Policy Contribution Issue n˚16 | December 2019 The European Union-Russia- China energy triangle Georg Zachmann Executive summary Concern is growing in the European Union that a rapprochement between Russia Georg Zachmann (georg. and China could have negative implications for the EU. We argue that energy relations [email protected]) is a between the EU and Russia and between China and Russia influence each other. We analyse Senior Fellow at Bruegel their interactions in terms of four areas: oil and gas trading, electricity exchanges, energy technology exports and energy investments. This Policy Contribution We discuss five key hypotheses that describe the likely developments in these four areas is a version of a paper in the next decade and their potential impact on Europe: prepared for the seminar ‘Trade relations between 1. There is no direct competition between the EU and China for Russian oil and gas; the EU, China and Russia’, 2. China and the EU both have an interest in curbing excessive Russian energy rents; co-organised by the 3. The EU, Russia and China compete on the global energy technology market, but specialise Delegation of the European in different technologies; Union to Russia and Bruegel 4. Intercontinental electricity exchange is unlikely; with the support of the EU 5. Russia seems more worried about Chinese energy investments with strategic/political Russia Expert Network on goals, than about EU investments. Foreign Policy (EUREN). The seminar was funded We find no evidence of a negative spillover for the EU from the developing Russia-China by the European Union. energy relationship.But, eventually, if these risks – and in particular the risk of structural The content of this paper financial disintermediation – do materialise, central banks would have various instruments to is the sole responsibility counter them. of the author and does not represent the official position of the European Union. Research assistance by Francesco Castorina is gratefully acknowledged. 1 Introduction Energy is a key area for cooperation between the European Union and Russia, and between China and Russia. These bilateral relationships influence each other and each relationship is of strategic interest to the respective third party, with potential spillovers that present risks and opportunities. In principle, there are four main areas of cross-border energy relations: hydrocarbon trading, energy technology trading, electricity trading and foreign energy sector investments. We discuss five key hypotheses that describe a likely development in these four areas in the next decade and their potential impact on Europe: 1. There is no direct competition between the EU and China for Russian oil and gas; 2. China and the EU both have an interest in curbing excessive Russian energy rents; 3. The EU, Russia and China compete on the global energy technology market, but specialise in different technologies; 4. Intercontinental electricity exchange is unlikely; 5. Russia seems more worried about Chinese energy investments with strategic/political goals, than about EU investments. The speed of energy-sector decarbonisation in China, Russia and the EU, and the way it is done, will also be key drivers of future bilateral energy relationships. If the EU choses to focus on full electrification of energy consumption using domestice renewables by the middle of the century, hydrocarbon trading relationships will become irrelevant. But if the EU decides to rely heavily on imports of ‘clean’ fuels from Russia, such as synthetic fuels1, existing hydro- carbon trading patterns might be perpetuated. The volatility in the domestic debates on the speed of energy-sector decarbonisation and the right approach to it makes it very difficult to forecast developments in energy relations over the longer term2. This Policy Contribution thus focuses on the next ten to 15 years. 2 There is no direct competition between the EU and China for Russian oil and gas Oil and gas exports continue to be the backbone of Russia’s economy. In 2018 they accounted for 59 percent3 of the total value of Russia’s exports and represented 46 percent4 of Russia’s total federal revenues. On the other side, in 2018, 70 percent of Russian natural gas exports went to the EU, while 15 percent of Russian oil exports went to China5. For China and the EU, energy imports from Russia are significant. In 2018, according to Eurostat, 27.3 percent of the EU’s total oil imports and 40.2 percent of its total gas imports came from Russia. Meanwhile, Russian oil accounted for 15.4 percent6 of China’s total oil imports (Russia’s share of China’s total gas imports is only 1 percent). 1 This can for example be hydrogen or methanol. BDI (2018), for example, includes a scenario in which Germany alone will import 340 terawatt hours of synthetic fuels, which is equivalent to more than 60 percent of current German electricity demand. 2 See Tables 1 and 2 in Zachmann and Marcu (2018). 3 Sources: https://wits.worldbank.org/ and https://oec.world/en/. 4 Author’s calculations based on data provided by the Ministry of Finance of the Russian Federation (see http:// www.eeg.ru/pages/580). 5 Figures are author’s calculations based on data in BP Statistical Review of World Energy 2019. 6 Author’s calculation based on data in BP Statistical Review of World Energy 2019. 2 Policy Contribution | Issue n˚16 | December 2019 Figure 1: Russian gas exports (billions of cubic metres) 200 6.8 LNG Via pipeline 150 168 100 127.8 16.8 50 67.6 55 1.3 0 2008 2018 2008 2018 2008 2018 to EU to China to rest of world Source: Bruegel based on BP Statistical Review of World Energy 2009 and 2019 editions, and Central Bank of the Russian Federation. Note: LNG = liquefied natural gas. Figure 2: Russian oil exports in millions of tonnes 200 150 100 50 0 2008 2017 2008 2017 2008 2017 to EU to China to rest of world Sources: Bruegel based on Eurostat, Central Bank of the Russian Federation, https://oec.world/en/ and BP Statistical Review of World Energy 2018. There is a concern in the EU that greater cooperation between Russia and China on energy could be detrimental to the EU’s energy interests. For example, if Russia becomes less reliant on the EU as a destination for its energy exports, Russia might become more assertive in energy negotiations and also political negotiations7. Russia’s leadership has highlighted on various occasions the increasing importance of China for the Russian energy sector. But is such a shift realistic and would it be a problem for the EU? Only about 10 percent of Russian oil exports go via direct pipelines to the EU. Another 10 percent goes already via pipelines to China8. In the oil market, it is already largely possible for Russia to ship all its oil to China via the sea route. But this would involve high transport costs, and refineries in China are not optimised for Russian oil grades. At the same time, the impact on the EU would be manageable because China would then have to import less oil from other countries – allowing the EU to buy elsewhere, though with higher transport costs and with some intra-European disruption (refineries in the east might become less competitive relative 7 We cannot explore the logic behind current observed and potential Russian gas and oil projects as they are often a complex combination of foreign-policy objectives (such as forging alliances), economic motives (such as linking new sources to new consumers) and internal distributional motives (such as providing rents for powerful stake- holders). 8 See https://en.wikipedia.org/wiki/Eastern_Siberia%E2%80%93Pacific_Ocean_oil_pipeline. 3 Policy Contribution | Issue n˚16 | December 2019 to refineries on the coast). This seems therefore to be a relatively symmetric lose-lose scenario without much strategic value for either side. For gas, the story is more complicated. Russia’s pipeline infrastructure is still largely directed towards the EU – and this would change only slowly. Of Russia’s gas exports, 68 per- cent goes through pipelines to the EU9. Russia currently has only one gas pipeline to China. And in terms of projects under construction, the Gazprom10 projects to supply the EU (Nord Stream 2: 55 billion cubic metres (bcm) and Turkstream: 31 bcm11) have greater capacity than the China-leaning projects (Power of Siberia: 38 bcm12). Europe continues to be a much more attractive market for Russia with existing pipeline infrastructure (345 bcm per year (EIA, 2019)), better developed resources13 and higher prices14. Connecting the West Siberian fields to China would be very expensive and time consuming. Consequently, it appears likely that the bulk of gas exports to China, if they increase, will not be drawn from fields in Western Siberia. Furthermore, China so far has not given gas-import projects from Russia any prefer- ential treatment, but seems to have commercially exploited Russia’s eagerness to diversify its export portfolio by pushing through a very low gas price15. It is expected that by 2040, Chinese demand for gas imports – currently at about a fifth of the EU’s – will increase drastically, despite significantly increasing domestic production. According to the IEA (2018) new policies scenario, Chinese demand will be equivalent to more than half of the EU’s gas import demand by 2040 (Figure 3), while according to the BP (2019) scenario, Chinese import demand would even surpass the EU’s import demand16. In this context, it is actually more surprising that Russia continues to expand its currently under-utilised gas delivery capacity to the EU at a faster pace than pipelines to China. Figure 3: EU/China gas import demand, million tonnes of oil equivalent 600 European Union 500 400 300 China 200 100 0 2000 2017* 2025 2030 2035 2040 Source: Bruegel based on gas production and consumption in the new policies scenario by the IEA (2018).