Market Capture: China’s Energy Relationship with Turkmenistan

by Ryan McKinley

China’s energy security has become predicated on its ability to secure cheap hydrocarbon imports. This is because China relies on cheap, reliable fuels to keep its manufacturing sector competitive and the lights on for a staggeringly large population. While domestically produced coal has historically played the largest role in in China’s electricity generation and provided a “price ceiling” for electricity prices, imported natural gas has been slowly edging its way into the market. Predictably, China has been looking to its Central Asian neighbors for secure sources of natural gas. To this end, Turkmenistan has become an increasingly important player in China’s energy and economic security. This paper seeks to outline China’s role in Turkmenistan’s burgeoning natural gas sector and explain why the relationship between Ashgabat and Beijing has become so close.

Coal’s Diminishing Returns

The year 2009 marked an important paradigm shift in the history of China’s energy security strategy. It represented the switch from coal self sufficiency to import-dependency – despite China’s incredibly large reserve base. China’s need for more imported coal could exert upward pressure on international coal prices and therefore threaten the competitiveness of its manufacturing sector. This poses a significant risk to economic growth. Some estimates predict that the world coal trade would need to increase by 135% over the next 15 years to meet China’s coal demand, though this figure does not take into account a reduction in coal consumption either due to an economic slowdown or the replacement of coal with natural gas (or renewable resources). Even if the Chinese decrease their energy consumption, domestic coal production simply cannot grow fast enough to keep up with demand.

While coal will still play a large role in China’s energy mix for the foreseeable future, natural gas has begun to take up a larger percent in recent years. The closest and arguably most attractive option for China has proven to be Turkmenistan.

China’s natural gas production and consumption. US EIA 2013.

China’s domestic coal reserves appear to be decreasing. Nearly 2,000 coal mines, with a total capacity of 117.48 million tons, are being closed in 2014 alone due to depletion. If coal is to be replaced, even in part, by natural gas, China will need to develop its domestic resources and secure supplies from reliable exporters. China’s close proximity to Central Asian hydrocarbon reserves makes the region an enticing option for Chinese national oil companies (NOCs) for just this reason. According to the EIA, while coal will still play a large role in China’s energy mix for the foreseeable future, natural gas has begun to take up a larger percent in recent years. The closest and arguably most attractive option for China has proven to be Turkmenistan. In order to fully understand why, it is necessary to first understand the historical influences of Turkmenistan’s natural gas sector.

Turkmenistan’s History of Isolation

Turkmenistan holds an estimated 13.4 trillion cubic meters of natural gas, making it the 4th largest in terms of reserves worldwide. Likewise, it is home to several of the largest natural gas fields in the world, which are located primarily in its southern and western regions. Unsurprisingly, these reserves have allowed Turkmenistan to become the leading natural gas exporter among the Caspian and Central Asian countries. While these numbers are impressive, it is important to remember that Turkmenistan’s openness to outside actors has been limited.

Niyazov’s reliance on natural gas to fund national programs helped generate the high degree of dependency the Central Asian state currently has on natural gas exports.

Golden Statue of Niyazov. Photo: Robert Preston. Fineartamerica.com.

After gaining independence in 1991, the former Soviet country was under the tight control of Saparmurat Niyazov – who had been in power since 1985. In some ways, Turkmenistan’s early energy strategy emphasizing centralization was similar to that of China, though much more extreme. Niyazov utilized the country’s large hydrocarbon infrastructure and wealth inherited from the Soviet Union to “fashion a highly idiosyncratic, tightly controlled despotism”, writes Martha Olcott, a senior associate at the Russian and Eurasia Program, in her 2013 paper entitled “Turkmenistan: Real Energy Giant or Eternal Potential?” The legacy of Niyazov’s strict neutrality and isolationism has had a lasting impact on Turkmenistan’s relationship with the outside world.

Niyazov’s reliance on natural gas to fund national programs helped generate the high degree of dependency the Central Asian state currently has on natural gas exports. Gurbanguly Berdimukhammedov, who is still the president to this day, replaced Niyazov after his death in 2006. Despite the odd, and still quite closed, nature of Turkmenistan’s internal politics, Berdimukhammedov has made some progress in building legal and civil infrastructure in the country. By opening up the political system (somewhat) and improving the business environment, he has managed to attract some foreign investors from Russia, China, and the West.

Mr. Berdimukhammedov was able to amend criminal, administrative, and foreign investment laws that were inhibiting the improvement of business climate. Because of these changes, however, clan politics have become an important factor in Turkmen politics. The government still remains highly centralized, but the current president doesn’t maintain a personality cult – unlike his forerunner. While Berdimukhammedov’s regime has largely shied away from nepotistic tendencies, his brother-in-law is the head of the agency that oversees oil and gas reserves. For this reason, Dr. Olcott infers that there is “no reason to believe that his control of the country’s energy policy is any less complete than that of his predecessor”.

Despite the reforms, the current state of Turkmenistan’s business climate remains challenging for investors. For starters, the power and capriciousness of local elites has made doing business in the country unpredictable. Compounding this are dubious government data and statistics, the state of national finances, and the lack of clarity for property protection laws.

Presently, China enjoys a privileged relationship with Ashgabat, and is – writes Dr. Olcott,  “the only country to have been granted access to onshore develoment” in Turkmenistan. Chinese-Turkmen cooperation certainly does not end there, as is evident from the Central Asia-China Pipeline.

Even in light of these challenges, investors simply see too much potential in Turkmenistan’s hydrocarbon reserves to be dissuaded. Companies seemed to have adapted to these challenges, and “the most successful foreign investors in Turkmenistan… all function not only as business partners of the Turkmen government, but also as ‘geopolitical agents’ working to advance the country’s interests internationally”, according to Dr. Olcott. Due to Turkmenistan’s distance from the world’s major markets, advancing these interests is extremely important for market access. Other challenges facing the Turkmen energy industry are the lack of technical personnel, domestic investment, and infrastructure. The lack of trained employees makes it difficult to meet growing demand for gas extraction, and the insufficient infrastructure and domestic investments make it difficult to develop new projects and entice foreign investments.

Chinese-Turkmen Energy Relations

China has managed to overcome these challenges and strengthened its ties with Turkmenistan. In many ways, we can see how China has ‘captured’ the Turkmen natural gas market. Presently, China enjoys a privileged relationship with Ashgabat, and is – writes Dr. Olcott, “the only country to have been granted access to onshore development” in Turkmenistan. Chinese-Turkmen cooperation certainly does not end there, as is evident from the Central Asia-China Pipeline.

CNPC is also developing South Yolotan, the 2nd largest gas field in the world, and will operate the gas processing facilities for the project.

Chinese company “CNPC” began the construction of the Central Asia-China pipeline, which gets Turkmen gas to the Chinese market, in 2009. It currently pumps 30 BCM a year to China, and there have been talks of increasing this amount. The pipeline, constructed in only 18 months, was the fastest ever built of its size, according to a paper published by a House Foreign Affairs subcommittee. According to figures from CNPC and Platts energy news, this amount accounts for over half of China’s natural gas imports, and nearly one-sixth of its total consumption. China’s president at the time, Hu Jintao, hailed the pipeline as a model of mutually beneficial cooperation and solidarity. In many ways, it was just the beginning.

[China’s] control and influence over Turkmen elite is “something that neither Russia nor Iran, never mind the European Union, has succeeded in doing”, writes Dr. Slavomir Horak.

Central Asia-China Gas Pipeline, first line completed in 2009, pumps 30 bcm. RFA.org.

In terms of upstream acquisitions, CNPC has reportedly invested $4 billion in the Bagtyiarlym field via a 35-year production sharing agreement with Turkmengaz (Turkmenistan’s national oil company). In addition to supplying China with natural gas from the project, the company also plans to distribute Turkmen gas via pipeline to countries in the surrounding region. CNPC is also developing South Yolotan, the 2nd largest gas field in the world, and will operate the gas processing facilities for the project.

Chinese Loan Influence

As stated earlier, China seeks to get the maximum amount of hydrocarbons at the lowest possible price in an effort to keep manufacturing costs low. In this regard, China’s NOCs benefit greatly from generous loan policies and backing of the Chinese government in Turkmenistan. China has used what is known as a “loan-for-gas” program as leverage for lower prices. In short, this strategy trades loans with generous interest rates for discounted gas. This has given China an advantage in negotiating prices with the Turkmen government. In fact, Dr. Olcott claims that “there are some reports that China is not only balking at paying more than $200 per 1,000 cubic meters, but is also pressing for offsetting credits as a payment form”. Even though China has tilted the negotiating table in its favor, some Turkmen officials are more optimistic about the relationship than ever, and by granting CNPC permission to operate onshore, they have solidified China as their primary development partner. As such, they expect total gas exports to China to reach 40 BCM in 2016, and to swell to more than 65 BCM by 2020. This optimism likely has a lot to do with the rise in personal incomes for the elite, as well as the stability that this money will generate for the regime. Increasing cooperation from Turkmen elites and low prices means that Turkmenistan could play a key role for Chinese energy security moving forward. It can be inferred that China is able to use its loan repayment terms and loan enforcement policy to influence Turkmen policymakers. This control and influence over Turkmen elite is “something that neither Russia nor Iran, never mind the European Union, has succeeded in doing”, writes Dr. Slavomir Horak in a paper titled “Turkmenistan’s Shifting Energy Geopolitics in 2009-2011. Despite the loss of autonomy that could come with these loans, the autocratic regime in Turkmenistan prefers them to western loans because they do not “come with any political demands relating to governance and human rights”, explains Dr. Alexandros Petersen in “Russia, China and the geopolitics of energy in Central Asia”. These loans, however, do come with some strings attached. In addition to protecting China’s manufacturing sector from volatile energy markets by accepting repayment in the form of natural gas supply, these loans often stipulate the use of Chinese goods and services, such as construction machinery and civil engineering. This means that Turkmen specialists and machinery cannot compete for a spot on these large projects, and CNPC has assurance that it will get some of the money back that it loaned. Undoubtedly, these attractive loans offered to Turkmenistan have proven to be a double-edged sword.

Russia lost a great deal of influence through a 2009 pipeline dispute (among other reasons), and attempts by western countries to form a PCA (Partnership and Cooperation Agreement) have been frozen for decades due to Turkmenistan’s abysmal human rights record.

Conclusion

In short, the Turkmen government has welcomed further economic engagement with China. In fact, writes Dr. Olcott, “Ashgabat appears to favor China as an energy development partner… leading one commentator to describe the Chinese as ‘light years ahead’ of the competition”. Chinese investment deals and loan offers have enabled Turkmenistan to avert crisis in the past, and have enabled economic development and growth. The reason this hasn’t worked for Russia or western IOCs has to do with both practical and historical developments. Russia lost a great deal of influence through a 2009 pipeline dispute (among other reasons), and attempts by western countries to form a PCA (Partnership and Cooperation Agreement) have been frozen for decades due to Turkmenistan’s abysmal human rights record. The Chinese, have facilitated the boost needed in Turkmenistan’s energy market. This economic boost, however, has come at a cost. The influence that China now wields over Turkmen elites is substantial, and as a result, future deals or opening up to western IOC onshore operations could be severely limited.

‘Capturing’ Turkmen natural gas resources early on has allowed China unfettered access to a gigantic amount of natural gas – that it will not have to necessarily compete for.

Turkmenistan provides a good illustration of Chinese energy security strategy at work. Although Turkmenistan’s closed, and often corrupt, societal institutions can be difficult for investors, China and its NOCs have nonetheless thrived. The ability to maintain such a close and nearly exclusive relationship with its Central Asian neighbor may prove to be a key component in keeping manufacturing prices low. China has realized that its domestic coal production can only last for so long. ‘Capturing’ Turkmen natural gas resources early on has allowed China unfettered access to a gigantic amount of natural gas – that it will not have to necessarily compete for.

Ryan McKinley is a graduate of the ENERPO program at European University at St. Petersburg.

Sources

Chau, D. and Kane, T. (2014). China and International Security, History, Strategy, and 21st-Century Policy. 1st ed.

Eia.gov, (2014). Turkmenistan – U.S. Energy Information Administration (EIA). [online] Available at: http://www.eia.gov/countries/country-data.cfm?fips=TX [Accessed 27 Jun. 2014].

Horak, S. (2012). Turkmenistan’s Shifting Energy Geopolitics in 2009-2011. Problems of Post-Communism, 59(2), pp.18.

The House Foreign Affairs Subcommittee on Europe, Eurasia, and Emerging Threats, (2014). China’s Energy Engagement with Central Asia and Implications for the United States. Washington, DC.

Human Rights Watch, (2014). World Report 2013: Turkmenistan. [online] Hrw.org. Available at: http://www.hrw.org/world-report/2013/country-chapters/turkmenistan [Accessed 9 Jun. 2014].

Lelyveld, M. (2014). China Pursues New Central Asian Gas Route. [online] Rfa.org. Available at: http://www.rfa.org/english/commentaries/energy_watch/gas-02102014124143.html [Accessed 9 Jun. 2014].

Olcott, M. (2013). The Geopolitics of Natural Gas Turkmenistan: Real Energy Giant or Eternal Potential?. 1st ed. [ebook] Houston: James A. Baker Institute for Public Policy Rice University. Available at: http://belfercenter.ksg.harvard.edu/files/CES-Pub-GeogasTurkmenistan-121013-1.pdf [Accessed 6 Jun. 2014].

Petersen, A. and Barysch, K. (2011). Russia, China and the geopolitics of energy in Central Asia. 1st ed. London: Centre for European Reform.

Reuters, (2014). China to close nearly two thousand small coal mines. [online] Available at: http://www.reuters.com/article/2014/04/04/china-coal-idUSL4N0MW2OJ20140404 [Accessed 2 Jun. 2014].

Reuters, (2014). Desert ceremony celebrates Turkmenistan-China gas axis. [online] Available at: http://www.reuters.com/article/2014/05/07/gas-turkmenistan-china-idUSL6N0NT2QS20140507 [Accessed 9 Jun. 2014].

Wang, J., Feng, L. and Tverberg, G. (2013).

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