Energy Cooperation between Kazakhstan and China

Усен СулейменEnergy cooperation is an important aspect of bilateral economic trade between Kazakhstan and China. China’s economy, while growing at an unprecedented pace, is nonetheless encountering acute shortages of hydrocarbons. As a consequence, the intensification of foreign energy arrangements with energy supplier-countries is becoming increasingly important for Beijing. In this respect, Kazakhstan, as one of the area’s major mineral resources exporters, is of particular interest to China.

Since the establishment of diplomatic relations in 1991, Astana and Beijing have agreed to support the economic entities of the two countries by carrying out several energy cooperation projects including: (a) the construction of the Kazakhstan-China crude oil and natural gas pipelines; (b) the exploitation and development of oil and natural gas; (c) the processing of oil and natural gas; and, (d) the construction of new power facilities and the transmission of electricity to third country markets.

Concomitant with their pursuance of the large-scale oil and gas projects, both sides intend to intensify efforts towards implementing important projects in the field of non-raw materials, improving the investment environment and actively supporting companies of the other side in investing in the respective domestic markets. Also welcome will be companies in the fields of oil and gas machinery and equipment manufacturing, food, the textile industry, transportation, logistic services, metallurgy, building materials and tourism. Moreover, both sides will strive to increase the rail cargo-shipping volume and to explore the possibility of constructing a new railway between Kazakhstan and China. They have further agreed to in-depth exploitation of the potential of transit transport and to promote the establishment of an international transit passage that will guarantee goods transportation in the Euro-Asian region and within the borders of Kazakhstan and China.

In general, the two countries’ interests coincide: the key aspects of their mutually beneficial cooperation are energy and hydrocarbon-resource projects. Kazakhstan, now Central Asia’s energy leader, accounts for the bulk of the region’s hydrocarbon resources, i.e. oil and natural gas. With its small population size and low consumption level, Kazakhstan is a significant net exporter of hydrocarbons in Central Asia.  However, the bulk of its exports had to pass through Russian territory or Russian-owned pipelines. At the same time, since the mid-1990s, China has increasingly needed more oil imports to maintain its economic growth.  Also, China seeks to reduce its dependence on marine imports by sea due to “the Malacca Dilemma” and the instability of some Middle Eastern and African countries.

The same mutual desire could be seen during the September 2013 visit to Kazakhstan by new Chinese President Xi Jinping that led to the signing of energy deals worth $30 billion, including China National Petroleum Corporation’s (CNPC) acquisition of an 8.3 percent stake in Kashagan, the largest oilfield in the world outside the Middle East.

The fact that Kazakhstan’s oil consumption is substantially lower than its production enables it to export oil massively. In the past, the biggest barriers to oil exports were limited transportation and infrastructure. In 2003, the newly constructed Caspian Petroleum Consortium (CPC) line to the Black Sea was put into effect. The subsequent increase in oil exports from the Tengiz and Karachaganak oilfields contributed significantly to the increase of oil production. Also, during the period 1990 to 2010, the country’s oil consumption decreased drastically from 21.7 million tons to 9.7 million tons mostly due to increasing energy efficiency and substitution with natural gas.  As a result, Kazakhstan’s oil exports on a net basis skyrocketed from 1.9 million tons in 1992 to 67.1 million tons in 2010. Kazakh oil exports continue to grow rapidly, with infrastructure delivering it currently to world markets via the Black Sea (via Russia), the Persian Gulf (via swaps with Iran), the north pipeline and rail to Russia, and now via oil pipelines to the East to China.

Currently, the cheapest route for Kazakhstan’s oil exports is via the Atyrau-Samara pipeline, which connects to Russia through its oil pipeline network. KazTransOil and Transneft jointly own it. The transit tariff is $0.73/tonne/100 kilometres—in other words, around $2-3 per barrel, excluding the tariff through Kazakhstan. However, both the capacity of the Atyrau-Samara pipeline and current agreements between Russia and Kazakhstan limit shipments through this route to 15-17.5 million tons a year. For this reason, government-owned or affiliated oil companies get priority rights to use this pipeline.      

The second most feasible route is the Caspian Petroleum Consortium with its tariff set at $3.70 per barrel. Use of the CPC’s capacity, however, is restricted to CPC members; and, while they may reassign their capacity to third parties, this requires the approval of all members of the consortium.

Another alternative is for Kazakh producers to ship oil from the port of Aktau in western Kazakhstan across the Caspian Sea to the eastern shore ports (Baku/Makhachkala), and from there on by rail to either the Russian port of Novorossiysk or the Georgian port of Batumi. The Baku-Novorossiysk oil pipeline has a limited throughput and cannot be a strategic export route. Another profitable trans-Caspian export pipeline, the Baku-Tbilisi-Ceyhan (BTC), became available in 2005. The total expense of shipping through the BTC pipeline amounts to $3-4 per barrel, including tanker and offloading costs. But here, the main problem is that Kazakhstan has limited export infrastructure because approximately 80 percent of Kazakhstan oil exports still depend on Russian-controlled pipelines and railway systems.

In December 2007, the Chinese National Petroleum Company pledged to invest $2.2 billion in a 1,800-kilometre, 1.06 trillion cubic feet/year natural gas pipeline that would run from Turkmenistan through Uzbekistan and Kazakhstan to China. According to the construction plan, the pipeline is expected to start at Gedaim on the border of Turkmenistan and Uzbekistan. Approximately 520 kilometres would run through Uzbekistan and the rest through Kazakhstan to reach Khorgos in China’s northwestern Xinjiang region. In August 2006, Turkmenistan and China signed a 30-year supply agreement for the gas that will fill the pipeline. The CNPC has set up two entities to oversee the Turkmen upstream project and the development of the second pipeline that will cross China from the Xinjiang region to demand centers in southeast China. The total cost of the entire project is expected to be in the vicinity of $7.31 billion. Also, Russia is planning a natural gas pipeline to China (International Energy Agency (IEA) 2008).

Approximately 30 percent of Kazakhstan’s coal production is for export, mainly to Russia and Ukraine rather than China. Although its coal is inexpensive to produce, there are questions surrounding the perceived profitability of exports due to the long distances involved.

There are two reasons why coal in Kazakhstan is not being exported to China. First, the markets for Kazakh coal in the former Soviet Union were under contract, meaning that from 1990 on, a certain portion of coal exports to Russia was contract-based; then, from 1999 on, the remainder was only to meet the country’s internal demand, notwithstanding the expansion of the economy. Second, China has large coal reserves, especially in its north-western provinces, e.g., Shanxi and Inner Mongolia.

Thus, it is not economically efficient for the north-western and central parts of China to import coal from Central Asia. In eastern China, coal is imported from Vietnam and Australia.  Thus, in effect, cooperation between Kazakhstan and China in the coal sector is reasonably limited.

As mentioned, China became a net importer of oil in 1993 when its demand for oil surpassed its supplies of oil.  By the end of 2002, it had overtaken Japan to become the second largest oil consumer behind the U.S. The net import dependency of oil soared from 7.5 percent in 1993 to 53.3 percent in 2011 (IEA, 2012). The Middle East is the principal source of China’s oil imports, accounting for 40.4 percent in 2005. A further 21.1 percent came from the Asia Pacific region, approximately 23.1 percent from Africa, and 11.7 percent from the former Soviet Union (IEA, 2012).

The main way of importing China’s oil is by ocean tankers, which accounts for 93 percent of the total. But, almost 80 percent of these oil imports pass through the Strait of Malacca, exposing China to the insecurities of overdependence on a congested passage. So China realized its need to start looking for new supplies for oil. It was agreed that Russia and Central Asia, particularly Kazakhstan, would account for an increasing share of China’s oil imports by means of oil pipelines.

According to the IEA (2007), China’s dependence on imports will rise from about 50 percent of consumption in 2007 to 80 percent in 2030, considering that the potential for increasing domestic oil production is small and the demand for oil is large and growing. The gradual increase in the country’s oil imports resulted from the stagnation of domestic oil production and a surge in domestic oil consumption. Although China became the fifth largest oil producer after Iran, the U.S., Russia and Saudi Arabia in 2007 (IEA, 2008), the growth rate of oil production lagged behind that of oil consumption, a situation borne out by BP statistics. Between 1990 and 2010, the average annual growth rate of oil production was 1.8 percent whereas that of oil consumption reached 7.3 percent (BP, 2011).

The stagnation in oil production is due to limited oil endowment and the aging of the country’s major oilfields. Although China discovered the Jidong Nanpu oilfield offshore of the Bohai Gulf in 2007, representing the biggest find in 40 years and the largest offshore discovery ever in China, the growth rate of domestic oil output will likely be moderate (CNPC, 2007). This discovery, while undoubtedly easing the domestic oil supply pressure, is unlikely to reverse the upward trend of China’s oil imports.

Given that most international agencies, with the exception of OPEC, have predicted that oil production will increase from 184.8 million tons in 2006 to only 189.2-199.2 million tons in 2020, the country’s net import dependency is set to go north. China’s demand for natural gas increased remarkably from 15,250 million cubic metres (Mcm) in 1990 to 69,523 Mcm in 2007, generating pressure on the supply side. China imported 950 million cubic metres of liquefied natural gas (LNG) for the first time in 2006: its natural gas imports are projected to increase sharply from 1,200 Mcm in 2010 to 2,800 Mcm in 2015 and 12,800 Mcm in 2030 (IEA, 2007).

Most of its imported gas will come by pipeline from neighbouring countries. Beijing has mooted several large-scale pipelines to bring supplies from abroad, among which is a 3,000-kilometre pipeline from Kazakhstan to Khorgos in Xinjiang, which is due to come on-stream in late 2014. This pipeline will carry gas mainly from Turkmenistan, which, as mentioned, in 2006 signed a 30-year deal with China to deliver 3,000 Mcm of gas annually, but also from other Central Asian countries. It will ultimately connect with China’s planned second west-to-east natural gas pipeline. Its capacity will be 1,000 Mcm per year initially and will rise to 3,000 Mcm per year by 2014.

In addition, the CNPC signed an agreement with Exxon (U.S.) and Russia’s Rosneft for an 800 Mcm capacity pipeline from Sakhalin-1 Island to the Khabarovsk region. The latest report shows that Sakhalin-1 gas supplies to the Khabarovsk region will reach 10 bcm by November 2013. Two other agreements were also signed between the CNPC and Russia’s Gazprom in 2006 to import gas through pipelines running first via an as yet undetermined route from western Siberia to China’s Xinjiang, and second from eastern Siberia to Heilongjiang Province in north-east China. These lines will have a combined annual capacity of 3,000 Mcm per year, with delivery targeted for 2013 (Economist Intelligence Unit (EIU), 2007).

Other gas imports will include liquefied natural gas (LNG) shipped in by tankers. The first LNG terminal, which was built by BP and the Chinese National Overseas Oil Company (CNOOC) in Shenzhen, opened for business in June 2006. Initially, the $10 billion project aimed to allow the import of 450 Mcm of LNG each year from Australia and up to 1,100 Mcm annually by 2008.  BP has a 30 percent equity stake in the project, while CNOOC controls 33 percent Six 320 MW gas-fired power plants will ultimately be fed by gas piped from the terminal (Asia-Pacific Economic Cooperation (APEC), 2006).

The Shenzhen LNG terminal is only the first of a dozen terminals planned along China’s coast. The second, which is located in Fujian province, opened in April 2008. So, now there are five LNG terminals planned to operate in China, including Shanghai (October 2009), Jiangsu (November 2011) and Dalian (November 2011). These projects will provide fuel to dozens of gas-fired power plants being constructed in tandem with the terminals or being converted from existing oil-fired facilities—part of a plan to boost gas-generated power from 960,000 kWh in 2000 (some 0.3 percent of the national total) to 2.8 billion kWh by 2020 (IEA, 2007).

China’s coal consumption increased from 1,055 Mt in 1990 to 2,897 Mt in 2010. Largely due to the transport bottleneck deadlock alluded to above, China’s net imports of coal climbed from 17.3 Mt to 59.8 Mt per year, with its self-sufficiency rate of coal dropping from 115.3 percent in 1990 to 102.2 percent in 2010 (China Statistics Yearbook, 2011). IEA reported that China has been a net importer of steam coal since 2007, its coal imports mainly meeting the demand in the country’s coastal provinces (IEA, 2011). Key suppliers in 2030 will be Indonesia, Australia, South Africa, Mongolia, Vietnam and Russia (IEA 2007). As Kazakhstan is situated on the west side of China, Kazakh coal will not be an ideal item for Kazakhstan-China energy cooperation.

Chinese decision-making regarding the purchase of oil and gas fields has been affected by the fact that Beijing was a late-comer in the Kazakhstan market. For this reason, in the early stages, China could only acquire sites of relatively marginal importance (as it did in Africa). Despite these negative initial conditions, Beijing’s purchases are still commercially rational. It invests in fields located in the Aktobe region and near the Caspian Sea, areas that are situated around the energy center of Central Asia. As well, it is also involved in more isolated fields that have the advantage of being located along the path of the Kazakhstan-China pipeline.

In 1997, the CNPC acquired 60 percent of the shares of the oil company Aktobemunaigaz, which is based in the Aktobe region. It also acquired a 20-year user license for the Zhanazhol gas site and the Kenkiyak oil site. In its own interests, and in a bid to gain favor with Kazakh authorities, the CNPC committed to investing $4 billion by 2010, of which $540 million would be made available in the first five years. In 2005, the CNPC launched its largest foreign acquisition, i.e., Petrokazakhstan (formerly Hurricane Hydrocarbons). The CNPC outbid its Indian competitor Oil and Natural Gas Corp (ONGC) by offering the sum of $4.2 billion.

Rationales of Energy Cooperation between Two Nations

Energy Rationale. The Kazakhstan-China energy cooperation is principally based on the simple fact that China needs to import energy for development and Kazakhstan needs to export energy to maintain its economic growth. Although China is a larger crude producer, its far greater population and rapid economic growth since the 1990s have transformed the country into a net importer of oil. In contrast, Kazakhstan is not a particularly big crude oil producer: its crude production was only 36.8 percent of China’s in 2007 (IEA, 2009). However, the country’s very small population and total amount of consumption sizes make Kazakhstan a significant oil exporter in Eurasia.

Both countries have adopted diverse strategies for energy trade. Currently, China’s crude imports are heavily dependent on the Middle East and Africa, countries that are politically unstable and suffer from active terrorism and sabotage. In 2005, the Persian Gulf and Africa accounted for 46 percent and 31 percent respectively. China would like to reduce its dependence on Middle East and African oil by creating alternative sources. On the other hand, for historical reasons, Kazakhstan’s oil exports have been overwhelmingly dominated by Russia’s network. Before the operation of the BTC, virtually all of Kazakhstan’s oil exports were towards Russia, or via Russia’s pipeline. Thus, selling oil to the East also meets the strategic interests of Kazakhstan energy trade policy.

Geopolitical Rationale. The energy rationale itself is not enough to justify certain forms of energy cooperation, e.g., building transnational pipelines, because such pipelines are expensive and unlikely to satisfy a significant proportion of China’s energy imports. This is also the reason why the two countries’ energy collaboration has been put on hold more than once. To understand the reasons for the two countries’ large-scale cooperation in the energy sector, certain geopolitical rationales need to be considered.

Broader Bilateral Cooperation. There are three forms of energy cooperation: cooperation of energy, cooperation for energy and cooperation by energy. The dimension of “cooperation by energy” needs to be taken into account. While Kazakhstan and China have not been significant economic and geopolitical partners, China’s need to import Kazakhstan’s energy has opened the door for broader cooperation. For example, the Kazakhstan-China trade turnover increased substantially from $1,557 million in 2000 to $25,113 million in 2012. Moreover, bilateral economic trade was not limited to energy; China’s exports toward Kazakhstan, presumably non-energy goods, grew even faster than China’s energy imports from Kazakhstan.

China’s Western Development Programme (or Strategy) and Xinjiang’s Strategic Importance. In order to narrow the income gap between Western and Eastern China, while at the same time living up to Deng Xiaoping’s promise and acknowledging the seriousness of the situation, in 1999, then President Jiang Zemin announced the Western Development Program (Holbig, 2004), which comprises six provinces (Yunnan, Guizhou, Sichuan, Shaanxi, Gansu, and Qinghai), five autonomous regions (Guangxi, Ningxia, Xizang, Inner Mongolia, and Xinjiang), and one municipality (Chongqing). The programme is considered the centerpiece of the leadership’s effort to strengthen national unity and integration.

 

To achieve the goals of the programme, it seemed important to create stronger economic ties between Western China and Central Asia. Even more importantly, economic cooperation between the Xinjiang Uygur Autonomous Region and Central Asia could help develop the local economy and, to some extent, reduce the attractiveness of Xinjiang separatism. Moreover, the Kazakhstan-China energy cooperation largely matches the economic structure and development strategy of Xinjiang. In 2000, for example, oil, gas and other extractive resources played a dominant role in the industrial sector, accounting for 61 percent of Xinjiang’s GDP. It comes, then, as no surprise that the region is considered the “oil tank” of China.

Symbolic Benefits. Besides “real” benefits, there are several important symbolic benefits of the cooperation. First, it serves as a platform to counterbalance the soft power of Russia and increases Beijing’s and Astana’s bargaining power when it comes to negotiations over energy with Russia. For example, the construction of the Kazakhstan-China oil pipeline already worried the Russian companies as they (wrongly) believed that China would not need Russia’s oil and the future Sino-Russia pipeline. Second, the cooperation is a successful hallmark of the Shanghai Cooperation Organization (SCO), which encourages integration of the Central Asia energy sector. It has increased SCO’s ‘soft power’ and regional influence vis-a-vis the United States and its ideology. Third, completion of the Kazakhstan-China oil pipeline will substantially reinforce confidence in, and the professional images of, the two governments’ energy companies. The pipeline will be constructed without technological support from third parties. This will gain the trust of other countries and motivate them to consider cooperating with Kazakhstan and China.

The author is Ambassador-at-Large at the Ministry of Foreign Affairs of Kazakhstan. This article is written with the support of the Samruk-Kazyna Sovereign Wealth Fund.