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Beyond Europe and Back

Quietly—over the past decade and even more so in recent months— Russia has been ramping up natural gas exploration and production in Nigeria, Egypt, Mozambique, and especially Algeria.

Russia and Algeria have a long history of close ties. Russia was the first to recognize Algeria's independence from France in the 1960s. Algeria was one of Russia's closest allies during the Cold War. The arms trade between them remains brisk. From 2003 to 2012, Algeria spent $54 billion abroad on military supplies, with over 90 percent of the money going to Russia. Those purchases accounted for 10 percent of Russia's total arms exports and made Algeria its third-biggest customer, after only China and India.

Whether out of gratitude or not, Gazprom was the first foreign company invited to participate in Algeria's petroleum industry, in 2006. The arrangement was recently extended to 2039. Their joint venture will explore and develop more than 30 prospective hydrocarbon deposits spread over an estimated 20 percent of Algeria's territory.

So what's going on here?

It's simple. Africa is the third-largest supplier of natural gas to the European Union, and by 2015 Moscow will control nearly half of Africa's production. That will put Moscow's hand on nearly 40 percent of Europe's gas supply. Moreover, Southern European countries like Italy and Spain, which don't depend on Russian pipelines but draw much of their natural gas from North Africa, would join the list of those sensitive to nudges from Putin.

Once again, Putin is thinking long term. When the infrastructure to process Africa's output is in place, nearly all of Europe will begin sliding into deep dependence on Russian-controlled gas. With Russia to the east and Africa to the south, the European Union will sit in an energy pincer that Putin can squeeze at any time for any reason.

Putin understands that being top dog in Europe isn't enough to be top dog in a world where European economies are stagnating and Asian economies are booming. Thus, while Gazprom seeks to heighten its influence in Europe, it's moving to expand its presence in the Far East as well.

The big prize there is, of course, the voracious energy market in China. (See Figure 8.3.) And by a big margin, there is no better source for the gas China needs than Russia. Perhaps because of centuries of mistrust between Russia and China, or perhaps because of the enormous size of the mutual benefit that was waiting for the two countries to come to terms, reaching a deal was a tortured process.

The sticking point was the pricing structure, which must protect both parties from market unknowns for a period of three decades. The two sides haggled for 11 long years. The agreement they finally reached and then signed in May 2014 derives prices for the gas from a formula driven by market prices of oil and oil products.

China's Energy Consumption

Figure 8.3 China's Energy Consumption

Source: Energy Information Administration. © Casey Research 2014.

What finally brought the two parties to terms was perhaps the shared fun of demonstrating that U.S. participation in the great matters of the day isn't needed anymore. Beyond that, China wanted to clean up the coal-choked air of its coastal cities and avoid an approaching "airpocalypse." Replacing coal with gas to fuel electric generation plants would help. Putin wanted to open the Asian markets, which are natural consumers for its Siberian gas fields. It was a marriage made in Eurasia.

The 30-year agreement is huge. Gazprom will supply China National Petroleum Corporation with 1.3 Tcf of gas annually, about a quarter of China's current gas consumption. The contract is worth around $400 billion. Gas will begin flowing to China by 2019, perhaps in 2018.

To make it all happen, Russia will invest $55 billion and China will invest at least $20 billion, according to Putin. Plans call for building the long-delayed pipeline to link China's northeast to a line that carries gas from western Siberia to the Pacific port of Vladivostok. Developing a gas center there will also support Russian exports to Japan and South Korea.

"Without any overstatement, this will be the world's biggest construction project for the next four years," Putin said.

There was jubilation in Moscow. Putin's visit constituted a "major step toward a strategic partnership of the two nations," said Mikhail Margelov, head of the foreign affairs committee in the upper house of the Russian parliament.

Alexei Pushkov, head of the international affairs committee of the parliament's lower house, jabbed at the United States, adding, "The 30-year gas contract with China is of strategic significance. Obama should give up the policy of isolating Russia. It will not work."

With all the talk, the aspect of the deal that is most important for the United States never came up: What currency will be used in the gas transactions? Doing it all in rubles and yuan would be a damaging blow to dollar supremacy in the energy sector.

More on that later.

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