three times in the last four years that a gas export deal would be done with China, but prices could not be agreed. Now China is importing from Turkmenistan and is in a better bargaining position with Russia.”

And while Russia loses ground, Europe still struggles to get on the playing field. The difficulties surrounding the Nabucco pipeline – the rationale of which is to bring gas from central Asia and the Caucasus to Europe, avoiding Russia – were highlighted last month, when European energy commissioner Guenther Oettinger said it probably will not be ready until 2018 at the earliest.

He hastily withdrew the statement after Nabucco managing director Reinhard Mitschek reiterated that he is aiming for a 2014 start-up – but the project is still far from securing the minimum necessary gas supplies needed.

While Europe has talked Nabucco, China has won agreement for, financed and built the 1,833 kilometre gas pipeline from Gadaim on the Turkmen-Uzbek border to Horgos in western China, where it joins CNPC’s 4,000+ km west-east pipeline to Shanghai.

MORE TO PLAY FOR

While the economic crisis reinforced Turkmenistan’s determination to open the gas export route to China, in Kazakhstan it strengthened Beijing’s hand in a longer-running competition for oil exports with US and European companies.

The three large fields from which Kazakhstan will ramp up production in the coming years – Tengiz, Karachaganak and Kashagan – are all being developed with the participation of US and Europe-based oil majors. China, however, is taking the lead. It has completed the second phase of its pipeline from Kazakhstan and lent $5 billion to Kazmunaigaz. It has also invested equity: the Chinese sovereign wealth fund bought 11% of Kazmunaigaz’s London-listed production subsidiary, Kazmunaigaz Exploration and Production (KMG).

On top of that, CNPC subsidiaries including Aktobemunaigaz and PetroKazakhstan now produce about one-fifth of Kazakhstan’s oil. Chinese companies are moving into downstream sectors: last month Kazakh deputy oil and gas minister Aset Magauov announced that Sinopec Engineering of China, with loan support from China’s Eximbank, will build a $1.3 billion polypropylene plant at a new $6.3 billion gas processing plant in western Atyrau.

Short term, Kazakh oil exports to China will be limited by the pipeline’s capacity. But Stanislav Zhukov, economist at the Institute of World Economy and International Relations (IMEMO) in Moscow, says that in the longer term the two countries are “natural partners” – they share a common border, and there are synergies between Kazakh fields and China’s own oil deposits in the Xinjiang-Uighur region. In this decade “not only Xinjiang, but also the Gansu, Lyaoning, Henan and Hunan provinces will increasingly depend on oil from Kazakhstan, and perhaps from Russia” he says.

Observers say there is a political element, too: Kazakh prime minister Karim Massimov, a Chinese speaker educated in Beijing, has publicly declared the aim of balancing foreign economic policy between Russia and China.

These ties will only get stronger. China’s trade with central Asian countries is likely to grow in line with its own economic, political and demographic advance. Nargis Kassenova, assistant professor at the Kazakhstan Institute of Management, Economics and Strategic Research (KIMEP) in Almaty says: “China’s influence is growing at a speed unrivalled by other external actors, and will continue to do so. It is next door, its economy is way too dynamic, and there is political compatibility between China and central Asian governments. It will be interesting to watch how increasing nationalist anti-Chinese sentiments will play against bigger dependence on China.”

China’s need to increase its imports of oil, gas and other raw materials, and to find new markets to which to export its manufactured goods, will drive this process in the next few decades, says Zhukov.

Chinese exports to the CIS (Commonwealth of Independent States) have soared from just 1% of total exports in 2000 to 6% in 2008 – $72 billion, of which about $7 billion were customs-cleared exports to central Asia. There is undoubtedly a significant black market element too. “China is successfully adapting to the role of industrial workshop for the post-Soviet space, leaving few chances for the latter to develop its own significant processing sector,” he says.

A major dilemma of central Asia’s future economic development will be how it can avoid being reduced to the role of a raw materials supplier to China.

Bobo Lo says China’s motivation in central Asia is primarily economic, but that it is bound to become a political player too. “China doesn’t want to be a dominant power in central Asia,” Lo says. “People in Beijing are not keen about the idea of a Sino-US ‘G2’ which implies great responsibilities of leadership. But, while China’s initial motivation is economic, it has power and influence and will increasingly take a strategic view.”

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