Mind the claws

Russia puts gas-hungry China in a bear hug

Russia has signed a long-awaited gas pipeline deal with China, and it leaves the People's Republic in a bear hug. Russia gets a new market outside the increasingly frosty European Union. Oil major PetroChina gets to balance out some losses from low regulated prices at home. But the optics of the deal shred Beijing's pretensions to political neutrality.

Russia could use a friend. EU countries have been planning to diversify supply away from dependence on Russia, which provides a third of their energy needs - especially after a dispute in 2009 saw gas cut off. Annexing Ukraine's southern Crimea region has raised the temperature further. New pipelines from places like Azerbaijan are designed to limit Moscow's leverage.

China presents Russia with a more willing customer. Its ravenous energy needs provide stable demand, which previously looked like it would have to be met by more inconvenient sources, like Australian and U.S. liquefied natural gas. Under the new deal, Russian state energy group Gazprom will supply Chinese counterpart PetroChina with up to 38 billion cubic metres a year, around 12 percent of China's target demand in 2018 according to Alliance Bernstein.

The timing looks good for PetroChina, which handles all pipeline imports of natural gas into China. Below-market tariffs set by Chinese regulators leave it in the red. PetroChina's average selling price of gas is $6.30 per thousand cubic feet according to CLSA analysts. Yet imported Central Asian supplies cost around $10 per thousand cubic feet, with LNG around $15. That drove PetroChina to make a loss of around 42 billion yuan ($6.7 billion) importing gas last year. Every bit of costly LNG this deal replaces will help.

The big question is where the deal leaves China itself. True, access to more natural gas would allow a shift from dirtier coal power, and cheaper supply would allow market-oriented price reforms at home. But the cost is that China will now be seen as an ally to Russia, which seemingly cares ever less about international views on its robust foreign policy. For Beijing, low-cost gas could come at the expense of the political neutrality that has opened numerous doors for Chinese trade and investment. That won't be won back quickly.