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Northeast Asia Energy FocusNortheast Asia Energy FocusVol.7 No.1 Spring 2010

Inside the KEEI 2Briefs on Northeast Asia 5

Basic Concepts of Cooperation in North-East Asia in the Oil and Gas Sector for the Period 2010-2030 10Alexander N. Gulkov

Apropos Cogeneration Based on the Development of the Small Power Industry Sector in the Far East 16Igor Svetlov / Andrey Zagumynnov

The Turkmenistan-China Pipeline: What Are Its Implications? 25Stephen Blank

The East as the New Priority of the Russian Energy Policy 36Vyacheslav Kulagin

Decline or Re-rise of OPEC: Implications for Northeast Asia 44Hooman Peimani

Energy Security Dilemma Bubble: Cold War Thinking in aWorld Supply Oil Market 52Kevin P. Kane

Effect of Biofuel Production on the Global Economy: Economic, Social, and Environmental Perspectives 65Youngho Chang / Sarah Ho / Patricia Seah

Nuclear Share of Total Electricity Generation in 2008 76Total Energy Requirement by Fuel Type in 2008 76

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NEA Statistics

ISSN 1738-8562

Spring 2010/ Northeast Asia Energy Focus

Inside the KEEI

The Third Korea-China EnergyWorkshop

The Korea Energy Economics Institute(KEEI) and the Energy Research Institute

(ERI) of China jointly organized a workshopnamed “Energy Security and OverseasInvestment and Green Energy Development,”which was conducted on November 25-26,2009, at the Coex Intercontinental Hotel, Seoul,Korea.The KEEI-ERI” Joint Workshop wasconducted under a performance agreementconcluded between Korea and China in 2002;it has been conducted alternately in Korea andChina since 2007, and the third meeting of thisseries was conducted in 2009.The workshop aimed to exchange informationand opinions regarding energy policy changesand the promotion of joint projects betweenKorea and China and to build the foundationof a close partnership by organizing regularworkshops.At the inaugural session, Dr. Ki-Yual Bang, thepresident of the KEEI, made the openingremarks, and Prof. Han Wenke, DirectorGeneral of the ERI, offered his congratulationsto all the participants.

The program comprised three sessions. Thefirst session addressed “Energy Security andOverseas investment” and was organized bythe chair of this session, Dr. Jin-Woo Kim ofthe KEEI.Dr. Gao Shixian of the ERI made apresentation on “China’s Energy SecurityPolicy for Overseas Oil & Gas Development”under the theme “Overseas Oil & GasDevelopment,” and Dr. Yongduk Pak of theKEEI made a presentation on the “Strategiesand Policies in the Overseas Oil and Gas E&Pof Korea.” Dr. Jiang Xinmin of the ERI madea presentation on “The Recent Expansion ofOil Refinery Facilities in China” under thetheme “Petroleum Products Market,” and Dr.Kim Hyung-Gun of the KEEI made apresentation on “The Oil Industry of Korea.” The second session organized by the chair, Dr.Yu Cong of the ERI, dealt with “Green EnergyDevelopment.” Dr. Zhang Yousheng of theERI made a presentation on “China’s CoalbedMethane Development and Utilization,” whileDr. Ahn, Dal- Hong of KEPCO KEPRI (KoreaElectric Power Corporation, Korea ElectricPower Research Institute) made a presentationtitled “Introduction to Korea IGCCDevelopment Program” under the theme“Clean Coal Technology.” Dr. Feng Shengboof the ERI presented a paper on “China’sCDM Policy and Progress,” and Dr. HwangIn-Chul, of KEMCO (Korea EnergyManagement Corporation) presented a paperon “CDM Implementation in Korea.”The last session involved a round-tablediscussion organized by Dr. Nam-Yll Kim ofthe KEEI and Dr. Gao Sixian of the ERI. Allthe participants interacted enthusiastically onthe subject of effective regional energycooperation and opportunities and visions foreffective energy cooperation between Koreaand China.

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SOC (The Senior Officials’ Committee)Conference

The KEEI hosted the Second ExpertWorkshop for the WG-EPP Joint Study

and the Third Meeting of the Ad-hoc TaskForce for Development of the Five YearStrategy on November 26-27 at the Lotte Hotelin Seoul, Korea.

The Second Expert Workshop for theWG-EPP Joint Study

The Second Expert Workshop for the WG-EPP Joint Study was conducted on

November 26 under the theme “EnergyProduction Potential and Development Plansin Northeast Asia, PhaseⅡ.” Approximately20 participants, including officials from theRussian Government and the ESI (EnergySystems Institute), the ERI of China, theMongolian Government and the EA (EnergyAuthority), the UN/ESCAP, and the KEEImembers participated in the workshop.The KEEI was designated a Nodal Institutionfor the 2009-2010 Working Group on EnergyPlanning and Policy (WG-EPP) on Feb 2009in Jeju Island, Korea. This conference wasorganized to inspect the progress of the2009-2010 joint research project on “NortheastAsia Energy Production Potential andDevelopment Planning” and interim findingsof each country and to conduct a debate onrelated matters. Furthermore, Dr. Sokolov ofthe ESI, Dr. Chimeddorj of the EA, Dr. Gaoand Dr. Jiang of the ERI, and Nam-Yll Kimand Dr. Ji Chul Ryu of the KEEI discussed onthe oil fields of China, Korea, Mongol, and

Russia, and they concluded that each of thesecountries would express their positions on theDevelopment of the Five Year Strategy ofNortheast Asian Energy IntergovernmentalAlliance.

Third Meeting of the Ad-hoc Task Forcefor the Development of the Five YearStrategy

The Third Meeting of the Ad-hoc TaskForce for the Development of the Five Year

Strategy was held on November 27 in Seoul,Korea. The KEEI was designated a NodalInstitution of Ad-hoc Task Force on June 2009in Bangkok, Thailand (at the seventh meetingof the Working Group on Energy Planningand Policy). This meeting was conducted toevaluate activities over the past three yearsand reset the future direction of operations. This meeting was attended by Dr. Aliev of theMinistry of Energy and Dr. Sokolov of the ESIfrom Russia, Dr. Chimeddorj of the EA fromMongol, Mr. Gao of the ERI from China, Dr.Maritess Cabrera from UNESCAP, and sixmembers of the KEEI, including Jin-Woo Kim,Nam-Yll Kim and Ji-Chul Ryu.

Presentation Detailing the Resultsof the 2009 Northeast Asia EnergyCooperation Research Projects

Apresentation on the results of the 2009Northeast Asia Energy Cooperation

Research Projects was made on December 22,2009, at the Coex Intercontinental Hotel inSeoul, Korea. The presentation detailed thefinal results of 16 research projects undertaken

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in 2009. Over 30 people attended thispresentation and provided valuable comments.The 16 research projects were as follows:

Study on the changes in the oil distributionmarket in JapanStudy on energy conservation policies ofmajor northeast Asian countriesStudy on energy welfare policies of themajor northeast Asian countriesStudy on the economic cooperation strategyof South Korea and North Korea throughthe energy system link of northeast AsiaAnalysis of the long-term energy plan ofnortheast AsiaStudy on the economic and social developmentstrategies of Turkmenistan and the energyresource development cooperation betweenKorea and TurkmenistanStudy on the green energy markets ofnortheast Asia and international cooperationsituation and prospectAnalysis of energy markets in northeastAsia; energy taxes and pricesStudy on securing the stability of the supplyof natural gas in RussiaStudy on the energy-related R&D situationof China and the cooperative measuresundertaken by Korea and ChinaStudy on the cooperative measures appliedto uranium resource development innortheast AsiaAnalysis of the energy export structure andtransportation system of RussiaStudy on the revitalization of Korea-Mongolenergy cooperation: energy developmentinfrastructureStudy on making inroads into the Uzbekelectricity marketStudy on the Local Distributed PowerDemand Survey and Resources CooperativePlan Research in Kazakhstan Study on the effect of changes in theinvestment conditions of Russian energycompanies on Korea-Russia energy cooperation

In addition, the international expert of the

KEEI, Dmitry Sokolov, presented a paper titled“Potentialities and Problems of IncreasingRussian Coal Supplies to markets of APRCountries.”

KEEI-IOG Joint Workshop

The KEEI-IOG (Institute of Oil and Gas)Joint Workshop was conducted on

December 4 in Vladivostok, Russia. Dr. Euy-Seok Yang and Dr. Sung-Kyu Lee of KEEIparticipated in the conference as speakers.The session began with opening remarkspresented by Dr. Alexander Gulkov, the Directorof the IOG, followed by a congratulatoryaddress to all the participants by Dr. Jin-Woo Kim, Managing Director of the KEEI.The conference comprised two sessions—presentations and a round-table discussion.In the first session, Dr. Eyu-Seok Yang madea presentation on “The Oil Industry of Korea,”which was followed by a presentation by DrSung-Kyu Lee on “Promotion Status of EnergyCooperation Projects after the 2008-MoscowSummit Meeting between Korea and Russia.”Later, Dr. Alexander Gulkov presented a paperon “The Development of the Oil and GasIndustry of the Far East of Russia.”Thereafter, at the round table discussionsession, all participants had a heated debateon issues related to the presentation. The KEEI and IOG concluded an agreementfor the implementation of the 2009 jointresearch project. The subject of their joint studywas “Contents and Promotion Status ofOngoing and Planned Energy Projects in theFar East Region of Russia.”

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Briefs on Northeast Asia

New energy to become focus ofChina’s strategic emerging industries

Departments including the Ministry ofIndustry and Information Technology

(MIIT), the National Development andReform Commission (NDRC) and theMinistry of Finance jointly formed acoordination group before the Spring Festival.In a group meeting, it was clearly pointed outthat China would constitute strategic emergingindustries to develop the “12th Five-YearPlan.”The meeting also decided that it wouldestablish a research and coordinationdepartment for accelerating the developmentof strategic emerging industries to coordinatedevelopment research ideas and to deal withimportant issues of constitution work as awhole. The department will consist of theheads of 20 organizations, and Zhang Ping,the director of the NDRC, will be thedepartment leader. The coordination groupwill make important arrangements suchas the main targets and tasks, the keydevelopment areas, the main developmentdirection and the industrial geographicaldistribution of China’s strategic emergingindustries.Reporters learned that of the 7 emerging high-tech realms brought forward by relevantgovernmental departments in November 2009including the information industry andbiotechnology, the new energy realm will mostlikely become the main development directionand obtain more policy support.Up until now, China has established 3important standards to select strategicemerging industries. First, it must have steadyand promising market demand. Second,

it must have excellent economic andtechnological effects and third, it must be ableto promote a group of other industries.Compared to other technological realms, thenew energy realm is most suited to thestandards.An official from the MIIT said that developingnew energy is quite identical to China’s ideaof developing a low-carbon economy. “Afterthe Copenhagen Conference, the MIIT has putthe low-carbon economy’s development in amore important position.”(People’s Daily Online, 2.23)

Russia threatens BP Kovykta assets

Russia’s Natural Environment Inspectorate,RosPrirodNadzor, has recommended that

BP’s joint venture in Russia, TNK-BP, bestripped of the giant Kovykta natural gasproject in eastern Siberia. Located in eastern Siberia’s Irkutsk oblast, theKovykta field holds an estimated 2 trillioncubic meters of gas. RUSIA Petroleum is thelicense-holding company (technically the“mineral resource user”) in the Kovyktaproject. TNK-BP owns a 63% stake in it. TNK-BP is a parity joint venture of British companyBP with the Russian TNK (formerly TyumenNeftegaz company), which is currentlycontrolled by four Russian billionaire tycoons. The Kremlin seems to be moving rapidly totighten the noose around TNK-BP’s asset,using the state’s regulatory apparatus tothreaten with revocation of the license. Inrecent weeks, RosPrirodNadzor has steppedup its inspection of the project. It claims tohave found “continuing violations” of licenseterms, with field development “persistentlylagging”. Officially, the decision regarding the license ismainly up to Russia’s Mineral ResourcesOversight Service (RosNedra). In practice,there is little doubt that the decision will be a

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political one, ultimately to be made at the topof the government and in the Kremlin. State oil company Rosneft has apparentlydeveloped ambitions to enter the natural gasbusiness through a major project. Rosneft’ssubsidiary, Rosneftegaz, is expected to bid fora controlling stake in Kovykta. On February 4, Aleksei Miller, chief executiveof gas monopoly Gazprom, announced thatthe company does not need to includeKovykta’s gas resources in Gazprom’s exportprograms for China or other countries in theEast Asia-Pacific region. On the following day,the natural resources ministry (to whichRosPrirodNadzor is a subordinate agency)announced an “extraordinary” round ofinspection of the Kovykta project. On February12, Natural Resources Minister Yuri Trutnovwarned that a decision to revoke the licensemight ensue within several weeks. In that case,the Kovykta field would be transferred intothe legal category of “unallocated mineralreserves” (unlicensed fields). The dispute dates to 2006-2007, although it laydormant since. RUSIA Petroleum wasplanned to have supplied 9 billion cubicmeters (bcm) per year from 2006 onward forthe needs of Irkutsk oblast. However, thatamount far exceeds the level of demand inIrkutsk oblast, and a local distributioninfrastructure would first have to be created.Project shareholders had considered exportingthe gas to China. However, the idea wasthwarted by the lack, or denial of access toGazprom’s export pipelines. RosNedra threatened to revoke the license in2007 on the pretext that field developmentwas lagging behind schedule and gasproduction was below the levels stipulated inthe license and the contract. Under pressure,TNK-BP agreed to sell its Kovykta stake toGazprom for a sum in the range of US$700million to $900 million, with an option toretain or regain a minority stake, subject to

further negotiations. At that stage, Gazpromwas trying to pressure BP into ceding a stakein BP’s liquefied natural gas (LNG) project onTrinidad and Tobago. That project suppliesthe US market, which Gazprom was trying toenter. The resolution was deferred in 2007-2008 bythe Russian stakeholders’ conflict with BP.Thanks to the Russian authorities’ strong-armmeasures, the TNK side evicted the jointventure’s chief executive, Charles Dudley (anAmerican citizen) from Russia in 2008, andforced changes on the joint venture’s board infavor of the Russian side. Gazprom employeeGerhard Schroeder (formerly the Germanchancellor) was foisted on TNK-BP’s board asan “independent” member. No sooner wasthe board coup accomplished than thefinancial crisis hit, further postponing aresolution of the Kovykta dispute. At this stage, license revocation threatens notonly BP, but also the Russian tycoon ownersof TNK: an offer that TNK-BP cannot refuse.Apparently, Russian authorities are about togive all concerned an option to avoid licenserevocation and investment forfeiture, if theyagree to sell the project to Rosneftegaz, orpossibly another Russian company. Gazprommay well also be waiting in the wings, itsdisclaimer notwithstanding. This time, however, Kovykta stakeholdersmight try to avail themselves of the EnergyCharter Treaty’s provisions on the protectionof foreign investment. In a potentiallylandmark case in December 2009, thePermanent Arbitration Court in The Hagueruled that Russia is bound by the EnergyCharter Treaty’s provisions from the momentof Russia’s signature in 1994. Under the terms of that signature, the treatytook legal effect in Russia through provisionalapplication, ahead of its ratification andirrespective of it. In August 2009, Russiaserved notice that it would not ratify the Treaty

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and that it was not bound by it. The court inthe Hague, however, ruled the opposite, in acase brought to the court by the shareholdersof the expropriated Yukos company. Thismeans that foreign investments made inRussia after 1994 are covered by the treaty’sprotection, apparently for the 20-year periodstipulated at that time. This in turn opens theway for investors to seek internationalarbitration of their disputes with the Russianauthorities in energy projects. (Asia Times, 2.24)

Russian watchdog may revoke TNK-BP’s Kovykta gas field license

Russia’s environmental regulator said onWednesday that the Russian-British joint

oil venture TNK-BP may lose its license todevelop a huge gas field in Siberia over afailure to comply with the terms of theagreement.Rosprirodnadzor has completed anunscheduled audit of TNK-BP’s operations atthe Kovykta gas condensate field, withestimated reserves of over 2 trillion cubicmeters of natural gas, and will recommendthat the Natural Resources Ministry revokethe license, the watchdog said.It was earlier reported that a decision on therevoking of the license for the gas field, whichalso contains 2.3 billion cubic meters of heliumand 115 million metric tons of gas condensate,could be made before March 1, 2010.The gas field is located in East Siberia’s Irkutsk

Region.Under the terms of the license agreement,TNK-BP, a highly lucrative 50-50 joint venturebetween the British major BP and four Russianbillionaires, is required to produce 9 billioncubic meters of gas annually in contrast to itsactual output of several dozen million cubicmeters.Russia’s Natural Resources Ministry carriedout a check of the joint venture’s compliancewith the license agreement in 2007 and gaveRUSIA Petroleum, the Kovykta operatorowned by TNK-BP, twelve months to bringup output to the level stipulated in theagreement.Natural Resources Minister Yury Trutnevearlier announced, however, that “the licenseagreements were not fulfilled in the past andare not being fulfilled at present.”Last week, Viktor Vekselberg, one of the fourRussian partners in the joint venture with BP,said there were difficulties with theimplementation of the Kovykta project, addingthat an unscheduled check by the regulatorwas damaging the investment environmentin the country and would not contribute toefforts to resolve the problem.The regulator’s plans to revoke the licensemay be linked to an unsettled deal betweenenergy giant Gazprom and TNK-BP on thegas field.Under an agreement signed in 2007, Gazpromintended to buy a 62.8% stake in RUSIAPetroleum to take over the Kovykta gas field.The deal, however, has not been closed asGazprom was reported in December 2008 tohave asked TNK-BP to reduce the price forthe purchase of the Kovykta field, originallyestimated at $700-900 million.(RIANOVOSTI, 2.17)

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China-Central Asian Gas Pipeline:Success and Pitfalls

Under a 2007 accord, Turkmenistan agreedto export 30 billion cubic meters (BCM)

of natural gas to China annually for the next30 years. The deal, the first PSA onshoregranted to any foreign country inTurkmenistan, allows CNPC develop naturalgas fields in the Bagtyiarlyk area on the AmuDarya Right Bank in Turkmenistan. Theoutput of natural gas from Bagtyiarlyk wouldamount to 5 BCM by next year.A natural gas pipeline linking Turkmenistanand China’s Xinjiang Uygur autonomousregion started operations earlier this monthas part of the agreement. The project isexpected to boost China’s efforts to increasethe use of natural gas to 5 percent of its totalenergy consumption in 2010, according toanalysts.To secure further gas resources, CNPC andcompanies from South Korea and the UnitedArab Emirates (UAE) have won contractsworth $9.7 billion to develop a large naturalgas field in Turkmenistan. The consortium,comprising of CNPC, South Korea’s LGInternational Corp and Hyundai EngineeringCo, and the UAE’s Gulf Oil & Gas FZE andPetrofac International Corp, will jointlydevelop the South Yolotan gas field,considered to be one of the biggest five naturalgas deposits in the world. According to someestimates, it may hold approximately 6 trillioncubic meters (TCM) of gas.The integrated gas exploration and productionin Turkmenistan and cross bordertransportation through Uzbekistan andKazakhstan into China is not merely acommercial partnership, it also creates apolitical alliance between the four countriesbased on such a single energy cooperationarrangement. It fosters systematic and broader

cooperation. Unfortunately, there are no inter-governmental contractual framework designedto govern the cross border transportationsystem as BOODC International advised.Taking account of the complicated relationsbetween these Central Asian states, CNPCwas advised to ink bilateral governmentalagreements with each of these Central Asiannations and form joint ventures withindividual country separately. However, thelegal regime may be vulnerable to deal withpossible disruption of supply, disputes or otherconflicts that may occur in the future. We areinvited to work out a proposal to assess theseissues from the lens of various stakeholders.(Financial Times, 2.13)

Mongolian Prime Minister: Dual Listingsto Take Time

Initial public offerings of Mongolia’s state-owned mineral assets could take more time,

as the government works on upgrading thestock exchange to facilitate dual listings,Mongolian Prime Minister SukhbaatarBatbold said Tuesday.“We’d prefer to list [companies] in Mongoliafirst, but it may take more time than weexpected to list on the local exchange becausethings are not running properly in terms ofinfrastructure and management and real timefunctions. It’s getting there but needs moreimprovements,” Mr. Batbold said in aninterview.Mr. Batbold would like to see dual listingsof Mongolian assets with companiessimultaneously offering shares on globalexchanges such as Hong Kong, London orNew York as well as on the Mongolian StockExchange. State-owned companies lined upfor listing include Erdenes MGL LLC, whichowns licenses for the Tavan Tolgoi coal mineas well as other mineral deposits, ErdenetMining Corporation and national carrier

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Mongolian Airlines, also known as MIAT.In addition to preparing the assets for duallistings, the government is working on hiringa team of new managers with internationalexperience for the exchange later this year, hesaid. Among the issues that need to beaddressed is establishing regulatory andaccounting standards that are in line withinternational standards.The prime minister said he would also like tosee foreign companies that hold Mongolianassets and are listed abroad to list a 10% stakeon the local exchange.Companies with Mongolian assets that arelisted on overseas stock exchanges includecoal producer SouthGobi Energy ResourcesLtd., which listed on the Hong Kong StockExchange just last week, as well as MongoliaEnergy Corp. Ltd. also listed in Hong Kong.Development of Mongolia’s nascent stockexchange is one of the challenges facing thepoor nation as it tries to capitalize on itsnatural resources to bring wealth into itspopulation of 2.7 million.Mongolia’s stock exchange was established in1991 when the Securities Committee was setup with the goal of privatizing more than 400major state companies. But since then, thestock exchange and securities market havefailed to drive Mongolia’s economy.“There’s a big discrepancy between theMongolian stock exchange, which lists about200 companies with a total marketcapitalization of about US$450 million andcompanies that list abroad,” said Alisher AliSjumanov, chief executive officer of EurasiaCapital.“Even if just a few companies [of those listedabroad] list, this will be a big boost to localcapital,” he said. (The Wall Street Journal, 2.09)

Alaska sees China as energy partner

China has a role to play in the Alaskanplans to develop its oil and natural gas

ambitions, said Alaskan Lt. Gov. CraigCampbell.Alaska’s Republican Gov. Sean Parnell saidhe would invite Chinese investors to the statefollowing a trip to the region by Campbell inDecember.Parnell in his January state of the state addresssaid “gushers” in the Prudhoe Bay and PointThomson regions of the North Slope requirean ambitious effort to exploit.The plans come as international explorationcompanies said they could slow efforts inAlaska and look for economic benefitselsewhere.“As North Slope oil production continuesto decline, we must work diligently tofind additional economic developmentopportunities,” said Campbell in a statementfrom his office. “Now is the time tosignificantly increase our marketing efforts inAsia.”Alaska needs investors to back its plans tobuild a gas pipeline in the state to market thegas potential in the North Slope. TransCanada and Denali, a joint venturebetween BP and ConocoPhillips, arecompeting to develop a natural gas pipelinefrom the Alaskan North Slope to the Lower48 states.“Alaska could become a significant partnerwith China in the development of value-added products from our natural gasresources, produced here in Alaska,” saidCampbell.Exxon Mobil said developing Point Thomsongas fields in Alaska’s North Slope would pushdevelopments of the pipeline.(UPI, 2.15)

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At present, we are witnessing theformation of a new era of civilization. It

is a result of the latest scientific advances thatpeople living on planet Earth today are in aposition to create a comfortable environmentfor themselves. There are, however, majorsystemic problems that remain: limitedterritory and resources, population growth,different levels of technological and politicaldevelopment of nations, etc. The solutions tothese problems are yet to be found, althoughwork in that direction is underway: thecreation of the European Community (EC),the Eurasian Economic Community (EEC),the Shanghai Cooperation Organization(SCO), and several other institutions isexpected to expedite the search for solutions.The decisions that will invariably need to betaken while we look for the aforementionedsolutions should be reached on the principlesof mutual trust and benefit so as to engendera more open society. Models for sustainabledevelopment that are needed by ourcivilization today do not really exist. It is wellknown that the center of global civilization inthe 21st century is increasingly moving towardthe Asia-Pacific region.The growing demand for oil in the industrialized

and developing countries is likely to be adecisive factor in the geopolitical struggle thatwill dominate the period between 2010 and2030. According to the forecasts of manyexperts, worldwide oil production willincrease until 2015, when production will beat its peak; the subsequent years willexperience a slowdown with all of the ensuingconsequences. In this regard, as we arecompelled to come up with the basis for amodel that will allow us to determine theconditions necessary for the development ofa prosperous region, it is imperative that webegin by selecting a region. In the subsequentyears, lessons learned can be extended to otherregions. In our opinion, one of the most appropriateregions to conduct a pilot project in is North-East Asia (NEA). The prerequisites for aproject of this nature are all met by the NEAregion-the presence, no matter how incipient,of different symbols of industrial andeconomic development, of energy and humanresources, of political systems, of the nuclearpotential, of history, of religion, etc.There are few regions in the world that are asacutely contradictory in their constitution,where symptoms of deep and dangerousdeterioration lie hidden only barely beneaththe surface. Many people are of the view thatit would take 15-20 years and if nothing wasdone, the situation could spiral out of controland lead to consequences that are difficult topredict. The basic contradiction lies in theuneven distribution of resources, especiallyenergy, which are indispensable for the future

Basic Concepts of Cooperation in North-East Asia inthe Oil and Gas Sector for the Period 2010-2030

Alexander N. GulkovDirector of the Institute of Gas and OilFar Eastern National TechnicalUniversity, [email protected]

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development of the region. The basis for the formation of a long-termdevelopment model for NEA can double upas the core around which co-operativedevelopment of the oil and gas sector of theNEA countries can be planned andimplemented during 2010-2030. As we know, the oil and gas sphere continuesto define the development of the NEA region.In the coming years, the influence of this sectorwill only intensify. Rapid economicdevelopment in NEA in recent years has ledto an increased demand for energy. Accordingto forecasts for the next 10 years, more thanhalf of the energy demand of the planet willbe driven by the NEA region. Already, out ofall the countries of the world, in terms of theirconsumption of petroleum products, China isthe 2nd; Japan, the 3rd; and South Korea, the7th. Further, their dependence on oil importsis 50%, 99%, and 97%, respectively. Nosignificant change in import policy is foreseenfor any of these countries in the coming yearsdespite the introduction of energy-savingtechnologies and the launch of alternativeenergy forms. Today, a large proportion of their energyimports are procured by these countries fromthe Middle East, Australia, and Russia. Russiais the second largest oil producing country inthe world and one of the largest gas producingcountries (generating approximately 13% ofthe global oil production and about 21% ofthe global gas); exports to the countries inNEA account for approximately 3% ofRussia’s exports.What has for so long deterred Russian energyexports from making their way to thecountries of NEA Several reasons could beascribed to explain the matter: first, the lackof transportation hubs-only railroads connectthe Far East with the oil-producing regions ofSiberia; second, there is a crucial lack of oilterminals on the Pacific coast of Russia; third,

the orientation of the oil and gas producers inEurope who are still steeped in the traditionalpatterns of supply and have not undertakenany significant investments in transportationor in the development of new fields; fourth,the lack of exploratory ventures to look fornew reserves of oil and gas and the lack ofcapital investment in this area; fifth, theinstability of markets-China, with the lack oforientation in its north-eastern areas whosereserves of coal are significant, and the bindingof the cost of imported energy to the cost oflocal coal; Japan, with the Northern Territoriesissue and the issue of long-term contracts withother countries for the supply of energy; andKorea, with its stable pool of long-term energysuppliers and the influence of external andinternal factors in the decision-making withinits energy sector. The energy supply to the Democratic People’sRepublic of Korea should be consideredseparately because of the nature of the existingpolitical system that governs it, which servesthe country with certain distinct disadvantagesas well as advantages. One of the positives isthat the specific consumption of naturalresources per inhabitant in that country, withits relatively minimal acceptable livingstandard, allows for an unusual pattern ofplanning and distribution throughout thenation. One of the primary disadvantages isthe largely imaginary threat that is perceivedas coming from that country to the worldcommunity in the form of aggression andnuclear weapons. While the threat does exist,it is largely a political affair, since theDemocratic People’s Republic of Korea isundoubtedly an aberration when the majorityof the nations of the world are committed tothe capitalist path of development. We shall now consider the foundations of theconcept of cooperation among countries inNEA, particularly with respect to their oil andgas sector, in the near future.

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Goals, objectives, and priorities ofthe concept

The main purpose of the concept advocatedin this study is to create a unified approach tothe oil and gas sector of NEA, a region capableof producing not only hydrocarbon oil andfood petrochemistry but also creatingconditions for the sustainable development ofits resources and people. To achieve the goal, key provisions of thedevelopment strategies of Russia, China, SouthKorea, and Japan would need to beimplemented by 2030. The following are themain tasks that need to be accomplished:- Drafting projections of the levels of oil and

gas production in the countries of NEA ona medium- and long-term basis, assumingoil and gas exploration

- Evaluating the prospects of the domesticconsumption of oil and gas in NEA basedon calculations of the optimal energy balancein the region while considering the economicand resource structures of the variousnations Studies delving into the followingareas may have to be conducted:

- On the countries in NEA, focusing on theircommon production, their transportinfrastructure, on the exploration, extraction,and processing of hydrocarbons in order toensure the region’s raw materials and oilproducts are utilized in the best possible way

- On the creation of a unified system of gassupply in the region

- On the creation of transport corridors for thetransfer of oil and gas pipelines forhydrocarbon processing and use

- On the organization of common centers fortraining and retraining and for studyingproblems related to the complex use ofhydrocarbons

- On the creation of conditions necessary toattract foreign investment, in order to

implement a unified approach to the oil andgas sector throughout the NEA

- And on the creation of an internationalconsortium for planning, organizing, andimplementing major projects in the oil andgas sector of the NEA

The key favorable factors toward theestablishment of a unified approach to oil andgas sector of the NEA are outlined as follows:- There is a substantial resource base of oil

and gas in the region. - A high and growing demand for petroleum

products and gas. - A need for improving and optimizing the

regional energy mix of the countries in theregion.

- The unique geographical position of theregion creates ample opportunities forexporting both oil and gas and their by-products.

The main factors hindering the establishmentof a unified approach to the oil and gas sectorof the NEA are listed as follows:■The lack of a comprehensive agreement on

cooperation in the oil and gas sector of theNEA nations stands out prominently. Theprevious agreement did not contain asystematic approach to support cooperationin the oil and gas sector; it was more of anagreement on the intent of the countriesinvolved and focused on theimplementation of local projects only. Allthis makes the formation of a unifiedapproach to the oil and gas sector of theNEA very uncertain, particularly in viewof the complexities involved.

■The lack of a coherent policy in NEA, aseach nation attempts to pursue anindependent policy in its oil and gas sectorwithout taking into account the interests ofother states, is a major deterrent to aunification drive today. Effectivedevelopment in the energy sector isimpossible without a coherent policy, as

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Issue & Focus

countries may be unequally placed in terms ofthe availability of resources, manpower andtechnological capabilities, levels of economicdevelopment, etc. Only the joint participationof countries in neftegazorazvedke, fieldconstruction, extraction of hydrocarbonsand their transportation, processing, andfinally, in the sale of products, will meet thechallenge of creating a single oil and gascomplex that can function stably andfacilitate solutions to the geopoliticalproblems in NEA without upsetting thebalance of forces in the region.

■The lack of an integrated policy with respectto subsoil use is already acknowledged. Alack of consensus plagues other fields too,most notably in relation to the running ofoil and gas fields and the managementof rights to geological exploration anddevelopment of large deposits. There havebeen difficulties in implementing tasksowing to the lack of clear positions on issuessuch as participation in mining andinfrastructure development in China, Japan,and Korea, particularly among the oil andgas companies in these countries. There isa need for clear and consistent policy inorder to draw potential foreign partners andglobal consumers of oil and gas.

Other inimical factors include the high capitalintensity of exploration, mining, oil andgas transportation, and the establishmentof processing facilities; the lack of owninvestment resources for the developmentof the complex; and the high levels ofenvironmental restriction that demandcompliance. The first step toward the realization ofprofitable cooperation can be the beginningof the construction of major oil and gaspipelines in the Far East of Russia. A majorpipeline from East Siberia to the Pacific Oceanwould greatly deliver on the economic and

geopolitical interests of Russia and those ofNEA as well. The following points are relevant to Russia asa whole: - An increase in the capacity of the Eastern

and Far Eastern regions would trigger theimplementation of important prerequisitesfor sustainable development.

- Strengthening the geopolitical potential ofRussia in the East would lead to the growthof Russia’s geopolitical influence in the Asia-Pacific region.

- The diversification of Russia’s economicsystems is vital.

- The formation of new places of employmentand income growth is important.

- A positive impact on the demographicpotential of the region is long overdue.

- The nation would have to meet its regionalneeds with regard to oil, gas, and energyresources, through its own sources.

For the countries of NEA (Japan, China,Republic of Korea) the following are distinctpossibilities: - Meeting the growing demand for oil and

gas.- Meeting the growing demand for electricity. - Diversifying their oil and gas markets and

energy resources.- Creating a more reliable and stable presencein the global market; the construction of theSakhalin-Khabarovsk-Vladivostok line andthe Yakutia-Khabarovsk channel are essentialboth for the development of the region andthe long-term natural gas supply among thecountries of NEA.

For the successful implementation of a regimeof cooperation between the countries in NEAwith respect to their oil and gas sector duringthe period 2010-2030, all the countries in NEAshould consider the following conditions: ■Stop pursuing questions related to possible

adjustments or revisions of existing stateborders.

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Issue & Focus

■The cost of oil and gas should bedetermined by prevailing world prices.

■Equal opportunity should be extended toinvolve all the countries of NEA in theexploration and development of oil and gasresources along the Far East of Russia,including the shelves of the northern andFar Eastern seas.

■The main export routes of oil and gas willend on Russia’s Pacific coast, particularlyaround south of the Primorsky Region.

■The main mode of transportation ofhydrocarbons is expected to be sea vessels;each nation should respond flexibly toemerging markets and eliminate thecreeping in of any privileges to any of theparticipants in the cooperative undertaking.

Raw materials and the state of oilexploration

In the Far East and the Republic of Sakha(Yakutia) lie concentrated 55 oil fields (13 oil,13 gas, 16 gas-oil, 13 oil and gas) withrecoverable reserves of 196.9 million tons inthe categories A, B, and C1 and 157.2 milliontons in category C2. Information on resources,reserves, and potential volumes of oil and gasin these regions is presented in <Table 1>.

According to preliminary estimates of Russia’sterritories and waters on the Far East carriedout by academic institutions, there are provenoil reserves of approximately 410 million tons;this includes the shelf off the Okhotsk Seawhere there are about 165 million tones of oilreserves. The oil found in these regions is ofa high quality, superior in terms of the basicparameters of Russia’s export standards,which basically means that it is of a light andlow-sulfur variety. Most of the proven oilreserves of the Far East (68.2%) have a densityless than 0.87 g/cm3, while about 78% have asulfur content of less than 0.5%. Proven natural gas reserves in the Far Easthave been measured at about 2000 billion m3,including the shelf off the Okhotsk Sea thatholds about 730 billion m3; previouslyestimated reserves were thought to be morethan 1300 billion m3, including the reservesunder the shelf off the Okhotsk Sea that wereestimated to hold more than 250 billion m3 ofnatural gas.The peculiarity of the gas fields of the Republicof Yakutia lies in the fact that their content ismade up of significant concentrations ofethane, propane, butane, and condensate.Moreover, the natural gas deposits of theLena-Tunguska province contain highconcentrations of helium (0.20%-0.60%).Estimated geological resources of helium standat about 60 billion m3. This means that thereis a need for a system of transportation forthese products in addition to processingfacilities that can handle the release of heliumgas, ethane, and the propane-butane fraction;further, the formation of new enterpriseswithin the oil and gas chemical industrywould be welcome. Initiatives in the region to conduct geologicaland geophysical explorations on land andwater can be expected to trigger newdiscoveries, with significant volumes of oiland natural gas likely lying untapped.

<Table 1> Mineral resources of oil and gasin Eastern Siberia and Yakutia

OOiill ((mmiilllliioonn ttoonnss))

Regions Stocks Resources Current productionYakutia 309 2653 0.36

Far East (includingSakhalin (land)) 44 141 1.5

Shelf Seas (Far EastFederal District) 310 5580 2.2

Total 663 8374 4.06GGaass ((bbiilllliioonn mm33))

Yakutia 2280 12098 1.57

Far East (includingSakhalin (land)) 68 246 1.4

Shelf Seas (Far EastFederal District) 1003 14123 -

Total 3351 26467 2.97

Proven reserves of oil and gas within theYakutia and the Far East can allow for thecreation of a new center of hydrocarbon rawmaterials, fully satisfying the needs of the FarEastern federal district in the oil and gas sector,as well as ensuring the possibility of EastSiberian oil and gas exports to the Asia-Pacific(notably, Korea, China, Japan, and the USA).Increased export of hydrocarbons to relevantmarkets will largely depend on the detailedexploration of oil and gas in the region. In analyzing the possible export of oil and gasto the NEA, the reserves in Western Siberiaand the shelf off the northern seas should beexamined. Even today, in connection withglobal warming, we should consider thepossibility of oil and gas transport along theNorthern Sea Route, subject to the explorationand development of deposits in the shelf offthe northern seas and the construction of gasliquefaction plants. The successful participation of Russia inthe proposed cooperation in the oil and gassector across NEA would depend on theunderstanding that Russia views itself as anequal strategic partner on the Pacific coast, asa nation that is able to influence thedevelopment of all events taking place in theregion. Moreover, with greater resources,including oil and gas, Russia would be readyto become a guarantor of energy security inthe region, subject to its interests.The main interests of Russia in the Far Eastwould be related to the following: - The economic development of territories

and improvements in living standards - The rational use of natural resources - Strengthening national security in the region - Building promising development and

exploration initiatives along the region,taking into account the geopolitical changesin the 21st century associated with thedepletion of natural resources.

The progression of the concept of cooperationin the oil and gas sector can be divided intothe following stages:■The conclusion of agreements on cooperation

in energy security in the region. ■The development of transnational projects

for the exploration and development of theoil and gas resources of NEA.

■Attracting investments for the implementationof transnational projects, taking into accountthe interests of all countries in NEA.

■Creating the oil and gas markets in NEA.■The gradual replacement of oil and gas as

sources of power with the advent ofhydrogen, nuclear, and alternative energysources.

In conclusion, this paper examined certainobjective prerequisites for the formationand development of energy cooperation,particularly within the oil and gas sector ofNEA. A special structure-forming role isproposed to be assigned to Russia. Theperformance of this role would be possibleonly if the efforts of all countries in NEA wereconcentrated. The adoption of a strategic linethat takes into account all the economic,political, and energy conditions in the regionand their associated global fall-out is necessaryin addition to the political will to implementthe same because only then would it bepossible to realize the proposals made in thispaper.

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Issue & Focus

The Far Eastern Federal District (FEFD)comprises a total of 6,216 thousand sq. km

(36.4% of the Russian Federation’s territory).FEFD includes nine subjects of the RussianFederation: the Republic of Sakha (Yakutia),the Primorski Territory, the KhabarovskTerritory, the Amur Region, the KamchatkaEdge, the Magadan Region, the SakhalinRegion, the Jewish Autonomous Region, andthe Chukchi Autonomous Region. As ofJanuary 1, 2009, 6,460 thousand people wereliving in the FEFD (4.6% of the totalpopulation of Russia); out of these, 74%comprised the urban population. At thepresent time, 4.6% of the gross volume ofRussia’s total internal product; 3.2% of thecountry’s industrial product volume; and 3.6%of its agricultural production volume isproduced by the FEFD. The Far East basinports provide 17.7 percent of the total cargoturnover of Russian seaports. Over the last few years, the FEFD’s grossregional product has shown a growth levelof 5.1% (Russia showed an average growth of7.2% as regards its real gross internationalproduct for 1998-2005). It is expected thatfor the period extending till 2025, the

development of the Far East will be definedappreciably by the development of itsconsiderable natural resources (fish, wood, oiland gas, coal, ore, and nonmetallic resources)as also by the essential involvement of thedistrict with the countries of the Asian-PacificRim (APR) in connection with goods turnover.The natural climatic conditions of the Far Eastcan be characterized as rather severe, evenextreme. Only in the south of the PrimorskiTerritory does the mid-annual temperatureexceed zero degrees centigrade. In the light ofthese facts, it is clear that the power industryplays a key role in the social and economicdevelopment of the FEFD. Secure and stableenergy and heat supply is a basic necessity forthe citizens and enterprises of the Far Eastduring the winter period and should beprovided at any cost. In other words, thesupply of these resources is mandatory andcannot be subject to the existing marketconditions.

Structure and Condition of theFEFD’s Energy Industry

The power industry in Russia can be divided

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Issue & Focus

Apropos Cogeneration Based on the Development ofthe Small Power Industry Sector in the Far East

Svetlov I.B. Director of the ANO “CSRD RPC FE” (Autonomous Non-commercial OrganizationThe Center of Strategic ResearchesDevelopment of Resources Power Complex of the Far East)[email protected]

Zagumynnov A.G. Deputy Director of foreign economic relations of theANO “CSRD RPC FE.”

into two sectors: the big power industry sectorand the small power industry sector.The traditionally large-scale power stations,which were earlier included in the opensociety system known as the “RAO UES ofRussia,” are classified under the “big powerindustry sector” (the big power). In the FarEast, “the big power” presently consists of anumber of large thermal power stations (TPS)that have entered into an open society holdingcalled “RAO Energy System of the East.” Thiscompany is engaged in supplying energy tothe population, the enterprises, and theorganizations of the Far East through electricaltransmission networks established by the state.Moreover, the company supplies thesettlements that are located near its TPS withthermal energy. The hydroelectric powerstations (HPS) located in the Amur andMagadan areas, the stations that use renewedenergy sources through entering into an opensociety system known as “RusHydro,” andthe Bilibinsky atomic power station located inthe Chukchi autonomous region andbelonging to the open society “ConcernEnergoatom” also fall under the “big power”category. In fact, the mains of the EastIntegrated Power System’s (EIPS) electricaltransmissions network, the open societiesmaintained under the “Federal GridCompany of the unified electric powersystem,” the open society “System Operatorof Unified Electric Power System,” whichoversees the administration of the powersupply systems of the EIPS, and the opensociety “Inter RAO UES of Russia,” which isthe export operator of electric power in Asiancountries-all of these belong to the big powercategory.The total installation capacity of the FarEastern power station is 14 thousand MWe.In this capacity structure, the greatest share(62.0%) is occupied by the TPS (Thermal

Power Stations) while the share of the HPS(Hydroelectric Power Stations) is 37.1%. Ofthe other renewed energy sources (RES)-geothermal power stations (GeoPS) in theKamchatka edge and the Sakhalin region asalso the wind power stations (WPS)-0.6% arenecessary energy resources. Moreover, 0.3%comprise the total capacity of the Bilibinskynuclear power station (NPS). <Table 1> belowpresents the details of the installed capacity ofthe power stations of the Far East and theplanned volume of energy production in 2009.

The total extent of the Far Eastern FederalDistrict’s electrical transmission networkexceeds 105 thousand km and includes. Thishigh voltage belonging to the main electricitytransmission lines with 220 kW and EIPS’smain with 500 kW which make 12.5 thousandkm, whose area totals 12.5 thousand km.The total installed heat generation capacity ofthe sources of heat in the structure of thecentralized heat supply system of the Far Easttotals more than 16.9 thousand Gkal/h. Thegeneral extent of the heat supply network ofthe centralized heat supply system exceeds 2thousand km. The productive supply ofthermal energy by the subsidiaries of the RAOEnergy System of East totaled 22.5 millionGkal in 2008.In Russia, we traditionally refer to the segmentof the power industry that is based on theinstallation of small generating units and

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Issue & Focus

<Table 1> Details of the installed capacity of the Far EasternFederal District’s power stations and planned

energy production in 2009.

Capacity, MWeElectric power

generation in 2009(planned),bln. kWh

TPS 8,682 27.6HPS 5,189 14.0RES (GeoPS, WPS) 81 0.4APS 48 0.2total 14,000 42.2

complexes and that functions on traditionalkinds of fuel and renewed energy sources(RES) as the “small power industry sector”(the small power). Some parts constituting thesmall power cannot be connected to thecentralized electrical transmission network. Asmall generating unit alludes to a generatingobject with the installed capacity of up to 25MWe while a small generating complex refersto a generating object having the combinedinstalled capacity to produce electric andthermal energy of up to 25 MWe, includingthe heat generating capacity.The small power has traditionally solvedpower-related problems by increasing thestability and reliability of all the state powersystems. It has been doing this by creatingadditional generating capacity, increasing theefficiency of the power systems at the regionaland municipal levels, bringing downtechnological losses by bringing generatingcapacities nearer to the consumers, and finally,by reducing the cost of transmitting power.The small power also facilitates theimprovement of power safety and aids thestate in balancing fuel and outputted energyby increasing the use of local fuels.Nevertheless, its key mission remains theprovision of power supply to decentralizedconsumers and increasing the reliability andprofitability of the existing power supply inhousing and communal services.The small power of the FEFD comprisesmunicipal and private boiler houses andelectric power stations, along with enterprisesbelonging to the local electrical transmissionnetworks and district central heating systems.Most of the “small power industry sector” iscontrolled and financed by regional andmunicipal authorities, in whom is also vestedthe responsibility for this sector. Owing to thespecific features of the power industry, privateenergy enterprises as a rule cooperate withthe regional and municipal authorities.

Although a substantial part of the FEFDpopulation lives in small towns and villages,the electricity and heat energy generationcenters are concentrated in big cities such asKhabarovsk, Vladivostok, Komsomolsk-on-Amur, Yuzhno-Sakhalinsk, and Petropavlovsk-Kamchatsky. The high concentration of energyfacilities in these cities helps them to producean adequate amount of heat. At the same time,most of the small towns and villages of theFar East are supplied with heat by privateindustrial enterprises and small municipalboiler houses located in housing andcommunal services. At present, there are atotal of 4,710 small municipal boiler houses inthe FEFD’s regions. Most of them use coal andmasout (black mineral oil) as fuel. DuringRussia’s economic development in the sovietperiod, the construction of apartment housessupplied with centralized heating waspreferred. Today, these apartment houses haveno alternative heating system, and therefore,the only sources of heat available to them arethe municipal boiler houses located in everysmall town or village. There are no electricity generation sources inmany small towns and villages of the FEFD,and therefore, electric power needs to betransmitted to these places from where thepower stations are located, which is oftentimes a long distance. As a result, small townsand villages in remote areas-especially nearstate borders and in the areas adjoining thepower systems of other subjects of the RussianFederation-experience shortage of electricpower supply during the peak of the winterseason.In a number of inhabited localities of theFar East, electric power is supplied bydecentralized sources-diesel power stations(DPS) that were constructed over the 60th tothe 80th year of the last century. In particular,in the Republic of Sakha (Yakutia), the localpower industry is equipped with almost 200

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Issue & Focus

DPS, for the functioning of which it annuallydelivers more than 120 thousand tons of dieselfuel. More than 80 diesel power stationsprovide consumers with electric energy in thedecentralized power supply zone of theKhabarovsk territory while 64 DPS work inthe Primorski territory toward supplyingpower. In the Sakhalin region, there are 22power knots carrying out a decentralizedpower supply function. Among these powerknots, 11 are located on the Kuril Islands.The present technical condition of thecomponents of the power industry andmunicipal services in majority of the regionsof the Far East points to a real threat of increasein breakdowns and compromised powersafety. In the FEFD, about 70% of the powergenerating equipment has been in operationfor terms ranging from 20 to 40 years-and theirdeterioration exceeds the 60% margin-while30% of the equipment has been in use for over40 years. The general share of the effectiveequipment totals only 22.8%. The deteriorationof the fixed capital of the housing andcommunal service enterprises ranges from60% to 100%. The percentage of the financial resources thatthe FEFD allocates from its regional and localbudgets toward power supply is a constantlygrowing number. In a situation of economiccrisis, this fact leads to an increased deficiencyin the budgets of the majority of the FarEastern subjects of the Russian Federation andmunicipal unions. Moreover, these limitedresources suffice only for the maintenance ofthe existing heat production capacity and DPS.The abovementioned chronic deficiency offinancial assets makes the acquiring of newpower equipment difficult and has thus ledto an increasing tendency of continuing to useextremely old power equipment. As a result,the efficiency of the equipment of municipalboiler houses is extremely low. It follows thatdue to the large scale poor quality of thermal

protection accorded to the district heatingsupply system’s pipelines, the loss of thermalenergy is excessively great.The basic fuel resources of Far Eastern subjectsof the Russian Federation are coal and mineraloil products. The cost of fuel and the transportcost of its delivery to consumers have bothbeen showing a constant rise. In the 2005-2006winter, the FEFD’s municipal boiler housesconsumed over 6.2 million tons of firm fuel-totaling the sum of almost 50 billion roubles-and 1.8 million tons of liquid fuel, totaling thatof over 16 billion roubles (taken altogether,about 66 billion roubles). The result of thedeficiency of fuel that arises during theseparate periods of autumn and winter is thatthe maximum power load, as a rule, occursduring periods of sharp cold. Thus, the heatsupply organizations are frequently unable tomaintain an appropriate temperature modeas regards the heat-carrier equipment in theheating systems’ pipelines. As a result, thewater temperature of the heating systemdecreases and owing to the low temperatureoutdoors, the population has no choice but tosupplement the provided warmth by usingelectroheating devices to heat their houses.The direct outcome of this is a considerablegrowth of electrical energy consumption inhousing and communal services, which inturn leads to the electrical supply systemgetting overloaded and compromises itsreliability. The average household powerconsumption in the FEFD territory is high. Itthus follows that in 2008, the share of theelectric power consumed by the FEFDpopulation exceeded the Russian middlinglevel on more than two occasions (by 19.6%and 7.4%).The equipment being used by the DPS todayis so worn out that it is inappropriate for usefrom even the moral point of view. Due to thefact that the cost of the electric powerdeveloped by these DPS is the highest,

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Issue & Focus

implementing an overestimated blanket tarifffor the electric energy provided to all the otherconsumers becomes necessary-a factor thatconstrains the development of the real sectorof the economy and displeases the population.This problem in especially acute in theRepublic of Sakha (Yakutia), where the cost ofsubsidizing diesel power has already reached4 billion roubles. In the Primorski Territory,the average deterioration of the DPSequipment is estimated to be 72.9%.Thus, the power branch of the FEFD-especiallythe “small power” branch-requires urgentmodernization, which should be carried outin the near future at any cost.

Prospects of Gasification in the FarEast Federal District

Almost 25% of the total gas and 15% of thetotal oil resources of Russia are located in thebowels of Eastern Siberia and the Far East. Theinitial total hydrocarbon resources present hereare estimated to have been equivalent to100-140 billion tons of oil. Within this region,including its sea shelf, 140 oil and gas fieldshave been developed, while the developmentof about 50 major oil fields and over 170 gasfields is predicted to take place in the nearfuture.In Eastern Siberia and the Far East, 15 gas and7 oil deposits containing 1,8 bln. m3 gas stocksand 396.2 million tons of oil have beenprepared for industrial development. Thereconnoitered and preliminary estimated oiland gas stocks of the six major oil and gasfields of the Sakhalin shelf are estimated at 292million oil tons and - 0.9 bln. m3 of free gas.At present, the development of oil gas fieldsis being actively carried out in the Far East.The construction of the main oil pipeline “theEastern Siberia - Pacific ocean” (ESPO) hasresulted in the development of some oildeposits of Yakutia that contain considerable

stocks of passing gas. The realization of the East gas program willallow for the installation of gas almostthroughout the small power of the Far East.Within the framework of this program, newcenters of gas production will be created inthe Yakutia, Kamchatka, and Sakhalin regionsof the FEFD. In the beginning of 2012, theopen society “Gazprom” will construct a main“Sakhalin-Khabarovsk-Vladivostok” gaspipeline, the resource base for which will bethe “Sakhalin-1” gas in the short term and the“Sakhalin-3” gas in the long term. In 2012,Gazprom plans to start the construction of a“Yakutia-Khabarovsk-Vladivostok” gaspipeline (implementation term: the beginningof 2017). The capacity of this gas pipeline willextend to 32-35 billion cubic meters per yearand its length will be about 4.5 thousand km.It will share a uniform corridor with the oilpipeline system ESPO and deliver gas from alarge Chajandinsky deposit and otherYakutian deposits to the Russian consumersof the Far East, besides exporting it to thecountries of the Asian-Pacific Rim. A uniformtransport system will be generated on the basisof these two gas pipelines. Gas supply to theKamchatka Edge is planned to be providedat the expense of infrastructural developmentof the Kshuksky and Under-Kvakchikskydeposits located at the western coast of theKamchatka Peninsula and the constructionof the main gas pipeline “Sobolevo-Petropavlovsk-Kamchatskij,” the operation ofwhich is planned in 2010. The project will alsoprovide the necessary resources for theconstruction of distributive networks in thePetropavlovsk-Kamchatskij area.However, in spite of the abovementionedefforts, the gasification of the Far East withinthe framework of Gazprom open society’sEast program will not result in its plannedresult, that of a sharp reduction of expenseswith regard to housing and communal

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Issue & Focus

services power supply, if not accompanied byan in-depth modernization of the powerbranch at the levels of both the RussianFederation subjects and the power generatingcompanies. An inspection of the boiler networkcommunications carried out by theAutonomous Non-commercial Organization“The Center of Strategic ResearchesDevelopment of Resources Power Complexof the Far East” (ANO “CSRD RPC FE”) inlocalities of the Far East experiencing shortagesof electrical objects and security energy carriersconfirms the urgent need for installing newpower object equipment. The requiredeconomy of fuel and decrease in the cost priceof electric and thermal energy can only beachieved through the modernization of “thesmall power” on the basis of the newesttechnologies facilitating the combinedgeneration of electric and thermal energy(cogeneration).

Cogeneration in “The Small Power”as means of Solving the PowerProblems of the Far East

As it is known, cogeneration is the highlyeffective use of a primary energy source forthe generation of two forms of useful energy:thermal and electric. The main advantage ofthis technology, as compared to the usualtechnological processes applied in thermalpower stations, is the maximum utilization ofthe generated thermal and mechanicalenergies, which are usually simply lost in thetraditional technological processes. Therequirement for purchasing developedthermal and electric energy thus decreases,thereby promoting a reduction of productioncosts. All this features increase efficiency fromusual 30-50% of power station to 80-90%efficiency which has system of cogeneration. A comparison between cogeneration and the

separate generation of electricity and heat isshown in <Table 2>. It is based on the typicalvalues of efficiency.

The installation of cogenerators helps thepower industry to effectively supplement theexisting power supply without reconstructingold, overloaded networks. This results in aconsiderable improvement in the quality ofthe electrical and heating supply. Theindependent work of the cogenerators allowsthe power industry to provide consumerswith electric power characterized by stableparameters of frequency and pressure, as alsothermal energy characterized by stableparameters of temperature and qualitative hotwater. Cogeneration can be most profitably appliedto the small power of the FEFD. Industrialenterprises, oil and gas fields, main pipelinesystems, hospitals, objects of housing andcommunal services of municipal unions, largebuildings, hotels, etc., are all potential subjectsfor the positive application of cogeneration. As a result of the implementation ofcogeneration technologies, it becomes possibleto provide consumers with power and heateven without the construction of additionalelectrical transmission lines and heating mains.

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Issue & Focus

<Table 2> A comparison between cogeneration and the separate generation of electricity and heat

Fuel electrical generatingstation100%

Electricity

36%

FuelKettle

100%

Heat 36+80200

general effectiveness:

efficiency= =58%80%

SSeeppaarraattee mmaannuuffaaccttuurree ooff eelleeccttrriicc ppoowweerr aanndd hheeaatt

Fuel CogenerationSystem

100%

CCooggeenneerraattiioonn

Energy

Heat35+55100Efficiency= =90%

Bringing the power sources nearer to theconsumers allows for the considerablereduction of networks, and therefore, leads tothe saving of the finance resources that areusually needed for the construction andservice of such networks. Moreover, itfacilitates an improvement in the quality ofenergy produced and lowers the lossesincurred during its transmission.The conditions that are put forward by theelectric power and heating suppliers forconnection to the electricity and heatingsupply networks often result in considerableirrevocable expenses and sometimes, even tothe revision of the above connections. Thespecific cost of connection to power networkshas already been reached and as regards anumber of power objects, has even exceededthe specific cost of cogeneration installationswith identical power parameters. The essential difference between the capitalexpenses for power supply from networksand power supply from one’s own source isthat the capital expenses connected withcogeneration acquisition are compensatedwhile the capital expenses incurred duringtaking a connection to the existing networksare irrevocably lost in the transfer of newlyconstructed substations. Therefore, accordingto the economically weak Russian customerswho want to connect to the existing electricitynetworks, the power supply companiesshould construct all the technologicalsubstations (transforming station connectors,etc.) that are needed for this connectionand transfer these substations free of costto the electrical network companies. The synchronized development of “big” and“small” (or local thermal) power is aphenomenon that is seen worldwide. Therehas been a global increase in the installationshare of the small power due to thecogeneration cycle, which allows for theoptimal development of heat and electric

power for the housing-and-municipal sectorand the establishment of a social and industrialinfrastructure, besides facilitating effectivepower saving. Moreover, cogeneration lightensthe load of the main heat and powergenerating networks of the big power. Forexample, in the USA and Great Britain, thesmall power cogeneration share reaches 80%while it reaches 70% and 50% in theNetherlands and Germany, respectively.Outside of Russia, this process is activelysupported by the state through legislativeregulation and budgetary financing. Theexperience of industrially developed countriesshows that the construction of thermal powerstations having a low generating capacityinstead of large power units results in a ten-fold reduction in the total expenses incurredduring the modernization process of thepower industry.

Gas Turbine Technologies as a Basisof Cogeneration in the Small Powerof the Far East

Aiming to create the necessary prerequisitesfor the re-equipment of the FEFD’s “smallenergy,” the ANO “CSRD RPC FE” designeda project concerning the construction of a cityplant in Khabarovsk that would comprise agas turbine and gas turbine cogeneration unit(GTCU) of small and medium generatingcapacity.A GTCU generates electrical power throughthe burning of natural gas, the primary energycarrier inside the turbine, while the thermalenergy and exhaust generated at the sametime are used for heating. A GTCU has aparticular advantage, especially in the caseswhere simultaneous electrical power supplyand large scale heating supply are needed.Better efficiency of fuel use, substantialdecrease in the primary demands for fuel, anddecrease in power and heating supply costs

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are the main advantages of using a GTCU. AGTCU is remarkable for its compact design,operation simplicity, extremely low vibrationrate, comparable ease of noise suppression,and low installation cost.In the Far East, GTCUs are able to efficientlysolve municipal heating supply problems aswell as local power supply problems. In thetowns and villages that are supplied withelectrical power through a transmissionnetwork of “large energy,” the electricitygenerated by a GTCU may be used tosupplement the existing heat supply or tocompete with the open society RAO EnergySystem of East, through which it may aid adecrease in energy tariffs.This project is undoubtedly economicallyviable. As a result of the modernization of4,710 Far Eastern boiler houses through thereplacement of old equipments by GTCUs - ofwhich 80% are to be produced at theKhabarovsk turbine plant - 4.6 million tons ofreference fuel will be saved per year. The totalamount of money saved only through thedecrease in fuel purchasing, even withoutcalculating the money saved in repair andoperation costs, will come to 36-38 billionrubles - perhaps even more. In our opinion, the introduction of advancedtechnologies used in overseas companiesthat are world class leaders of turbinemanufacturing is the most reasonable way ofimplementing the Khabarovsk gas turbineplant project. We have already initiatedcontact with our future partners in Japantoward this objective. We also plan to use thetechnologies developed in Russia during theimplementation of this project.The Limited Liability Company “Khabarovsk’sgas turbine plant (KGTP)” was founded as aproject operator toward the implementationof this project on March 31st, 2009.In April, the Khabarovsk Region’s governmentprovided the KGTP with a 31.6 hectare plot

in the northern industrial area of Khabarovsk.Together with the concerned Khabarovskagencies and organizations, we formulated anelaborate plan of action aimed at the successfulimplementation of the project. This plan alsoincluded such project support measures asthe granting of tax relief and financingof endorsements to the KGTP by thegovernment of the Khabarovsk region.This project was backed in full by therepresentative of the Russian president in theFEFD, Victor Ishaev, and by the RussianFederation’s minister of energy, SergeyShmatko. With their support, we could obtainthe preliminary consent of the Russian“Vnesheconombank” and “Vneshtorgbank”managements toward extending the creditguarantee of the Japan Bank for InternationalCooperation to the KGTP. Moreover, theKhabarovsk gas turbine plant construction isto be included in the priority project list of thepresidential commission for the modernizationand technological development of the Russianeconomy. The Russian government’s decreeconcerning the state’s support to the projectis presently under consideration in the relatedministries and agencies. At the present time, increasing the energyefficiency of its economy and the saving of itsresources are Russia’s national priorities.On June 4, 2008, the president of theRussian Federation-Dmitry Medvedev-signedthe presidential decree No. 889 “on certainmeasures aimed at increasing the energy-related and ecological efficiency of the Russianeconomy.”At the extended session of the state councilheld in June 2009, the measures needed forincreasing the energy efficiency of the Russianeconomy at large was the main subjectof discussion. President Medvedev, whochaired the session, set a target of reducing thepower intensity of the state economy by 40%.The state council took the decision to outline

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some drastic measures concerning themodernization of the thermoelectric powerstations, including switching them over tothe combined heat and power generationmode (cogeneration mode). Medvedev alsorepeatedly brought up the question of energyefficiency at the sessions held by thepresidential commission for the modernizationand technological development of the Russianeconomy. In the session of the commissionheld in September 2009, the President said:“We have a lamentable situation on our handsbecause the energy intensity of our country’sgross internal products outnumbers manifoldthe same of developed countries. Our heatsupplying system loses more than 50% of itsgenerated heat.” The federal law of the Russian Federation No.261-fl dated November 23 (f 2009), whichstates that “energy-saving and increasing ofpower efficiency is also about the introductionof changes into certain legislative acts of theRussian Federation” has already taken effect.This law introduces the concept of energy-saving as well as technologies related toenergy-saving and increasing energy efficiency.It also establishes legal relations in this field.The law gives priority to investment projectsaimed at reducing the consumption of naturalgas, electricity, and useful heat consumption.Companies, organizations, and businessmenimplementing such projects might be grantedpayment subsidies from the federal budgetestablished by the Russian Federation’sgovernment.The law outlines the measures related to theplanning of power saving and increase ofenergy efficiency at the federal, regional, andmunicipal levels. These plans will go on tobecome the base for setting goal-orientedindicators of power saving and increasingenergy efficiency together with the fixing ofthe amount of subsidies granted from thefederal budget to the regional and municipal

budgets toward furthering the aims of energysaving and increased energy efficiency. Probably, in the immediate future, the personalcontribution of the presidential representativesin federal districts and of the state ministers,governors, and other managers towardincreasing energy efficiency and recoursessaving will become the main criteria forestimating the results of their activities.The construction of the Khabarovsk gasturbine plant completely corresponds to thegovernment’s established priorities, leadingus to believe that the project will undoubtedlyreceive governmental support and that theplant’s production in the Russian market willmove forward smoothly.As increasing Russia’s energy efficiency,especially in the country’s housing and publicutilities, is not only an imperative need fromthe point of view of the country’s economybut is also one of the most important politicalchallenges facing the Russian leaders of today,the active participation of Korean businesscircles toward solving this problem will serveto strengthen the friendship and goodwillbetween Korea and Russia. The successfulimplementation of the Khabarovsk gas turbineplant project will not only serve as a perfectexample of such participation but also hasevery chance of fostering large-scalecooperation from Russia, which will provefavorable to Korean firms for exerting powerin Far East Russia. This cooperation,undoubtedly, will positively impact otherspheres of mutual relations between Koreaand Russia.

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On December 14 2009 China andTurkmenistan formally opened the gas

pipeline from Turkmenistan through CentralAsia to China. This pipeline, built withChinese capital, is the first gas pipelineconnecting China to Turkmenistan and toCentral Asia, but is unlikely to be the last suchpipeline. Therefore this pipeline has significantconsequences for both Central Asia and China,as well as Russia. But the likely repercussionsof this pipeline do not stop in Central Asia.Instead they also affect the future of energyflows in East Asia as both Central and EastAsia (as this pipeline shows) are becomingincreasingly more integrated in energy andother forms of social infrastructure, e.g.transportation.This pipeline is in fact two pipelines. The firstpipeline, opened on December 14, travels 1833km from Turkmenistan through Uzbekistanand southern Kazakhstan to Xinjiang in China.From there it will connect to China’s domestic

pipeline network, ultimately traversing 700km(4349 miles). While iniitally Turkenistan willbe the only supplier of gas; by 2011 Uzbekistanand Kazakhstan will open up the second line,also 1833km long, enabling China to get gasfrom all three Central Asian producers, notjust Turkmenistan.i Second, the pipeline willbe sending China 40bcm by 2012 if not earlier.Thus it stands in stark contrast to thePrikaspiiskii (Caspian coastline) pipelineagreement negotiated by Russia withKazakshtan and Turkmenistan in 2007.Whereas the entire Turkmenistan-Chinapipeline was negotiated, signed, and builtin three years, there has been little progresson the Prikaspiiskii pipeline, a starkdemonstration of Rusisan graft, inefficiencyand bad faith, compared to China’s progresswith its Central Asian neighbors.ii

Consequently even the most cursory analysisof the new pipeline suggests a victory forTurkmenistan and the other Central Asianproducers, as well as China, but also a cleardefeat for Russia. The benefits to Turkmenistanfrom this pipeline have already been largesince the agreement in 2006 and will continueto flow for some time to come. Mostimportantly, it was this deal that for the firsttime gave it negotiating leverage vis-á-visRussia , which had consistenlty forced it toexport its gas through the only available

The Turkmenistan-China Pipeline: What Are Its Implications?

Stephen Blank Strategic Studies InstituteUS Army War College [email protected]

i Open Source Center, Analysis; PRC, Central Asian Media Laud Gas Line: Russian Officials Downplay Impact, Open Source Center: Foreign BroadcastInformation Service, Central Eurasia, (Henceforth FBIS SOV), January 5, 2010; Moscow, ITRAR-TASS, in English, December 14, 2009, FBIS SOV, December14, 2009; Pavel Baev, “China Trumps Gazprom,”Moscow Times, December 17, 2009

ii Ibid

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pipelines that were Russian ones and to do soat prices well below the market price fornatural gas. Since 2006 Turkmenistan’s andother Central Asian states’ leverage regardingprices has increased as a result of the availbilityto them of other options besides Russia andRussia’s continuing and growing dependenceupon obtaining cheap Central Asian gas tosubisdize its own inefficient and alreadyoverly subisdized domestic energy economywhile meeting surging Eruopean and Asiandemand. Although Turkmenistan has not yetsufficiently prevailed upon Moscow to pay itwhat it receives from Eruopean ocnsumers ofthe gas it ships westward, its receipts haveclearly grown in size as Russian demand forits gas grew. Thus when the current economiccrisis hit in 2008-09 Moscow had committeditself to paying $300tcm to Central Asianproducers in the belief that it could chargeEurope $380-400/tcm. The crisis ended all that,forcing Moscow to buy Central Asian gasat a loss, a growing and increasinglyunaffordable burden for Gazprom. Moscowsought to cut the price it paid butTurkmenistan refused to cut its prices. Thenin April 2009 a mysteriious explosion in thepipeline to Russia which Turkmenistanblamed on Russia led to a cessation of allshipments for the rest of the year. As PavelBaev of Norway’s Peace Research Institute(PRIO) writes,

As the international economic crisis gainedsteam and global demand for energyresources dropped dramatically, Gazpromcould no longer afford to buy gas at thesehigh prices. But it was unthinkable to raise

this issue with Kazakhstan, and politicalrelations with Uzbekistan were too delicateto back out of the deal (which meant gasthrough the Prikaspiiskii pipeline-author).Therefore it was Turkmenistan by defaultthat had to take the blow alone. The explosionon the pipeline near the Turkmen-Uzbekborder in April inflicted little materialdamage, but it was used as a pretext toput a complete stop to all Turkmengas imports. The flow was restoredin November after Turkmen PresidentGurbanguly Berdimukhammedov’s visit toMoscow, but Russia bluntly refused to honorthe “take-or-pay” provision in the contract.iii

Moscow also reduced the amount of Turkmengas that it would take in 2010. Gazprom hadbeen ready to buy over 50bcm fromTurkenistan, in 2010-2012 at a price of$375/tcm but it scaled back its purchases for2010-12 to 10.5bcm and wanted to payTurkmenistan about $220-240/tcm, the sameprice it is trying to obtain from Uzbekistanand Kazakhstan, believing that these forms ofpressure would force Turkmenistan, whichdepends on gas exports, to relent on the highprices for which it had contracted withMoscow in 2008.iv However, in a portent offuture trends, Turkmenistan employed its newleverage with China to obtain a $3 Billion loanfrom Beijing for the development ofTurkmenistan’s South Iolotan gas field withan estimated 4-14 trillion cubic meters.v

Turkmenistan raised the amount of gas it willexport to China through the pipeline from30bcm to 40 bcm and graned it the rights toSouth Iolatan to pay off the loan.vi China’sreadiness to assist Turkmenistan escape

iii Ibidiv“Turkmenistan: Gazprom To Make Cutback On Gas Purchases,”Eurasia Insight, November 24, 2009, www.eurasianet.org; Baevv Moscow, ITAR-TASS, in English, May 29, 2009, FBIS SOV, May 29, 2009vi Chemen Durdiyeva, “China, Turkmenistan, Kazakhstan, and Uzbekistan Launch Turkmenistan-China Gas Pipeline,”Central Asia Caucasus Analyst, January20, 2010

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Russian threats has clearly paid off , not justin the rapid construction of this pipeline butalso in gaining subsequent contracts and evenmore gas supplies. Thus in December, 2009 aconsortium comprising China NatonalPetroleum Corporation (CNPC), SouthKorean, and UAE companies won contractsto develop the field in South Iolotan.vii

Turkmenistan’s victory is apparent. And tofollow up that victory it is consoldiating itsdiversification policy by builidng a newpipeline to Iran to provide it with gas. Thtpipeline will carry 20bcm of gas even thoughTurkmenistan is only shipping 8bcm annuallyso Turkmenistan will ikely increase its ablityto supply Iran, adding more diversity to itscustomer base.viii Meanwhile, shortly afer thepipeline to China opened Gazprom andTurkmenistan negotiated an agreement to endthe acrimony that had poisoned relationsbetween them in 2009. But there is no doubtthat Russia lost this round to bothTurkmenistan and China and that byimplilcation other Central Asian producerslike Kazakhstan and Uzbekistan have won.Russian officials have been trying to put agood face on this deal signalling theirunconcern, totuting the resumption of gassupplies from Turkmenistan, and reiteratingthat the new pipeline, by annually shipping40bcm of gas to China, will make it impossiblefor Turkmenistan to supply the EU’s rivalNabucco pipeline that is supposed to competewith Russian pipelines in shipping CentralAsian gas to Europe.ix However, this Russianargument only holds water if one believes that

Turkmenistan holds much less gas than itclaims to possess and that the Gaffney-Clinereport of 2009 suggesitng vast reserves iswrong or fraudulent.x

However Moscow’s behavior shows that itunderstands very well who won this round.In late December 2009 it reached agreementwith Askhabad to buy 30bcm annaully ofTurkmen as starting in 2010 and to build anew pipeline to link untapped gas reserves inestern Turkmenistan with the Prikaspiiskiipipeline.xi Even with this agreement it isclear that by 2012 when the two pipelinesconnecting China with Central Asia open,China, not Russia, will be the main buyer ofCentral Asian gas. Even if alternatives likeNabucco have been shut off by Russia’s retreatand new agreements (which is doubtful)China’s primacy in the Central Asian gasmarket is undoubtedly a blow to Russiawith long-lasting consequences.xii As onenewspaper report suggested,

Strengthening of China’s economic positionswill ineivitably boost its poltical influenceand eventually transform China into theleader of the whole regoin and the truemaster in the regional structures like theShanghai Cooperation Organization. WithRussia’s silence signifying consent, CentralAsian hydrocarbons flow eastward at anever increasing rate. The impression is thatRussia accepted it. Fierce battles for theTurkmen gas with the paper Nabucco ratherthan with the actual gas pipeline to Chinaplainly show the true scope of Moscow’sambitions. The Kremlin lacks either strength

vii Beijing, China Daily Online, in English, December 31, 2009, FBIS SOV, December 31, 2009viii“Russia, China, and Iran to Forge a New Energy Axis This Year,”www.asianews.it, January 8, 2010ix FBIS SOV, December 14, 2009; Moscow, ITAR-TASS, in English, December 22, 2009, FBIS SOV, December 22, 2009x“Energy Superpower Emerges In the Caspian,”http://www.peakoil.com/modules.php?name=News&file=article&sid=43522, October18, 2008; “TurkmenistanGas Reserves Revealed,”www.kommersant.com, October 15, 2008; Regis Gente, “TURKMENISTAN: ASHGABAT ENERGY-RESERVE CONTROVERSY CONTINUESTO FLARE,”http://eurodialogue.org/energy-security/Turkmenistan-Ashgabat-Energy-Reserve-Controversy-Continues-To-Flare, Accessed on January 18, 2010

xi Isabel Gorst, “Russia Welcomes End to Gas Dispute,”Financial Times, December 22, 2009, www.ft.comxii FBIS SOV, December 22, 2009

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or willingness to put up a fight for CentralAsia. It finds protection of its posiitins in heEuropean gas market a more rewaridingoccupation.xiii

Even if this might be an exaggeratedassessment of China’s future position inCentral Asia, what it also means for China isthat it now no longer has to approach Russiawith regard to gas as a supplicant, but ratherit has a superior bargianing position becauseit does not depend on Russia for gas no matterhow much it wants that gas. Despite theRussoi-Chinese agremeents of 2009 to buildpipelines to ship China 68bcm of gas , Russianeither has the money to build the pipelines,nor possibly the gas -- as it closed many fieldsdue to the current crisis -- unless China lendsit the money to reactivate pipelines, wells, andfields that were shut down in 2009 due to theeconomc crisis. Indeed China alreadyproudces 76bcm of gas a year and consumesonly about 80bcm with Australian LNGmaking up the difference. So it really does notneed Russian gas anytime soon, espeically asit will now be getting 40bcm fromTurkmenistan.xiv And, in any case, neiher sidehas yet agreed on prices os their agrementsare merely declarations in principle, not hardcontracts, and to judge from previousnegotiations, no agreement is imminent,despite Russian claims to the contrary. Ifanyting we can expect hard barginaing onprice because china will demand belowmarket prices and Russia will demand marketprices in a classic confrontation betweensupplier and buyer. Indeed Russia needs thispipeline and its revneues more than Chinadoes, and therefore the Turkmen-Chinapipeline could ultimately contribute to

expanding China’s increasingly visibleascendnacy over Russia, not just in CentralAsia, but in East Asia as well.

Russo-Chinese Rivalry in Central Asia

Neither is this deal the end of China’soffensive in Central Asia, indeed it has onlyrecently begun. This pipeline ties into China’slarger strategy of global acquisitions andexpanison of influence that became clear in2009. China’s strategy is clear. In conditionswhere Far Eastern infrastructure is onlybeginning to appear; where the Middle Eastremains as volatile as ever; and China’s Straitsof Malacca dilemma remains unabated, itmust define energy security as having diversesuppliers, at least some of whom cannot beinterdicted in the Indian Ocean by the US,Indian or other navies or other hostile forces.Yet as the Middle East remains its largestsource of energy, China’s strategy is clearlyboth one of hedging against the future and ofextending its energy and other security linksabroad through economic power.Second, China also seeks to tie Central Asianproducers to it to deter them from supportingtheir cousins and coreligionists, Muslim rebelsin Xinjiang, its own largest energy producingprovince. Third, to the extent that China cangain leverage over both Russia and CentralAsian countries, it forestalls a Russianmonopoly over Central Asia that could alsobe used to deprive it of energy or threaten itsinterests in Xinjiang as happened during theSino-Soviet split of the period 1956-90 whenMoscow sought to exploit Han-Muslimtensions there.xv Therefore for geostrategicreasons it also seeks to avoid excessive

xiii Alexander Gabuyev, “Cost of the Matter,”Moscow, Kommersant, December 23, 2009, FBIS SOV, December 23, 2009xiv“Warmer Ties For Russia, China With Big Gas Deals,”www.cbsnews.cm/storis/2009/10/14/ap/asia/main5384036, October 14, 2009xv Lowell Tillet, "The National Minorities Factor in the Sino-Soviet Dispute," Orbis, XXI, No. 2, 241-260.

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dependence upon Middle Eastern and Africanproducers even as it buys ever more energyfrom them, seeking producers as far away asIran who can then ship gas and oil to itoverland through new pipelines that China ishelping to build in Kazakhstan, Turkmenistan,and Uzbekistan and which could ultimatelyconnect to Iran. Beyond that China ties loansto energy because it not only gets back theloans plus interest it can now tie up energyassets in long-term contracts at reduced pricesfor exclusive access.Central Asia is one of the links in this chainfor China clearly invests its economic resourcesin countries with which it has a politicalaffinity and which enjoy a dubious reputationabroad because of their authoritarianism. Wefind China replicating this approach in Africa,Latin America, and in Southeast Asia whereit is Myanmar’s staunchest foreign supporter.China also invests in these countries for twoother reasons. Many other fields in producerstates that were opened earlier are notavailable for sale and when China has soughtto buy in major countries, e.g. its efforts to buyinto UNOCAL in 2005, that action has raiseda storm of disapproval from host states. Buteven bearing these things in mind, China’sstrategy began before 2005 and worksremarkably well with its geopolitical strategy.This is unlikely to be a coincidence orfortuitous event. This political dimension isanother reason why China’s energy strategyis also connected to its overall foregn policyand defense strategy and may be thought ofas mtuaully reinforcing aspects of its overallgrand strategy.xvi

For example China’s Export-Import Banklent the state-owned Development Bankof Kazakhstan $5 Billion, and CNPC islending Kazmunaigaz, Kazakhstan’sstate-run gas company, another $5 Billion.Moreover, CNPC bought a 49% minorityholidng in Kazakhstan’s company AOMangistauMunaigaz from KazMunaiGazNational Co.xvii This deal enables Kazakhstanto continue its robust pace of explorationfor oil, which finances its overall developmentplan whose long-range aim is its comprehensiveeconomic diversification and modernization.Having received an estimated $21.1 Billion in2008 in investment for exploration andproduction, it needs to keep that up duringthis crisis to prevent an even more severeeconomic contraction. Kazakhstan’s state newsagency Kazinform said the $5 Billion loanwould help pay for the MangistauMunaiGazdeal and the construction of the Beineu-Bozoi-Akbulak gas pipeline, which will servesouthern Kazakhstan.xviii Thus Kazakhstan’sneed for capital and reliable export marketsplays into China’s strategy and China’s victorywas clearly facilitated by its deep pockets andcash reserves.xix But China’s actions do notbreak with past Sino-Kazakh relations.Indeed, according to Kazakhstan’s PresidentNursultan Nazarbayev, at least since 2006,“economic cooperation has become themajor motivation for pushing the overalldevelopment of the Kazakhstan-Chinarelationship.”xx

Nevertheless this deal exemplifies the way inwhich China can now exploit the strickencondition of countries like Kazakhstan whose

xvi Michael Swaine and Ashley j. Tellis, Interpreting China's Grand Strategy: Past, Present, and Future, Santa Monica, CA: Rand Corporation, 1996xvii M.K. Bhadrakumar, “Cash-Rich China Courts the Caspian,”Asia Times Online, April 18, 2009, www.atimes.comxviii Ibid;“Kazakhstan: A Chinese Energy Loan,”ww.strafor.com Analysis, April 17, 2009; Joanna Lillis, “Kazakhstan: China’s Deep Pockets Make Beijing a

Potent Player in Central Asia,”Eurasia Insight, April 20, 2009;xix Ibid.; Bhadrakumar; “Kazakhstan: a Chinese Loan”xx“Interview With President Nursultan Nazarbayev of Kazakhstan,”Beijing, Xinhua Domestic Service in Chinese, June 8, 2006, FBIS SOV, June 8, 2006

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banking system was all but insolvent andwhere foreign investment has fallen by halfsince 2008 by early 2009. Indeed this deal givesChina control over about 15 percent ofKazakhsan’s total oil output and other Chinesefirms have already been there for some time.Furthermore Kazakhstan’s national nuclearpower company Kazatomprom has begunmining uranium fields in southernKazakhstan in a joint venture with Chinesenuclear power companies.xxi Terms of the dealalso call for Kazakhstan to provide China withmore than 24,000 tons of uranium by 2020.More recently, the China Guangdong NuclearPower Group (CGNPG) and Kazakhstan’sstate nuclear agency, Kazatomprom, haveagreed to form a joint enterprise that wouldbuild atomic energy stations in China.xxii ThusChinese Prime Minsiter Wen Jiabao recentlyoutlined a four point proposal for enhancingbilateral partnership that emphaiszed first ofall maintaining the growth of bilateral trade,and second, fulfilling previous agreementsand giving priority to cooperation in theenergy and resource sectors. Then comescooperation in investment and finances toensure smooth implementation of constructionprojects. Finally both sides should promotecooperation in infrastructure. xxiii

This strategy of gaining critical access toCentral Asian energy neither occursexclusively in Kazakhstan, or even Central

Asia nor only in regard to hydrocarbons.Apart from lending Kazakhstan money Chinais also building power plants in Tajikistan andKyrgyzstan and pipelines in Turkmenistanthat will then go on to Uzbekistan so that itcan buy gas from these countries at lower thannormal prices. It also is mining iron ore inKyrgyzstan from what is apparently Asia’slargest source of iron. Not surprisingly theKyrgyz government is encouraging furtherChinese investment in its coal mining, non-ferrous metals, precious metals, andinfrastructure sectors.xxiv Kyrgyz officials alsowant China to import electricity from theKambarata power station that Russia isbuilding to prevent surplus capacity andunder production. Buying hydropower makessense for China which has increasingly beenpledging infrastructure assistance and cash toCentral Asian states through the SCO, e.g.helping Tajikistan build dams and roads.Moreover, China can become a handler ormiddleman, e.g. wiring Central Asia intoPakistan and Afghanistan and picking uphuge transit and construction fees.xxv

Likewise, in the past few years China hasinvested heavily in Afghanistan’s energy andmineral resources, which have been found tobe abundant, with a view to building pipelineseither directly to China or possibly throughthe port of Gwadar and Pakistan to China.xxvi

As many analyses suggest, China ultimately

xxi John C.K. Daly, “Analysis: China Increases Stake in Kazakh Energy Assets,”UPI.com, www.upi.com, April 28, 2009xxii“China, Kazakhstan: Nuclear Power Deal Agreed,”www.stratfor.com, April 30, 2009 xxiii“Chinese Premier Raises Four-Point Proposal. For china-Kazakhstan Cooperation,”Beijing, Xinhua in English, April 17, 2009, FBIS SOV, April 17, 2009xxiv“China Reform Monitor,”April 15, 2009 from the American Foreign Policy Council, www.afpc.org, citing Interfax, April 15, 2009xxv Jian Yang, “Beyond Energy: China’s Energy Relations With Japan and India,”Paper Presented to the Annual convention of the International Studies

Association, New York, 2009xxvi“Mining Boom Boosting Economics of Afghanistan,”www.sananaews.com.pk, April 22, 2009; Ian McWilliam, “China Wins Major Afghan Project,”BBC News

South Asia, November 20, 2007; “Afghanistan Looking Mining Companies To Explore Iron Ore Mine,”http://paguntaka.org, April 5, 2009; Niklas Norling,“The emerging China-Afghanistan Relationship,”Central Asia Caucasus Analyst, May 14, 2008; Kevin Slaten, “China’s Bigger role in Pakistan,Afghanistan,”South China Morning Post, February 12, 2009, www.scmp.com; Ron Synovitz, “China: Afghan Investment Reveals Larger Strategy,”RadioFree Europe Radio Liberty, May 29, 2008; Tariq Mahmud Ashraf, “Afghanistan in Chinese Strategy Toward South and Central Asia,”Jamestown ChinaBrief, VII, BNO 10, May 13, 2008; Jeremy Page, “Afghanistan Copper Deposits Worth $88 Billion Attract Chinese Investors,”Timesonline, May 15, 2008,www.timesonline.co.uk;

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hopes to ship Persian Gulf oil from Gwadaroverland through Pakistan to Xinjiang inChina. Inasmuch as the Turkmenistan-China pipelineis now functioning and Turkmenistan hasexpanded its pipeline capacity to Iran, it doesnot require much imagination to expect thatChina is going to sek to finance a means ofconnecting those two pipeline systems intoone so that gas as well as oil can be pumpedoverland from Iran to China through CentralAsia. Since 2004 China has signed severalmajor oil and gas deals with Iran which isalready supplying over 15% of China’s energyneeds. The most recent deal for $3.2 Billionwas signed on March 15 2009 where Chinawill help develop the South Pars field, part ofwhat is believed to be the world’s largestnatural gas reservoir.xxvii But beyond energyconsiderations these deals meet China andIran’s overall foreign policy objectives. Thesedeals are not only instrumental in ensuingChina’s continuing receipt of large quantitiesof oil and gas, they also meet Iran’s desire toreplace Japan with China as its main Asianenergy importer. Thus Iran has warned Japanin the past that if it backed out of energy dealsdue to Western pressure it would turn toChina.xxviii Iran’s foreign policy since 2001 hasalso been driven mainly by Tehran’s“Ostpolitik”, a policy placing primaryemphasis on securing Russian, Chinese, andAsian support for its programs Indeed, Iranseeks broader cooperation with Russia notonly on nuclear issues but on a gas cartel andon all security issues in the CIS, or at least so

it claims.xxix And it clearly seeks to be a majorsupplier to China to earn its political supportand help break Western sanctions. Indeed, Iranpoints to such deals as signs that US claimsthat foreign energy firms are shunning Iranare baseless and that US opposition to energydeals with Iran can be overcome.xxx

Therefore these deals also compromise theunity of the P-5 (permanent members of theSecurity Council) and the negotiationsbetween the EU and Iran that include Chinaand Russia in forging a strong united front toarrest or reverse Iran’s ever more open questfor nuclear weapons. Thanks to these dealsIran not only gains strong supporters in theEast, it gains capital to develop its energysystems and evade or mitigate at least someof the impact of UN and US sanctions.Indeed, according to a report from the CIA,“Chinese entities - which include privatecompanies, individuals, and state-ownedmilitary export firms - continue to engage inWMD-related proliferation activities “ to Iran.And even though Beijing has tightenedregulations on sensitive equipment exports,“enforcement continues to fall short.”xxxi

China not only hamstrings the US and deflectsits attention away from China’s growingpower, putting it in the status of a demandeurvis-a-vis China as regards Iran. China also getsan enormous source of reliable energysupplies and by forging these deals it hasalready begun to create a basis for enhancingthe viability of any projected pipeline linkingit through Pakistan and Central Asia (eitherKazakhstan or Uzbekistan, Afghanistan

xxvii Borzou Daragahi, “Iran Signs $3.2 Billion Natural Gas Deal With China,”Los Angeles Times, March 16, 2009, www.latimes.comxxviii“Iran Eyes Russia, China If Japan Stalls On oil Deal,”The Japan Times, August 29, 2006, http://seaarch.japantimes.co.jp/print/nb20060829a1.html; F.

William Engdahl, “China Lays Down Gauntlet in Energy War,”Asia Times Online, December 21, 2005, www.atimes.comxxix Andrei Kolesnikov, “Vladimir Putin Includes Iran in Sextet,”Moscow, Kommersant, in Russian, June 16, 2006, FBIS SOV, June 16, 2006xxx Wang Ying and Dinakar Sethuraman, “China, Iran Sign $2Billion Oil Production Agreement,”Bloomberg, December 10, 2007xxxi“Iranian Nuclear Work Unhindered By Sanctions, CIA Report Says,”Global Security Newswire, May 8, 2009, Nuclear Threat Initiative, www.nti.org, or

http://gsn.nti.org

and/or Pakistan) directly to Iran. Here againChina would thus be in a postion to realize itsultimate dream of diverse supply lines thatcannot be cut off by the US Navy or in thiscase by Russia or India, all potential rivals.Thus China’s energy deals with Iran for oil

and gas parallel its energy deals in 2009 withRussia and Kazakhstan in that theyconsolidate a community of interests bindingChina to its suppliers. But these deals alsoenable China to attack U.S. objectives, attainlasting partnerships with important energysuppliers and generally strategically importantstates, gain secure and reliable energy supplies,deflect Washington’s attention and energyaway form it and its growth, and to do so atrelatively little poltiical cost. At the same timethe current economic crisis offers Chinahitherto undreamt of opportunities to pursueits energy strategy at knock-down prices, forexmaple in the Russian case, where it canobtain its goal of getting energy whereverpossible at below market prices.Beyond that oil pipeline from Iran China isalso considering a major infrastructuralinvestment there to make it into an overallenergy corridor where it sets up an oil reinferyand Gwadar Port Energy zone that alsoaccomodates other energy industries, andcreates the basis for oil and gas explorationprojects in Pakistan from which the latter willbenefit as well.xxxii Indeed, a comprehensiveexamination of Pakistan-China relationsunderscores the trend to deepen what hadbeen essentially a security and geopolitically

driven relationship with a strong energy andeconomic component comprising energy,trade, and investment by China in Pakistan.xxxiii

Despite enormous Indian concern aboutChina’s naval strategy of using Gwadar orMyanmar’s ports for military purposes, thattask appears to be beyond the Chinese Navy’scurrent and foreseeable capabilities as a thePLAN admits, and the main purpose ofGwadar and other similar port projectsappears to be for energy transmission andinfrastructure.xxxiv

Thus much of its investment in energy andinfrastructure abroad in Central Asia seemsto be connected or could easily be connectedwith its efforts to open up the port of Gwadar.Were this port to be established as a hub itcould spare China the necessity of goingthrough the Straits of Malacca and becomethe hub of a network of pipelines from Iranand the Middle East, if not also South andCentral Asia, to China.xxxv Indeed, China’s socalled string of pearls strategy in the IndianOcean that combines large infrastructuraldevelopments in and around Myanmar andPakistan with military construction of whatappears to be potential naval bases, not onlyis viewed as an effort to project naval powerinto that Ocean through available ports orbases, but also as a way of bypassing theStraits of Malacca and creating strongholdsof economic and political influence tyingthese areas to China through energy andinfrastructural investments.xxxvi When and ifthe infrastructure tying these ports to China

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xxxii“Chinese Mulling $13B Investment in Gwadar,”Pakistan Real Estate Now, May 9, 2008, www.livenreal.com/news/index.pho./chinese-mulling-13b-investment-in-gwadar; Sumita Kumar, “The China-Pakistan Relationship: Trade, Investment, Energy, and Infrastructure,”Strategic Analysis, Vol. 31, NO. 5, 2007, pp.757-790

xxxiii Ibid.xxxiv Andrew Erickson and Lyle Goldstein, “Gunboats for China’s New “Grand Canals”,?”Naval War College Review, Vol. 62, NO. 2, Spring, 2009, pp. 43-76xxxv Kumar, pp. 757-790xxxvi Erickson and Goldstein, pp. 43-76; Shebonti Ray Dadwal, “China’s Search for Energy Security: Emerging Dilemmas,”Strategic Analysis, Vol. 31, No. 6,

2007, pp. 889-914; You Ji; “Dealing with the Malacca Dilemma: China’s Effort to Protect Its Energy Supply,”Strategic Analysis, Vol. 31, NO. 3, 2007, pp.467-489; Gupreet S. Khurana, “China’s “String of Pearls’In the Indian Ocean and Its Security implications,”Strategic Analysis, Vol. 32, No. 1, 2008, pp.1-39

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is completed these projects could create long-lasting economic and political relationshipsdominated by China and that ensure thatMiddle Eastern and African energy suppliesneed not be at risk in the Straits of Malacca.In another example in early 2007 China loanedTajikistan several million dollars withoutinterest. In return the Tajik government thensigned a political or cooperation agremementwith China foregoing recognition of Taiwan,tightening security linkages, and postulatingan identity of interests with China on abilateral basis outside of existing linkagesbetween them through the SCO.xxxvii Similarlyonce the loan to Kazakhstan was announced,Chinese Vice Premier Wang Qishan indicatedthat it should lead to further bilateralcooperation in business and politics whilePresident Nazarbayev of Kazakhstan indicatedhis suppport for Chinese investment inKazakhstan and entrrpeneurial activity thatcarried out mutually beneficial cooperation.xxxviii

The different nuances in these remarksindicate what is at stake here, i.e. Central Asia’seconomic independence. Although these areonly a few of many such examples in CentralAsia and elsewhere, they underscore thetactics by which China is advancing its overallstrategy for Central Asia in energy and otherdomains.

CNPC’s Future Plans

CNPC, in its own words, has been making

acquisitions in Eurasia non-stop. Indeed, itrecently announced a detailed plan to “striveto build five cooperation zones coveingCentral Asia, Africa, South America, theMiddle East, and the Asia Pacific region withineight to ten years.” Ultimately its overseas oiland gas buisiness would amount to 200million tons of oil and gas annually.xxxix As thisplan does not include the loans for oil plansthat have already started so it represents a newcampaign.xl Indeed, Central Asia is the mostimportant zone for foreign energy cooperation,another sign of the intertwined nature ofenergy, strategic, and political considerationsin China’s energy policies.xli Apart fromexpanding holdings in Africa and LatinAmerica, the efforts in the Middle East shouldbe strengthened to make it the company’sfuture key development zone. Meanwhileefforts should also be made in the Asia-Pacificfor producing both natural gas and LiquefiedNatural Gas (LNG).xlii That last point hasparticular relevance for China’s energy ties toMyanmar, a major gas and oil supplier.CNPC has also indicated that this is anauspicious time for such bold plans sinceenergy demand will grow while Chinaalready imports most of its oil. Moreover,CNPC aims to become an integratedinternatonal energy company with six oil andgas business centers in Asia, America, andEurope. Meanwhile the value of investmentbecomes more apparent as global economicgrowth slows down and both energy and

xxxvii Beijing, Xinhua, in English, January 15, 2007, FBIS SOV, January 15, 2007; Dushanbe, Asia-Plus Internet Version, in Russian, January 1`6, 2007, FBISSOV, January 16, 2007; Beijing, China Daily (Hong Kong Edition) Internet Version, in English, January 16, 2007, FBIS SOV, January 16, 2007

xxxviii Beijing, Xinhua, in English, April 16, 2009, FBIS SOV, April 16, 2009xxxix Ming Quan, “CNPC’s Expansion Blueprint: Oil and Gas Capacity To Reach 200 Million Tons in 10 Years,”Guangzhou, Shiji Jingji Baodao Online, in

Chinese, March 19, 2009, FBIS SOV, April 16, 2009xl Ibid.xli Ibid.xlii Ibid.xliii Ibid.

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assets decline in price.xliii CNPC estimates thatCentral Asia has 8% of world oil and 5% orworld gas and that negotiations are not thattricky since states like Turkmenistan areapproaching China.xliv Thus in Central AsiaCNPC emphasizes the need for going beyondthe already estimated 40bcm of gas to betransported through pipelines from there to50-60bcm annually and transmitting 20 milliontons of oil annually through the pipeline fromKazakhstan. Apart from the oil pipeline fromRussia discussed below, CNPC wants to finisha pipeline that annually transmitts 30bcm ofnatural gas from Russia. This means a priorityon finishing pipeline deals, wrapping up theirfinancing, and their construction from CentralAsia and Russia. Therefore we can expect aneven greater Chinese energy drive andfootprint in these areas, for example, CNPCalso wants to establish a heavy oil and LNGshipping company to control those productsfrom the wellhead to China itself.xlv

CNPC also believes that with thebreakthrough in Sino-Russian talks there areno longer strategic obstacles to getting oil andgas from all four of these major strategic routes(Central Asia and Russia, South America,Africa, Asia-Pacific) and also expectsbreakthroughs on the Sino-Burmese pipelinethis year.xlvi CNPC also announced its tactics,i.e. merger and acquisition efforts with closelymonitored and selected targeted oil and gascompanies and assets , i.e. small to mediumsized independent oil companies sufferingfrom financial difficulties but with futurepotential, as well as sophisticated oil and gasassets. Second, it will also target larger oil andgas firms for mergers and acquisitions toexpand its overseas oil and gas business.xlvii

Although most of China’s energy imports stillcome from the Middle East; Beijing is clearlyand rapidly seeking to diversify its supplierson a global basis: Venezuela, other LatinAmerican countries, Africa, Russia, andCentral Asia. Neither will China slacken thepace of acquisitions anytime soon. As notedabove, CNPC’s program will not stop. Itrecently announced its intention to invest upto $44 Billion in oil and gas projects in 2009,especially in core projects like the ongoingKazakhstan-China oil pipeline that will sendChina 15 billion tons of oil a year from 2011-2034. We can expect that other projects inCentral Asia, e.g. the gas pipeline fromTurkmenistan, will also be moved further tocompletion and that Chinese firms and thegovernment will continue searching fordistressed energy firms that they can acquireat cut-rate prices to gain global and regionalleverage among suppliers and governments.

Conclusions

Remarkably enough the implications ofthe new Turkmenistan-China pipelinesimultaneously go beyond the scope of thequestions addressed here and deeper intothose issues. For example, if China can outbidRussia in Central Asia or provide analternaitve to states feeling excessive pressurefrom Russia what does this say about Russia’sfuture prospects there or in East Asia whereit is clearly unable to compete economicallywith China? Certainly this pipeline alsostrenghtens native proudcers in Central Asiaand may yet effect a new series ofrleioatnships between Iran and China. So thesignificance of this particular pipeline goes

xliv Ibid.xlv Ibid.xlvi Ibid.xlvii Ibid.

beyond econmics to involve profundgeopolitical relationships as well. But that ishardly surpriisng given the salience of energyissues in both Russia’s and China’s policies. Finally, it also is clear that this pipeline doesnot represent the end of China’s policies butis only a very early stage in the expanison ofChina’s internatinal energy and econmoicprofile. CNPC’s plans and the other dealsChina has made in 2009 and is now makingall ppoint to the expaniosn of its presence inCentral, South, and even Southeast Asia.China’s recent deals also suggest that itgaining sufficient leverage as to be able toinduce those states to reorient their preferencestowards China and even accommodate itsviews.xlviii Some have discerned even a similartrend in Australia though others deny it.xlix

Others argue this is happening in East Asia,particularly Southeast Asia, but also possiblyin South Korea.l The evidence submitted heresuggests that we can begin to discern suchpatterns of accomodation, particularly in theface of the current crisis, backed up by theunstated but always present specter of China’spower, especially in neighboring areas likeCentral Asia. Indeed, several writers not onlypoint to the growth of that power in Central orSoutheast Asia, they openly herald the adventof a new order that is gradually becomingbased on an increasing acomodation to China’sprefreences, often manifested thorugh suchsoft economic power as we have seen here.li

Thus Thonmas Rawski and William Kelleropenly warn that “the balance of influencebetween China and the United States in Asia

is shifting decidedly in China’s favor.”lii

Observers and experts will undoubtedlydebate those conclusions. But they cannotdebate or negate the viogr and assertivenessof China’s overall recent policies inintenrational affairs and econmics which areindeed linked togther quite closely. Clearlystrtegic transformations in energy and inAsia’s and China’s overall policies are nowupoon us and are accelrating in their pace anddeepening in their implications of which wecan only see the first or early stages. But nomatter how undertain we are of the finaloutcome of these transformative processes,we can be sure that they will not stop anytimesoon.

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xlviii Stephen Blank, “Chinese Energy Policy in Central and South Asia,”Korean Journal of Defense Analysis, XXI, NO. 4, Fall, 2009, pp. 448-453xlix James Manicom and Andrew O’Neil, “Accommodation, Realignment, or Business as Usual?: Australia’s Response to a Rising China”Paper Presented to

the Annual Convention of the International Studies Association, New York, 2009; “Australia’s Chinese Entanglement,”p. 46l Robert S. Ross, “Balance of Power Politics and the Rise of China: Accommodation and Balancing in East Asia,”William W. Keller and Thomas G. Rawski,Eds., China’s Rise and the Balance Of Influence in Asia, Pittsburgh: University of Pittsburgh Press, 2007, pp. 121-145 77 Ibid . And the essays containedthroughout the book; Manicom and O’Neil; David C. Kang, China Rising: Peace Power and Order in East Asia, New York: Columbia Press, 2008.

li William W. Keller and Thomas G. Rawski, “Asia’s Shifting Strategic and Economic Landscape,”Keller and Rawski, Eds., p. 7

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The development of the eastern regions ofthe country will become one of the key

priorities of the Russian energy policy in thetwenty-first century. This will take place in thecontext of increasing diplomatic and trade andeconomic cooperation with the neighboringcountries in Northeast Asia. Undoubtedly, the development of the energysector will be prioritized in the implementationof the state policy in the East.

The Current Structure of the Energy Sector

Traditionally, the Russian energy sector wasoriented toward meeting the needs of thedomestic market and exports, primarily tothe CIS countries and Europe. This structureof supplies was determined in light of historic,economic, and technological reasons. Prior to the beginning of the twenty-firstcentury, energy trade with Asian countrieswas limited. As of 2008, the share of theeastern direction in Russia’s exports of oil andoil products was only 8%. Within coal exports,this share was 22%. There were no gasdeliveries to Asia (1, 2). At the same time, there has been significant

progress in increasing the energy exportvolumes to the Asia Pacific in recent years. In2003, when the Energy Strategy of Russia for2020 was being set, the share of the AsiaPacific region in Russian oil exports wasmerely 3%, which means that it has beengrowing by an average of 1% a year for the lastfive years. Coal exports to this region more thandoubled in the period from 2003 to 2008 (3).The processes taking place in the Russianenergy sector are determined by the changesin the global market and the new Russianenergy policy.

The New Stage in the Developmentof the Energy Sector

The global energy market has gone throughthe stages of national and regionaldevelopment and has entered a newtransnational level. This happened largely due to trade in oil andoil products, as inter-regional trade becameone of the foundations for the developmentof the entire global economy in the twentiethcentury. After economically profitable waysof transporting coal and natural gas by seawere developed, these types of fuel also tooka significant place in international trade.Russia is the largest energy exporter in theworld. Taking into account the new economicreality, it aims to diversify both methods oftransportation and directions of energyexports. In the long term, Europe and the CISwill remain the main buyers of Russiannatural resources. However, the eastern

Vyacheslav KulaginEnergy Research Institute of the RussianAcademy of [email protected]

The East as the New Priority of the Russian Energy Policy

direction is taking on increasing importancein the Russian energy sector. This is linkedboth to the development of the Russianregions extending from the Urals to the PacificOcean and to rapid economic growth in Asia. The analysis of the currently developing oiland gas pipeline distribution system andmethods of oil, gas, and coal transportation(by sea and rail), coupled with the growingelectricity trade lead us to consider theformation of a new unified Eurasian energysystem. The possibility to correct and optimizethe direction of supplies depending on thecurrent market demand is one of its specificfeatures. The energy systems of separatecountries could serve as reserve supplysources for their neighbors. Even today, it is possible to deliver energyresources from the CIS countries both to theWest and to the East, and the well-developedtransport infrastructure enables to redirecttrade volumes during periods of peakdemand. Russia plays a key role in thissystem, as a chain link between Asia andEurope. The development of new productionareas and transport infrastructure in EastRussia is crucially important for the entireEurasian energy sector.

Development of the Energy Sectorin East Russia

The accelerated socioeconomic developmentof East Siberia and the Far East is one of themain long-term strategic priorities for Russia.The energy sector plays a crucial role inachieving this aim. First and foremost, thisrelates to the development of a new energyinfrastructure system, which should connectRussian regions and form new productioncenters based on the development of energysupply and processing facilities. By 2030, the share of eastern regions of Russia

in the total coal production should increaseto 46-47% as compared to 33% in 2008; thatin the total oil production, to 18-19% ascompared to 3% in 2008; and that in naturalgas production, to 15% as compared to 2% in2008 (1). Therefore, the development of theregion’s energy sector will make a significantleap in the next 20 years. In the next few decades, new centers ofproduction, processing and export of fuel andenergy resources will be introduced in theRussian Far East. The inclusion of hydrocarbon reserves in commercial explorationwill give an impulse to the development ofpetrochemical and gas chemical facilities andwill promote accelerated socioeconomicdevelopment of East Siberia and the East. Itwill also ensure the growth of gross regionalproduct of at least 0.5-1.5% above averagegrowth across the country. The aim to increase hydrocarbon productionwill require significant investment ingeological exploration. An increase in oilreserves needs to reach optimum productionlevels in East Siberia, and the Far East isestimated at 1.8 billion tons by 2020 and atover 3 billion tons by 2030 (1). To ensure thedevelopment of the resource base of the fueland energy sector in remote and difficult-to-access regions, the state should createappropriate legislative, taxation, institutional,and other conditions. The component structure of the oil and gasfields in East Russia is conducive to large-scaledevelopment of the petrochemical industry.Gas fields in East Siberia have high heliumcontent (from 0.15% to 1%), necessitating thedevelopment of the helium industry, includingthe construction of several large gas processingplants and underground helium concentratestorage facilities. There are plans to build arefinery in Primorsk with an annual capacityof 20 million tons. The following areas will become the largest

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centers of gas production: Sakhalin (Sakhalin-1,Sakhalin-2, Sakhalin-3, Sakhalin-4, Sakhalin-5,and Sakhalin-6 projects and the fields inthe eastern Kamchatka sector of the PacificOcean), Yakutsk area (Chayandinskoye field,Srednebotuobinskoye, Taas-Yuryakhskoye,Verkhnevilyuchanskoye, and other fields),Irkutsk (Kovyktino field), Krasnoyarsk(Sobinsko-Paiginskoye, Yurubchen-Tokhomskoye,Omorinskoye, Kuyumbinskoye, Agaleevskoye,and other fields). They will produce up to 132-152 billion cm of gas a year. In addition to the Kansko-Achinsk basin, coalproduction in East Russia will also develop atthe following new deposits: Urgalskoye,Elegestskoye, Elginskoye, Apsatskoye, andpossibly, the Bering coal basin (ChukotskAutonomous Region). In addition to the growing production ofenergy resources and power generation, wewill see an increase in the demand forelectricity in East Siberia and the Far East, inresponse to the socioeconomic developmentin the region. This growth in demand will bemuch higher than that on average acrossRussia. It will be met by increasing thecapacity of hydro power plants, constructionof thermal power plants operating on coal andgas, new nuclear power plants, and small-scale facilities operating on renewable energysources. There are also plans for the large-scaledevelopment of power transmission grids,which will help meet the strategic aim to unifythe energy systems of Siberia and the Far East. In 2030, the Far Eastern federal district will bea region producing a large surplus of energy,which will meet its own needs in primaryenergy sources, including those in the remoteregions, by utilizing local resources andrenewable energy sources. It will have a largepotential for providing exports to the AsiaPacific region.

Russia’s East Export Strategy

The diversification of energy export routes isone of the main aims of the Russian energypolicy. This will be achieved mainly byincreasing exports to the Asia Pacific region.Russia aims to develop trade in the region byensuring the balance between the interests ofcountries that import, export, and transitenergy resources. Russia is willing to supplyenergy resources needed by foreignconsumers. However, their prices shouldenable the implementation of large energyprojects (including production in remoteregions) and transportation over largedistances. The policy of the Russian government isaimed at creating favorable conditions for thedevelopment of exports to the East. Forexample, the Russian government made adecision to exempt some of the oil fields thatserve as the resource base for the ESPOpipeline, from export duties, in order to speedup the development of these fields. Thisshould promote a growth in productionvolumes in East Siberia. Zero rate of MineralExtraction tax was also introduced for thefields in the region. This is another mechanismof economic support for the producers. Thefact that the government is taking these stepsdespite the global economic prices and areduction in budget revenues testifies that thedevelopment of the energy sector in theeastern regions of the country is a high priority. By 2030, the share of Asia Pacific countries inthe structure of Russian energy exports isexpected to increase to 26-27% as comparedto 4.5% in 2005. (1, 4) Cooperation with Northeast Asian countriesis now developing in all the main spheres ofthe energy sector.

Cooperation in the Gas Sphere

In 2009, Russia entered the global LNGmarket, offering its own LNG for the first time.This happened owing to the Sakhalin-2 projectimplemented by Sakhalin Energy. TheSakhalin liquefaction plant is due to startoperation at full capacity in 2010, producing9.6 million tons of LNG a year. Since thelaunch of the LNG plant in February 2010,Sakhalin Energy has already shipped over 5.5million tons of liquefied natural gas. Over 50%of it was delivered to Japan in 2009. The restwas delivered to South Korea, India, Kuwait,China, Taiwan, and other countries (5).Sakhalin Energy Consortium includesGazprom (holds 50% plus 1 share), Shell(27.5%), Mitsui (12.5%), and Mitsubishi (10%).Therefore, the new LNG plant was a result ofthe successful cooperation between Russian,Japanese, and European companies. Tankersfor the project were built in Japan, ensuring afull load of capacity for local shippingcompanies. Therefore, the Sakhalin-2 projectclearly demonstrates that joint energy projectsin Russia promote the economic and industrialdevelopment of the entire region of NortheastAsia. It is no coincidence that the first LNG plant inRussia, which has the largest natural gasreserves in the world, is oriented towardexports to the Asia Pacific region. An analysisof the forecasted world gas demand byvarious research organizations shows that by2030, the increase in gas demand in Asia willbe significantly above that in the Atlanticbasin. According to the International EnergyAgency, by 2030, the volume of demand forLNG in the OECD countries in Asia will growat an average of 1.1% a year, while that in non-OECD countries will grow by 3.8% (6). Forcomparison, in Europe, demand is expectedto grow at 0.8% a year, while there could be

negative dynamics in the United States. Currently, the possible expansion of LNGproduction capacities in Sakhalin is beingconsidered. The construction of other plantsin the Russian Far East is also under review.An analysis of the resource base and salesmarkets indicates that these projects are highlyattractive for investment. In the long term, the expansion of LNGproduction capacities will be supplementedwith export pipelines. China has signedagreements that propose two possible optionsof gas supply routes: (1) the Western optionthat provides for supplies from West Siberianfields and (2) the eastern option that providesfor supplies from the fields in East Siberia,the Far East, and the Sakhalin shelf. Theparties are also considering the potentialimplementation of joint projects in the gasprocessing and gas chemicals sphere in EastRussia. There are regular negotiations betweenGazprom and Kogas in relation to the supplyof Russian natural gas to the Republic ofKorea. The companies confirm that it iseconomically feasible to build a gas pipelinebetween Russia and South Korea. However,the issue of transit through the territory ofNorth Korea has not been resolved.

Cooperation in the Oil Sphere

The oil industry is also actively developing inEast Russia. In recent years, the capacity of oilproduction facilities in the Far East hasincreased, including the projects in theSakhalin Island. Infrastructure is also beingdeveloped for the delivery of oil from Siberiato the Far East. The ESPO pipeline project hasbecome the largest oil transportation projectin recent years. This pipeline is over 4,770 kmlong. The specialized oil-loading sea portKozmino in the Primorsk territory is itsendpoint. In December 2009, the first phase of ESPO-1

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was commissioned. It is a 2,694km pipelinefrom Taishet (Irkutsk region) to Skovorodino(Amursk region). The capacity of the firstphase of ESPO is 30 million tons a year. Priorto the completion of the second phase ofESPO, oil will be sent by oil trains weighingfrom 4.5 to 4.8 thousand tons to the PacificOcean. The total amount of delivery will reach15 million tons per year. Another 15 milliontons will be delivered to China by a branch ofESPO pipeline being built in the Skovorodinoarea. The first oil cargo from the ESPO-1 phasehas already been sent to Hong Kong. The system will be technologically linked toTransneft’s existing trunk pipelines and willenable to create a unified network, which willensure the effective distribution of oil in theRussian territory in the eastern and westerndirections. Therefore, ESPO will becomeanother element in the developing unifiedEurasian energy system.

Cooperation in the Power Sector

There is a large potential for cooperation withNortheast Asian countries in the power sector.This is due to both the balance of the demandand production capacities of separate regionsand the difference in the peak levels ofconsumption. For example, in Russia, themaximum load in the energy system of theEast is in the winter period due to the coldclimate, while in South Korea, the peakdemand is during the summer due to the useof air-conditioning. Therefore, there is apotential to send power supplies to SouthKorea in the summer and to Russia in thewinter. This would enable to optimize thecapacity load and solve the issue of peakdemand in both the countries. The possible integration of electricitytransmission grids in Russia, Mongolia,China, Korea, and Japan is being consideredwithin the framework of the North East

Asian Region Electrical System Ties(NEAREST) international energy program.The “NEAREST program proposes theconsistent integration of countries in theNortheast Asian region into a unified energyspace with the aim to ensure the reliability ofelectricity supply to consumers by using cross-border exchange of electricity and capacity.”Naturally, there are still many problems onthe way to create a unified power system inthe Northeast Asian region. The issues areas follows: participation of North Korea,attracting investment, construction ofnecessary electricity transmission lines, andnegotiation of tariffs. However, the parties’intent to make progress, backed by the signingof formal documents, indicates that thissystem could begin full operation as soon asin the coming decade. The results of severalresearch studies confirm that it is economicallyviable to integrate the power systems.The active electricity trade projects betweenthe countries in the Northeast Asian regionwill become the elements of the new unifiedpower system. In 2009, Russia supplied 854million kWh of electricity to China (7).According to intergovernmental agreementsapproved in the autumn of 2009 during ameeting between the prime minister of Russia,V. Putin, and head of the State Council ofChina, Wen Jiabao, by 2020, the transit ofelectricity to China should grow more than60-fold to 60 billion kWh. To meet this target,new electricity transmission lines, convertersubstations, and necessary infrastructurefacilities are being built on both sides of theborder. The expansion of generation capacitiesis planned in the Russian territory. Russia also trades electricity with Mongolia,another country in the Northeast Asian region.In 2008, Russia exported 195 million kWh toMongolia and imported 15 million kWh. Atpresent, the viability of increasing power flowfrom Russia to Mongolia is being considered.

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There is no electricity trade with othercountries in the region, but potential projectshave been under consideration for manyyears. Russia is in negotiations with SouthKorea and Democratic People’s Republic ofKorea on a project to build 500 kW powertransmission lines from the Primorsk territoryto Seoul. This is not only an energy project butalso has great political significance. Itssuccessful implementation should enhancecooperation and trust in the Korean peninsula.The project to create a Russia-Japan energybridge has been in discussion for severaldecades. It envisions the construction ofgenerating capacities in the Sakhalin Islandand Yakutia and electricity transmission linesto export electricity to Japan. Since the projectis fairly complex to implement and requiresconsiderable investment, it has not yetmanaged to enter the investment stage.However, in the long term, the participationof Japan in the unified power system of theNortheast Asian region is possible. The lastfew decades have shown that Japan has to beconnected with neighboring countries viaelectricity transmission lines. In the wake of anumber of natural disasters, includingearthquakes, nuclear power plant units inJapan were shut down on a number ofoccasions, leading to a shortage in electricitygenerating capacities. Russia does not to intend to limit itscooperation with the Northeast Asian regionto electricity trade. Russian companies alreadyhave expertise in the construction of powergeneration facilities in the region. Potentialfurther participation of Russian companies insimilar projects is being discussed. At the endof 2009, an agreement was reached with Chinaon the construction of the second phase of theTyan’van Nuclear Power Station in China.This project is the continuation of theconstruction in the first phase, implementedby Russia’s Atomstroyexport, which

commissioned two nuclear power units of1,000 MW each. In addition, Russia and Chinaare discussing building a nuclear power plantequipped with fast neutron reactors. Russiaand Mongolia are in discussion on futurecooperation in projects to implementMongolia’s Power Sector DevelopmentProgram. In particular, this relates to theconstruction of thermal power plants. The participation of Russian companies inenergy projects in the Northeast Asian regionand the simultaneous participation ofNortheast Asian companies in the Russianenergy projects enhance the mutualunderstanding between the parties andpromote the development of political andhumanitarian dialog.

Mutual Interest is the Basis forLong-Term Strategic Cooperation

Currently, Northeast Asian countries arehighly dependent on energy supplies fromthe Middle East. High country risk of some ofthe Middle East countries poses a threat tolong-term energy security in Asia. This is thereason that Northeast Asian countries shouldbe interested in steadily developing Russia,who can help diversify import sources andguarantee a stable supply of energy to regionaleconomies. Cooperation with Asia will allowRussia to stimulate the development of itseastern regions and diversify energy exports,which consequently means reducingassociated risks. Therefore, we can speak ofmutual dependence, which is in the interestof all countries in the region. However, the implementation of complexenergy projects in the region requires attractingsignificant investment and use of moderntechnologies. Russian, Chinese, Japanese, andSouth Korean companies have highinvestment and technological ability as wellas expertise in the implementation of projects,

unrivalled in the world. Uniting this potentialwithin the framework of separate initiatives,which are of interest to several countries inthe region, will enable the implementation ofeven the most ambitious projects. The fieldsbeing developed and the pipelines and nuclearpower plants under construction are all relatedexamples. In the near future, the number ofthese projects should grow significantly. Thejoint cooperation of these companies ispossible not only in this region but also in thethird countries. The advantages of variousparticipants will allow them to set upconsortiums, which will be able to offerattractive terms for securing contracts andwinning tenders in many parts of the world. The nuclear power industry could becomeone of the potential directions of developingcooperation, of interest not only to Russia butalso to other Northeast Asian countries.Within the region, there are countries bothwith large uranium reserves (Russia,Mongolia, and nearby Kazakhstan) and largenuclear power consumers (Russia, Japan,South Korea, and China). At the same time,these consumers have extensive expertise inthe construction of nuclear power units.Therefore, there is a basis for cooperation inthe construction of nuclear power plants,delivery of fuel to them, and waste utilization.A regional nuclear fuel bank could also be setup. Its reserves would ensure stable supplyto power plants. China, Japan, and South Korea are significantglobal importers of energy resources. In thelong term, the dependence of these countrieson supply from abroad will grow. The highshare of import will undoubtedly have anadverse effect on the level of energy security,unless there is a 100% guarantee of supplyreliability. Considering this, Asian countriesare aiming to extend the operation of theircompanies in producing regions and partiallyprovide the import from their own stakes in

production. However, the participation offoreign companies in energy projects is notalways attractive to exporting countries. Incooperation with Russia, setting the conditionsfor the access of Russian companies to thedomestic markets of Asia in return for theparticipation of its companies in productioncould become a compromise option. Thismeasure would promote the creation of aunified energy space and would guaranteethe development of a regional energy marketbased on free market trade. The entry ofRussian companies into the markets of severalEuropean countries could be an example ofthis. This has had a positive impact on boththe development of the energy sector of thesecountries and on the development of bilateralrelations. European energy companies in theirturn are successfully participating in manyprojects in Russia. Northeast Asia has significant potential forthe development of the renewable energysector. In particular, this is the case with hydrogeneration, tidal power, geothermal power,and wind power. Renewable energy projectsrequire that the countries in the region developeconomically efficient technologies. Cooperationis possible in the area of scientific developmentand exchange of expertise during projectimplementation. With respect to developing cooperation inNortheast Asia and the implementation ofnew large-scale energy projects, it must benoted that the region we live in is unique. Inaddition to endangered animal population,there also exists a multitude of valuable fishspecies, beautiful natural parks, and waterreservoirs. Depending on how attentively andprudently we treat nature today, the nextgeneration will or will not be able to see thegrey whale (lives in the Pacific Ocean nearRussia, Japan, and South Korea), Amur tiger(small numbers remain in Russia, China,and North Korea), and other wildlife under

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threat of extinction. It is reassuring thatenvironmental issues are given high priorityat the political level. For example, on thedecision of the Russian government, the routeof the ESPO pipeline was moved 400 km tothe north of Lake Baikal, despite a significantincrease in project costs. There is increasedfocus on preserving the environment withinthe framework of other energy projects, whichare being implemented in Russia. Allcompanies starting or developing theiroperations in the country have to be preparedfor this. In conclusion, we list several key tasks thatpromote the successful development of energycooperation with Northeast Asian countries:

■Creation of a regional system and rules oftrade in energy resources, which take intoaccount the interests of producers andconsumers

■Use of expertise, investment, andtechnological abilities of companies in theimplementation of joint production,transportation, and generation projects

■Enhancing trust and broadening thepossibility of operation in the sales marketsin the region

■Stimulation of innovative development andexchange of technological expertise

■Preservation of the environment andecology in the region

■Integration of Northeast Asian countriesinto a unified Eurasian energy system

In the long term, the energy sector of theNortheast Asia region should become areliable unified blood supply system for therapidly developing regional economy. Thesuccessful achievement of this aim to a largeextent depends on the development of theeastern part of Russia, which will be thecentral element of the system being created

now. Therefore, the current energy policyof the Russian government is of utmostimportance not only for Russia but also forthe entire region. We would like to believe thatcooperation in the energy sector will becomea sound basis for the development of mutuallyprofitable cooperation between our countriesin the economic, political, and humanitarianareas and with respect to issues concerningthe preservation of ecology.

References

1. Russian Energy Strategy to 2030, November2009.

2. V. Rashevsky, Investment and developmentin the Far East, SUEK, 2008.

3. Russian Energy Strategy to 2030, August 20034. A. Makarov, Gas Industry’s Perspectives in

the Russian Energy Strategy, Beijing, January2010.

5. Sakhalin Energy, press release “100th LNGcargo has been shipped within the Sakhalin-2 project,” January 2010.

6. IEA, World Energy Outlook 2009, November2009.

7. Eastern Energy Company, press release,January 2010.

43


Issue & Focus

44


Issue & Focus

Housing three large, growing and vibranteconomies of South Korea, Japan and

China, Northeast Asia1 is the engine of growthfor Asia. This continent is the world’s risingeconomic powerhouse to qualify the 21stcentury as the Asian one. The Asian growingeconomies, corrected for the troubled Japaneseeconomy, and populations with improvingliving standards have demanded a large andincreasing amount of energy to make Asia theworld’s single largest energy consumer. Withinthis context, the share of the Northeast Asianeconomies is the largest thanks to their largeeconomies and also populations, which, in thecase of China, is the world’s largest and stillgrowing significantly. Their huge andexpanding energy requirements have resultedin especially large imports of fossil energy.With respect to oil , lacking any oil reserve ofsignificance, Japan and South Korea haveheavily depended on oil imports while Chinahaving, relatively-speaking, substantial oildeposits has been increasing its imports dueto a growing gap between its oil production

and consumption. China is the region’s largestoil consumer whose demand for oil isincreasing on a fast and steady basis. Briefly, Northeast Asia will remain heavilydependent on imported oil in the foreseeablefuture. For this matter, the availability ofsupplies will be a major objective of theregion’s energy security policy for which itsthree major economies cannot be indifferentto the developments in the global oil markets.As the single major grouping of oil suppliers,OPEC(Organization of the Petroleum ExportingCountries) is of obvious importance for thembecause of its salient impact on those marketsin terms of supply availability and pricing, onthe one hand. On the other, the fact that theseeconomies are dependent significantly onOPEC countries for a large share of their oilimports makes them unsurprisingly interestedin OPEC’s life. Given all indicators suggestthat non-fossil energy to include theenvironmentally clean ones will not growsignificantly in the foreseeable future toreplace fossil energy, including oil, despiteenvironmental necessities, there is no doubtthat this interest will remain in place especiallybecause of the status of many OPEC membersas the large, long-term oil suppliers drawingon the bulk of the currently-discovered oildeposits. Against this background, the future role ofOPEC in the global markets is of interest to all

Hooman PeimaniHead of Energy Security at the EnergyStudies Institute (ESI)National University of [email protected]

Decline or Re-rise of OPEC: Implications for Northeast Asia

1 North Korea is also part of Northeast Asia. However, it is excluded from this study given its insignificant energy requirements, mainly the result of its smalland stagnating economy. References to it are only made regarding the regional energy resources.

45


Issue & Focus

the players in this market whether suppliersor consumers, including the Northeast Asianconsumers, as any major development in thisregard will surely have an impact on them insome form. Within this framework, OPEC’ssomewhat loss of worldwide significance overthe last two decades worth elaboration as thisdevelopment has provided a ground forarguing about its future and thus whether itcan and will continue as a grouping of themajor oil suppliers facing many newindependent oil suppliers. Yet, while a degreeof limiting of its clout and global role is a factof life, all indicators suggest its continuity andgrowth in the future as the single largestgrouping of the major oil exporters, a pointthat the Northeast Asian economies need totake into consideration in their pursuit ofenergy security.

Why OPEC Is Important to NortheastAsia

Despite the necessity of using environmentally-clean energy to address environmentaldegradation, including global warming,Northeast Asia, like other regions, is stillheavily dependent on fossil energy,particularly oil. This is notwithstanding theregional efforts to expand the share of non-fossil energy of the regional energyrequirements reflected in the growing solarwater boilers, solar panels and wind farms,for instance. Yet, being its primary source ofenergy, Northeast Asia has limited fossilenergy resources. Having small amount ofcoal (Japan: 355 million tons [mt] and SouthKorea 133[mt] and North Korea: 600 [mt])providing self-sufficiency only in NorthKorea’s case, South Korea and North Korea

has no oil and gas deposits of any significancewhile Japan has very insignificant oil (44million barrels) and gas (0.738 trillion cubicfeet) reserves incapable of meeting even itsbasic needs for these fuels.2 Comparatively,China’s fossil energy resources are substantial,i.e., being 15.5 billion barrels (hereafter bb) ofoil, 86.7 trillion cubic feet of gas and 114 billiontons of coal.3 China was self-sufficient in thesefuels until the early 1990s when it had to beginimporting especially a large and growingamount of oil as its consumption started toincrease way beyond its production.Despite differences between the East Asiancountries in terms of fossil energy reserves,their resources are inadequate to meet theircurrent and future needs. Of course, thisinadequacy varies from one regional countryto another given the differences in terms ofavailability of oil, gas and coal between andamong the regional countries. Yet, even in thecase of oil in which China is relatively rich,there is a phenomenal gap between theircurrent production and consumption asindicated in <Table 1> based on the mostrecent available statistics (2008).

2 Energy Information Administration (EIA), International Energy Statistics, Washington, D.C.: EIA 2009. (http://tonto.eia.doe.gov/cfapps/ipdbproject/IEDIndex3.cfm?tid=5&pid=57&aid=6; accessed on 18 December 2009); BP, BP Statistical Review of World Energy, June 2009, London: BP, 2009, p. 32.

3 BP Statistical Review of World Energy.

CChhiinnaa JJaappaann NNoorrtthh KKoorreeaa SSoouutthh KKoorreeaa

Production 3,790.18 6 0 0Consumption 7,831 4,784.85 16 2,174.91

Sources: Self-created table based on the data provided by EIA Energy Profiles as

follows: EIA, China Energy Profile, 19 November 2009.

(http://tonto.eia.doe.gov/country/country_energy_data.cfm?fips=CH; accessed on

26 December 2009); EIA, Japan Energy Profile, 19 November 2009.

(http://tonto.eia.doe.gov/country/country_energy_data.cfm?fips=JA; accessed on

26 December 2009); EIA, Korea, North Energy Profile, 19 November 2009.

(http://tonto.eia.doe.gov/country/country_energy_data.cfm?fips=KN; accessed on

26 December 2009); EIA, Korea, South Energy Profile, 19 November 2009.

(http://tonto.eia.doe.gov/country/country_energy_data.cfm?fips=KS; accessed on

26 December 2009). 2008

<Table 1> Current Production and Consumption of oilin Northeast Asia

(Unit: Thousand barrels per day)

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Issue & Focus

China, Japan and South Korea will allexperience an increase in energy consumptionin the foreseeable future ending thebenchmark year of 2030. Given their lack ofsignificant fossil energy resources and theirpredicted insignificant increase of non-fossilenergy production, Japan and South Koreawill be unable to significantly change theirdomestic production of energy. In a generalsense, this regional pattern is also true forChina although it has relatively-speaking largeoil, gas and coal resources. To meet its growingenergy needs, China has sought to increase itsproduction of both non-fossil and fossil energy.Despite its impressive achievements, non-fossilenergy, including renewables, will not be largeenough to sharply decrease its needs for fossilenergy (11% of its energy demand in 20304). In short, all the East Asian countries willremain heavily dependent on imported fossilenergy despite differences in their productioncapabilities at home. Their dependency on oilwill be especially high as indicated in the caseof China (from 114 million tons of oilequivalent [mtoe] in 2007 to 758 mtoe in 2030)and also Japan although its oil consumptionwill decrease somewhat (from 230 mtoe in2007 to 152 mtoe in 2030). Thus, despitefluctuations in their oil consumption, theregion will remain heavily dependent on oilimports. For this matter, developments in thesupplying countries and organizations are andwill remain very important for China, Japanand South Korea both for the availability andpricing of supplies. Being the largest and the

most important supplier’s organization,OPEC’s future to be discussed below will beparticularly crucial for them especially becausemany of their large suppliers are OPECmembers.

OPEC’s Impact on the Global OilMarkets Since Its Establishment

OPEC was founded in 1960 to help itsmembers improve their status as oil suppliersvis-a-vis their major clients and particularlythe large Western oil corporations dominatingthe global oil markets. Being in a monopolisticposition, these corporations basically dictatedtheir terms to the weak supplying countries,including low prices, with the effect ofdenying them a fair price and thus incomefor their valuable export commodity. Thedissatisfaction with the status quo of thelargest oil exporters having vast oil resources(Iran, Iraq, Saudi Arabia, Kuwait andVenezuela) gave birth to OPEC; many otheroil exporters of whom the majority are majorones joined the founders over the period 1961to 2007.5 These are Qatar (1961), Indonesia(1962), Libya (1962), United Arab Emirates(1967), Algeria (1969), Nigeria (1971), Ecuador(1973), Gabon (1975) and Angola (2007).6 Beingunhappy about their OPEC-determinedexport quotas and/or unwilling to pay theirlarge annual membership fee, Ecuador andGabon suspended their membership in1992 and 1994, respectively,7 but Ecuadorrejoined OPEC in October 2007.8 Indonesia’s

4 International Energy Agency (IEA), World Energy Outlook 2009 (Paris: IEA, 2009), p. 646. (http://www.worldenergyoutlook.org/index.asp; accessed on 18December 2009)

5 OPEC, “The Organization of the Petroleum Exporting Countries (OPEC)-Brief History,”OPEC Official Website, 2009 (http://www.opec.org/aboutus/his-tory/history.htm; accessed on 29 September 2009)

6 Ibid. 7 Ibid. 8 Simon Webb and Alex Lawler, “Ecuador rejoins OPEC, bolsters producer power,”Reuters, 17 November 2007. (http://uk.reuters.com/article/idUKL173394620071117;accessed on 3 November 2009)

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Issue & Focus

membership in OPEC was suspended uponits own request in September 20089 given itsinability to meet its designated OPEC exportquota due to its large domestic consumptionand its depleting operational oil fields. To affect the global markets in favour of itsmembers, OPEC’s main objective is tocoordinate its members’ oil policies throughmanaging the supply of crude oil (by settingquotas for its members). If fully implemented,this should help it set oil prices at anacceptable level for its members. Hence,although each OPEC member can sell itsquota to whomever it chooses, OPEC’sstrength lies in its membership’s collectiveoperation in the international markets to setprices through the management of supply,and thus prevent low prices resulting fromexcess supply.10

OPEC has served since its establishment as avehicle for its members to upgrade their statusin their dealing with their major customers.Yet, in its first decade, OPEC had a negligibleimpact on the global markets as it was mainlyin the process of consolidation. Thecoordinated efforts of its members to bringabout a degree of control over these marketsin their favour began in the early 1970s as itsmembers nationalized their oil resources afterthe 1960s excluding Iran and Indonesia whichdid so in the 1950s. In fact, the politicaldevelopments starting in that decade helpedimprove the economic lot of its membershipby pushing up oil prices substantially. TheOPEC countries improving financial

capabilities and their large oil resourcesaccounting for the bulk of the world’sdiscovered reserves helped them act as a forcein the global energy market and, in fact, ininternational relations.Particularly, certain military event in the 1970shad a major impact on OPEC added to itspreceding one. Reacting to the humiliatingdefeat of the Arab states in the Arab-Israelisix-day war of 1967, OPEC’s Arab membersand two other Arab oil-producers with muchsmaller resources and production (Egypt andSyria), founded the Organization of ArabPetroleum Exporting Countries (OAPEC).11

Pressuring the Western supporters of Israel,particularly the United States, was their mainobjective. The Arab-Israeli war of 1973 (YomKippur War) had a major impact not only onthe Arab OPEC members, but also on OPEC,in general, a war bringing another majordefeat for three major Arab parties to theArab-Israeli conflict: Egypt, Syria and Jordan.The development led to the 1973 oil crisis asin October 1973 OAPEC imposed an oilembargo (lasted until March 1974)12 on theUnited States for its backing Israel; it wassubsequently extended to other Westernsupporters of Israel. The resulting reductionof oil supplies to the United States and theuncertainty about supply availability for otherWestern countries depending on Arab oilsuddenly increased oil prices from US$3 toUS$12 in 1973.13 Given the Arab countriesaccounted for the majority of OPEC members,the embargo was seen as a show of power by

9“Indonesia leaves OPEC as output fails to hit target,”Gulf News, 10 September 2008. (http://gulfnews.com/business/oil-gas/indonesia-leaves-opec-as-output-fails-to-hit-target-1.130735; accessed on 3 November 2009 )

10 The Organization of the Petroleum Exporting Countries (OPEC)-Brief History.11 Mohammed Ahrari, “OAPEC and "Authoritative" Allocation of Oil: An Analysis of the Arab Oil Embargo,”Studies in Comparative International Development,Volume 14, Number 1, March 1979, pp. 12, 20.

12 U.S. Department of State, Second Arab Oil Embargo, 1973-1974. (http://www.state.gov/r/pa/ho/time/dr/96057.htm; accessed on 19 October 2009) 13 Clifford Singer, Energy and International War: From Babylon to Baghdad and Beyond (Singapore: World Scientific, 2008), p. 158.

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Issue & Focus

OPEC even though its major non-Arabmembers (Iran, Venezuela and Nigeria) didnot participate in this action.The development has remained the onlycoordinated political action attributed toOPEC. The reason is two folds. On the onehand, OPEC is an oil grouping with a cleareconomic objective of preserving itsmembership’s interests regarding oil trade.On the other, there is not any common groundamong its members subscribing to differentpolitical orientations and objectives. OPEC has therefore been mainly focused onsecuring for its members the highest possibleoil prices. To that end, it has set export quotasfor them by which excess supplies in theglobal markets that bring down oil prices canbe avoided. OPEC record in this regard hasbeen mixed for certain major reasons: periodiceconomic declines in the oil-importingcountries decreasing their oil demand and thenon-OPEC oil exporters. Since such exportersdo not follow OPEC’s policy of controllingsupplies to prevent sudden oil-price falls, onoccasions, they might substantially increasetheir supplies for immediate gains when pricesare high notwithstanding its predictablelowering impact on oil prices when the globaloil markets are saturated. An additional reasonis “cheating” by some OPEC members andthus their exporting more than their allocatedquotas to take advantage of special situationswhen both oil prices and demand are high, acommon practice for those members with a

significant unused export capacity (e.g., SaudiArabia).

OPEC’s Current Global Role

OPEC holds the bulk of the world’s provenoil reserves having a great potential to increasedue to new discoveries. Thus, its share of thesereserves being 78% (equal to 939 bb) in 200714

jumped to 79.3% (1023 bb) in 2008.15 OPECnow provides for 60.3% of the global oildemand.16 The fact that OPEC possesses suchlarge reserves has guaranteed a veryinfluential status for the oil organization,added to its combined membership’s rank asthe single largest global oil exporters.17 In short,these facts indicate its importance for theglobal energy markets and its long-termsalience for all oil-importing economies.Nonetheless, OPEC’s role has been somewhatweakened over the last three decades forcertain reasons, but, first and foremost, thegradual emergence of new exporters outsideOPEC. Started in its earnest in the 1970s, theprocess was preceded by the Soviet Union’sexporting oil to non-Communist states(Western European countries) at a substantialscale in the 1960s.18 Having kept their status tothis date, Norway and Britain emerged as oilproducers and, in the case of Norway, asignificant oil exporter in 1970 as the NorthSea’s large oil reservoirs was discovered.19

At least three major factors have contributed

14 OPEC, “OPEC’s Share of Crude Oil Reserves (2007),”OPEC Official Website, 2009 (http://www.opec.org/home/PowerPoint/Reserves/OPEC%20share.htm;accessed on 20 October 2009)

15 OPEC, “World proven crude oil reserves by country, 2004-2008 (m b),”OPEC Official Website, 2009, p. 41. (http://www.opec.org/library/Annual%20Statistical%20Bulletin/pdf/ASB2008.pdf; accessed on 30 October 2009)

16 OPEC Statistical Bulletin, “World crude oil exports by region, 1988-2008,” OPEC Official Website, 2009, p.34. (http://www.opec.org/library/Annual%20Statistical%20Bulletin/pdf/ASB2008.pdf; accessed on 11 September 2009)

17 OPEC’s Share of Crude Oil Reserves (2007). 18 The role of oil and natural gas in Soviet trade with the west,”Economic Bulletin, Volume 11, Number 6, July 1974.19 1970: Large oil field found in North Sea,”BBC News, 19 October 2009. (http://news.bbc.co.uk/onthisday/hi/dates/stories/october/19/newsid_3769000/3769639.stm; accessed on 4 November)

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Issue & Focus

to an increase in the number of non-OPEC oilsuppliers since the 1990s. First, the SovietUnion’s breakup increased the number of oilexporters in the ex-Soviet territory from oneto five (Russia, Azerbaijan, Kazakhstan,Turkmenistan and Uzbekistan). Russia hasremained their single largest oil exporter whileamong the rest Azerbaijan and Kazakhstanhave significant non-regional oil exports.Second, discovery of major new oil reservesin the countries with limited productioncapabilities mainly for domestic purposes andin others with no known oil resources havealso pushed up the number of non-OPEC oilexporters. The examples for the first groupinclude Sudan and Vietnam20 while those ofthe second group include two surprisecountries: Cambodia having found offshoreoil and gas in 2005 (estimated to be between400 and 700 million barrels of oil)21 and, mostrecently, Cuba having found in September2009 offshore oil reserves with potentially 3-4bb of recoverable oil.22 Based on geologicalevidence suggesting the availability of oil inmany other regions (e.g., West Africa), thenumber of non-OPEC exporters will probablyfurther increase. Third, the current accessibilityof many inaccessible oilfields especially verydeep offshore ones has consolidated the globalstatus of the non-OPEC suppliers. A recentexample is the September 2009 discoveringby BP of a large offshore oilfield (Tiber well)in the American territorial waters of the Gulfof Mexico requiring drilling the well to a totaldepth of about 10,685m.23 The predictable

future technological advancement will surelymake many currently-inaccessible onshoreand offshore oil fields accessible.

The Impact of the New Situationon OPEC

The increasing number of non-OPECsuppliers has negatively affected OPEC.Having a significant export capabilitycombined, they have lessened to some extentOPEC’s ability to keep oil prices as high aspossible. As many of them have smallexportable oil resources, they would ratherkeep themselves out of the OPEC exportquota and pricing system and thus operate asindependent suppliers to take advantage ofopportunities. When combined, these newsuppliers and the old non-OPEC members(being mainly small- and medium-sizeexporters such as Canada, Mexico and Egypt)have a significant share of the global marketof about 40% in 2009 (exactly 39.7% in 2008).24

These non-OPEC suppliers do not work inconcert in the global markets, but theircombined supply capabilities have been amajor factor, though not the only one, inweakening OPEC’s power to regulate theavailability of supplies, a crucial factor todetermine oil prices. As a result, the non-OPEC suppliers’ largeshare of the global oil markets has weakenedOPEC to a degree. However, this developmentshould be analyzed within its appropriatecontext and thus should not be exaggerated

20 Vietnam is currently has a limited export capability due to its rising domestic consumption and the rapid depletion of its reserves. 21 Yee kai Pin, “Chevron's Cambodian Oil Project on Track for 2009 Start-Up,”Rigzone, 4 November 2008 (http://www.rigzone.com/news/article.asp?a_id=68777; accessed on 4 November 2009); W Crispin, “Cambodia's coming energy bonanza,”Asia Times, 26 January 2007. (http://www.atimes.com/atimes/Southeast_Asia/IA26Ae01.html; accessed on 4 November 2009.

22 BP, “BP Announces Giant Oil Discovery in the Gulf Of Mexico,”BP Website, 2 September 2009. (http://www.bp.com/genericarticle.do?categoryId=2012968&contentId=7055818 ; accessed on 10 September 2009)

23“BP in 'giant' new oil discovery,”BBC News, 2 September 2009. http://news.bbc.co.uk/2/hi/8233504.stm ; accessed on 4 November 2009) 24 Statistical Bulletin, “World crude oil exports by country, 2004-2008 (1,000 b/d),”OPEC Official Website, 2009, p.88. (http://www.opec.org/library/Annual%20Statistical%20Bulletin/pdf/ASB2008.pdf; accessed on 30 October 2009)

given OPEC’s unchallenged status because ofits controlling 79.3% of the global proven oildeposits and its currently having 60.3% of theglobal market share. Moreover, theoverwhelming majority of the world’s largestoil suppliers (e.g., Iran, Kuwait, Saudi Arabiaand Venezuela) are among its members.Consequently, the impact of the increasingnumber of non-OPEC supplier on OPEC hasbeen mainly translated in its relative loss ofglobal influence compared to its status in the1970s. That’s why its current phenomenalcapability to affect oil prices through managingsupplies thanks to its members’ large exportshas motivated in many cases large non-OPECsuppliers such as Norway and Russia tofollow OPEC’s lead in pricing and thuscontrolling supplies out of self-interest.

New Trend

Evidence suggests that OPEC’s somewhatweakened role will be restored to its previousstrength in the medium- and long-term. Thereason lies in the fact that the majority of thenon-OPEC exporters are short-term ormedium-term exporters with relatively smallexport capabilities. Along with the older non-OPEC suppliers (e.g., Denmark and Norway),they will therefore cease to supply oil oncetheir resources are depleted, a scenario to takeplace long before the OPEC members’depletion of their oil reserves. Undoubtedly,OPEC’s ability to have a major impact on theglobal oil markets will be sure bet given thehuge reservoirs of its members, particularlyits Persian Gulf ones, namely Saudi Arabia

(264.1 bb), Iran (137.6 bb), Iraq (115.0 bb),Kuwait (101.5 bb), UAE (97.8 bb) and Qatar(27.3 bb).25 Another contributing factor is itsmembers large daily exports accounted for24.19 million barrels per day (m bpd)26 of theworld’s total oil exports of 40,114.4 m bpdbased on the 2008 statistics, the most recentyear on which OPEC-provided statistics areavailable today (January 2010). Among other indicators, OPEC’s growingshare of the global oil markets over the period1998 to 2008 during which many new oilexporters emerged indicates its gradualrestoration of its previous unrivalled status. Ittherefore increased its market share from55.3% in 1988 to 60.3% in 2008.27 Symbolically,Angola’s joining the oil organization andEcuador’s rejoining it in 2007 reflected, amongothers, this reality’s appreciation by at leastsome of the independent exporters.

Conclusion

OPEC was founded for a specific reason,which has remained valid for all its membersto this date. The coordinated act of itsmembership through observing the quotasystem to secure the highest possible price fortheir finite strategically important commodityhas helped the OPEC members to improvetheir financial gains of oil exports whileending the unacceptable one-sided pricingmechanism of the Western oil corporations.This factor has remained the single majorincentive for the OPEC members to remain inthe organization despite their occasionalunhappiness about its quota system, which

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Issue & Focus

25 BP Statistical Review 2009, p. 6.26“Crude oil exports by OPEC Members, 1988-2008 (1,000 b/d),”OPEC Statistical Bulletin, OPEC Official Website, 2009, p.31. (http://www.opec.org/library/Annual%20Statistical%20Bulletin/pdf/ASB2008.pdf; accessed on 30 October 2009)

27 OPEC, “Crude oil exports by region, 1988-2008 (1,000 b/d),”OPEC Official Website, 2009, p. 34. (http://www.opec.org/library/Annual%20Statistical%20Bulletin/pdf/ASB2008.pdf; accessed on 29 October 2009)

may deny them short-term gains whilesecuring them long-term profits of well-pricedoil exports. Surely, the new oil discoveries inmany OPEC and non-OPEC countries addedto accessibility of many ex-inaccessible oilwells have increased sharply the global oilsupplies to prolong the global oil markets’ lifespan. However, these resources are finite andthus their predictable rapid depletion becauseof the growing demand will gradually deprivethe oil exporters from their exports’ revenues.This reality will surely provide another strongincentive for the oil exporters to seek thehighest possible oil prices. This will be a majormotivating factor for the OPEC members tostay in the organization. It will also be a strongfactor for at least some of the non-OPECsuppliers to join it to offset other non-OPECsuppliers’ ability to overflow the globalmarkets with oil for immediate gains only toeventually decrease oil prices in thesesaturated markets. Respectively, joining andrejoining OPEC by Angola and Ecuadorindicate the importance of this issue in the oilexporters’ calculations.Hence, even though the increase in thenumber of non-OPEC exporters hasweakened the status of OPEC to some extent,OPEC’s current large share of the globalmarkets and its drawing on the bulk of theworld’s proven reserves (securing its long-term export capability) will surely help itrepair its somewhat eroded influence in theglobal oil markets. Far from becomingirrelevant to these markets, OPEC is on its wayto consolidate its status as the world’s largestgrouping of oil exporters to reckon with. Given this reality, OPEC will remain the singlemajor player of long-term importance to thethree large economies of Northeast Asia.Despite their efforts for supply diversification,their current heavy dependency on the OPECsuppliers dictated by the sheer fact of their

large export capabilities will most probablylast. The strategic importance of the latter fortheir economies as the world’s long-term oilsuppliers, as many non-OPEC suppliers willdisappear in the foreseeable future due to theirdepleting resources will be the major factor inthis regard.

51

Spring 2010/ Northeast Asia Energy Focus.

Issue & Focus

Abstract

World leaders and news outlets oftenrefer to energy independence, upstream

investments, and oil supply strategies froma national lens while seeing these pursuitsas vehicles towards energy security.Consequently, individual national populationslikely view the pursuit of their native oil &gas company exploration and productioninternational investments as efforts to returnoil to their economy; what is more, they likelyview energy security as an achievable nationalpriority that will insulate them from potentialfuture oil supply instability. This paper selectsa sample of governments including the U.S.,China, and South Korean to analyze theirviews towards oil and establish evidencesupporting the argument that much of theworld views oil from a Cold War lens thatdoes not reflect the reality of globalization.Second, this paper provides evidencesupporting the argument that viewing oilsupply from a national lens is incompatible

with our single world supply and pricingsystem coupled with the effects of economicand financial integration on energy security.Third, this paper argues that the world’smisinformed view of oil perpetuates aphysically pointless, but existent, energysecurity dilemma bubble.

Introduction

In 1980 following Soviet military gains nearoil producing states, the Iranian Revolution,the Arab Oil Embargo, and the Organizationof Petroleum Export Countries (OPEC) pricehikes, President Jimmy Carter contended inhis State of the Union address,

“The region which is now threatened bySoviet troops in Afghanistan is of greatstrategic importance: It contains more thantwo-thirds of the world’s exportable oil...therefore, that poses a grave threat to thefree movement of Middle East oil... Anattempt by any outside force to gain controlof the Persian Gulf region will be regardedas an assault on the vital interests of theUnited States of America, and such anassault will be repelled by any meansnecessary, including military force...”1

President Carter went on to argue that byreducing dependence on Middle Eastern oil,this would make America stronger. Thisargument reflected a zero-sum nationalsecurity view of oil, one in an era before the

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Issue & Focus

Kevin P. KaneInternational Energy StrategistKorea Energy Economics [email protected]

Energy Security Dilemma Bubble: Cold War Thinking in aWorld Supply Oil Market

1 Jimmy Carter. "State of the Union Address 1980." (January 23, 1980), http://www.jimmycarterlibrary.gov/ documents/speeches/su80jec.phtml (accessed February09, 2010).

emergence of economic integration, before thedecline of OPEC’s influence on world prices,and before the evolution of today’s supplyand demand fundamental market forcesserving as the dominant driver behind oilsupply and demand equilibrium.2 On theother side of the world, Northeast Asiannations appeared even worse off comparedto the U.S. during the 1970s, an experiencecompounded by rapidly growing regional oilconsumption growth and import dependence. Although the U.S. appears to have adjustedits view of oil after the end of the Cold War toaccept that market forces govern oil supplysecurity, the oil supply policies of NortheastAsian nations, emerging global rhetoric onenergy security, and a globally misinformedmedia continue to propel momentum into analternative view of oil supply security thatdoes not reflect the physical reality of oil in anera of globalization. The belief that diversifyingoil import sources coupled with securingphysical supply for national consumptionwould improve energy security reflected thereality of the Cold War: a view no longerapplicable in an era of economic and financialinterdependence with a single oil supplymarket measured in one world price.However, in Asia for many nations includingChina and South Korea, the Cold War maynever have ended, or at least, from their view,it may be put on temporary hold ahead ofanother conflict. With China emerging as agreat power and South Korea emerging as asolid middle power on its periphery, the pursuit

of long term oil import contracts coupled withpopular support for nationally owned oilcompanies may be an implicit reflection oftheir societies’ fears that they will face aresource war sometime in the future.3 Themedia appears to be perpetuating theseunnecessary fears, contributing to a zero-sumview of oil supply. Such a condition wheretwo states fear the other’s intention, but donot necessarily prefer this situation, is definedas a security dilemma.4

Although the U.S. may view oil from a marketlens evidenced by its reliance on spot marketsand support for private companies in the oilmarket, supply nationalism appears to becreeping back into the hallways of the DC-area bureaucracy as well, at least in rhetoric.With the U.S. practically a member of Asia bydint of its trade, economic, and financialintegration, any energy supply-securitydilemma in Asia naturally entangles the U.S.;therefore, this paper analyzes not only China,South Korea, and the media, but divergingviews towards oil within the U.S. as well.5

Views towards Oil Supply

U.S. Policies

President Jimmy Carter set the U.S. on acourse towards “energy independence” in his1980 State of the Union address.6 Like formerPresident Carter, all of the presidents after himsought to “free the U.S. from foreign oil,”including U.S. President Barack Obama. In

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Issue & Focus

2 James Hamilton, “Understanding Crude Oil Prices”Department of Economics, University of California, San Diego (May 22, 2008), 20-25,http://dss.ucsd.edu/~jhamilto/understand _oil.pdf (accessed February 09, 2010).

3 The terms Great and Middle Power are derived from International Relations theory interpretations. 4 Robert Jervis, “Cooperation under the Security Dilemma,”World Politics 30, no. 2 (January 1978), 167?174, http://www.jstor.org/pss/2009958, (accessedFebruary 15, 2010)

6 Jimmy Carter. "State of the Union Address 1980." Jan 23, 1980.http://www.jimmycarterlibrary.gov/documents /speeches/su80jec.phtml (accessed February 09,2010).

2006 speaking before the Governor’s EthanolCoalition in Washington, D.C., in a speechtellingly titled “Energy Security is NationalSecurity,” the then Senator Obama contended,

“During World War II, we had an entirecountry working around the clock toproduce enough planes and tanks to beatthe Axis powers. In the middle of the ColdWar, we built a national highway system sowe had a quick way to transport militaryequipment across the country. When wewanted to beat the Russians into space, wepoured millions into a national educationinitiative that graduated thousands of newscientists and engineers. If we hope tostrengthen our security and control our ownforeign policy, we can offer no less of acommitment to energy independence.”7

In 2004 when speaking at the DemocraticNational Convention, the then Senator BarackObama quoted John Kerry when he said“John Kerry believes in energy independence,so we aren’t held hostage to the profits of oilcompanies or the sabotage of foreign oilfields.”8 To suggest that ending oil imports willcreate energy independence and that oilcompanies hold the U.S. “hostage,” meansthat the then Senator Barack Obama wouldlike the listener to accept the assumption thatAmerican oil companies can exert downwardpressure on prices by distributing their incometo mitigate its effects-indisputably untrue-andthat if a foreign field is sabotaged, the U.S. willbe secure should it not import oil from that

export source-again indisputably untrueunder a single world supply/price system.Moreover, the five Majors only possess a 12%share of the entire world oil market andare unable to influence prices regardlessof individual actions.9 10Of course, anunderstanding of economics proves thatindividual companies, especially Majors,cannot set or influence prices by reducing theirprofits. Most importantly, economic integrationmakes supply export source-diversificationincapable of insulating a nation from oilsupply or price shocks. Despite Obama’s misleading words subtlyconnecting the Cold War race to the pursuitof a modern energy security and oil insecurityto “greedy” oil companies, there are manyinformed academics in the U.S. bureaucracythat promote a more accurate view towardsoil supply and energy security. Home to twoof the world’s five Majors as well as the NewYork Mercantile Exchange (NYMEX) whereworld oil prices are set by futures contacttraders, some, but not all, American policymakers are well aware of the single supplynature of oil despite expressing rhetoricotherwise. In 2006, the U.S. Council on ForeignRelations produced an independent taskforced composed of 26 distinguishedmembers.11 This task force produced a reporttitled “National Security Consequences of U.S.Oil Dependency.12” Task force membersargued that the reemergence of China andRussia coupled with other global paradigm

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Issue & Focus

7 Barack Obama. “Energy Security is National Security." Feb 28, 2006.http://obamaspeeches.com/054-Energy-Security-is-National-Security-Governors-Ethanol-Coalition-Obama-Speech.htm (accessed Feb 10, 2010).

8 Barack Obama. “2004 Democratic National Convention Keynote Address.”Keynote, Democratic National Convention, Fleet Center Boston, 27 July 2004.9 James Hamilton, “Understanding Crude Oil Prices” Department of Economics, University of California, San Diego (May 22, 2008), 20,http://dss.ucsd.edu/~jhamilto/understand _oil.pdf (accessed February 09, 2010).

10 Oil Majors include Exxon Mobile, Total S.A., Royal Dutch Shell, British Petroleum, Chevron, ConocoPhillips.11 John Dutch and James R. Schlesinger, “National Consequences of U.S. Oil Dependency," U.S. Government, U.S. Council on Foreign Relations (October 2006)www.cfr.org/content/publications /attachments/EnergyTFR.pdf (accessed Feb 10, 2010)..

12 Ibid.

shifts, “diminished U.S. leverage, particularlyin the Middle East and Central Asia. Forexample, Chinese interest in securing oil andgas supplies challenges U.S. influence incentral Asia, notably in Kazakhstan.”13 U.S.interests in global oil and gas appear morerelated to maintaining political influence ratherthan securing stable supply. Despite the liberal market nature of oil supplyand pricing, nations that view oil supplyquantities from a national security point ofview may be capable of encouraging aninaccurate Cold War-like lens of oil supplyand pricing. Insofar, the task force furtherargued,

“Many more of [China’s Africa and oil-tieddevelopmental project] investments alsoinclude equity stakes for state-controlledChinese companies... These arrangementsare worrisome because they lead to specialpolitical relationships that pose difficultiesfor the United States. And they allowimporters to believe that they obtain securitythrough links to particular suppliers ratherthan from the proper functioning of a globalmarket.”14

These authors essentially point out thatalthough viewing oil through a very strategiclens by connecting infrastructure anddevelopment investments to exploration andproduction (E&P) contracts will not necessarilyresult in increased energy security and oilimports from those destinations, these policiespromote a fatally flawed worldview-thatdiverges from the physical reality: onecountry’s supply gain is another country’ssupply gain. Oil supply is not zero-sum! On

the other hand, an alarming trend appears tobe emerging in the U.S. where leaders areframing oil from a national lens as well.Leaders such as President Obama, SenatorJohn McCain, Howard Dean, Newt Gingrich,former Governor Sarah Palin, and BrookingsInstitute Scholar David Sandalow (selected forappointment to Assistant Secretary of Policyand International Affairs, a Department ofEnergy post), have all argued in some formor fashion that the U.S. can be free fromforeign oil, either through drilling inU.S. territory, building a green economy,or embracing conservation.15 16 The firstassumption with this argument is that thereis a distinction between domestic and foreignoil in a one world supply system. There is nodistinction! On the other hand, despite thisrhetoric promoting a false reality with thepolitically loaded concept of “foreign” oil, theU.S. continues to rely on the market place forcrude oil imports. Juxtaposing U.S. relianceon spot market purchases for energy security,Northeast Asian nations appear more focusedon physical security of supply despite havingthis global system to offer them market pricedoil.

Chinese Policies

Perhaps far more complicated than the originsof U.S. policy towards oil, Chinese policiesreflect a diverse mix of interests withinmultiple state-run oil companies, energyministries and ad hoc oversight groups,Chinese Communist Party objectives, andforeign policy interests.17 Understanding

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Issue & Focus

13 Ibid., 27, 35-47.14 Ibid., 27, 35-47.15 David Sandalow, Freedom From Oil (New York: McGraw Hill, 2008), xi-xii, 1-5.16 See “Freedom from Oil”by David Sandalow, President Barack Obama’s 2008 Campaign Energy Strategy, Sarah Palin and John McCain’s comments onoffshore drilling, and Thomas Friedman NY Times writings on energy independence.

17 Erica Downs, “China,” Brookings Institute, The Brookings Foreign Policy Studies Energy Security Series (2006): 16-25, 35-47.http://www.brookings.edu/~/media/Files/rc/reports /2006/12china/12china.pdf (accessed Feb 10,2009).

China’s view towards oil requires one to putinto perspective China’s relative position toits closest rival: the U.S. Although Americanmedia often comments on the strength ofChina’s emerging military capability, it isimportant to keep capability in relative view.With American naval, air, and space-relatedforces patrolling every single sea lane at anygiven second in the entire world, China’s viewof natural resources may likely includeincreasing anxiety as they are at the mercy ofAmerica supply security guarantees throughdangerous areas such as the Strait of Malacca,a location known for terrorist attacks on oiltankers. In fact, Yang Ji, director in 2006 ofChina’s National Defense University, Instituteof Strategic Studies, commented on the matterwhen pointing out that when an American inWashington D.C. asked him how Chinawould defend strategic sea passages for oil ifit became necessary to do so, he replied, “theU.S., the worlds’ traffic cop, is very good atmaintaining order and that we can go alongfor the ride.”18 He later said, “Truthfullyspeaking, this is not reliable. If we do not haveany conflicts of interest with the U.S., we cango along for the ride. As soon as a conflictoccurs, however, it will be disastrous.”19

Such a view places China in a position ofanxiety, and perhaps a position conducive toirrational calculation in energy security bynarrowly focusing on a specific goal that couldprove irrelevant. Anxiety can create both panicand sharpened focus; however, it can also

create tunnel vision due the inherent narrowimpulses humans sometimes demonstratewhen under threat. Supply security in an ageof economic interdependence may generatesuch a narrow impulse in China and itsperipheral neighbors such as South Korea.Believing that physical supply guarantees willinsulate an economy from oil insecurity servesas one such fatal miscalculation. Coupled with this narrow survival impulseis an exacerbating collection of interests andpower interest. China’s energy bureaucracyincludes a web of power entangled oversightleaders, energy-related ministerial leaders, andenergy policy ad hoc arrangement leaderscomposed mostly of former Chinese oilcompany executives and employees. Withinthis web of power, Chinese energy policiesare set and managed by the NationalDevelopment and Reform Commission(NRDC), Ministry of Land and Resources,Ministry of Commerce, Ministry of Finance,and the ad hoc Energy Leading Group (ELG)and managed through the State Energy Office(SEO).20 Each of the leaders and companyexecutives are wrapped in a web of powerthat includes political-oil company favors,inefficiency, waste, corruption, and generaldisorder.21 Furthermore, China’s energysecurity concerns are also entangled [Figure 1]with China’s profit-seeking, governmentpower-connected, nationally owned oilcompanies (NOCs).22

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18 Yang Ji, Zhuongguo de anquan huangjing zenme yang?”[How is China’s security environment], Shijie zhishi [World Knowledge] no. 9 (2002) Quoted inErica Downs, “China, Brookings Institute, The Brookings Foreign Policy Studies Energy Security Series: (2006) 14, http://www.brookings.edu/~/media/Files/rc/reports /2006/12china/12china.pdf (accessed Feb 10,2009).

19 Ibid 1420 Erica Downs, “China, Brookings Institute, The Brookings Foreign Policy Studies Energy Security Series (2006): 16-25, 35-47, http://www.brookings.edu/~/media/Files/rc/reports /2006/12china/12china.pdf (accessed February 10,2009).

21 Ibid., 16-25, 35-47.22 Ibid.

China’s NOC-government power web createsa situation where NOC CEOs push thegovernment for assistance in pursuing profitsfor their companies overseas, partly becauseNOC leaders are rewarded with high levelgovernment positions should they makesignificant strides in acquiring upstreaminvestments once their leadership appointmentterm ends.24 NOC CEOs are motivated tosecure upstream investments for profitscoupled with the reward of post-NOC-CEOappointments to senior government positions.25

These NOC interests mix smoothly withgovernment interests that are driven byanxiety and a narrow vision towards oilsupply security. The pursuit of upstreaminternational E&P investments and equityoil reflects a relationship between the

government’s supply insecurity driven by aperspective that increases in oil upstreaminvestments will mitigate this fear.26 The valueof equity oil, however, may be exaggeratedsince it accounts for less than 13% of China’simports: equity oil equals 372,370 importedbarrels per day out of a total of 4.7 millionimported total barrels per day.27 28 Moreover,between CNPC, CNOOC, Sinochem, andSinopec, 89%, 8%, 2%, and only 1% of their oilproduction accounts for equity oil with 11%,92%, 98%, and 99% of their oil production soldon the world market place, respectively.29

When Chinese companies invest in exploring,developing, and producing oil, they areinvesting in the process of supplying theworld with oil, not simply Chinese consumers.Moreover, even when they import equity oil,this benefits the world because this frees upmore oil supply for purchase from othersources such as a spot market. Although newfor some leaders to fathom, oil reflects oneworld supply making equity oil and long termimport contracts unable to provide energysecurity any more than purchasing it on a spotmarket.30

China’s energy strategy appears to beuncoordinated, competitive between ministriesand nationally owned companies, and viewedthrough a Cold War-like zero-sum lens thatfocuses on securing physical supply as if onenation’s oil imports is another’s loss. Ifincreasing equity oil does not benefit China’ssupply security and benefits world supply,

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[Figure 1]23 Illustration Created By Erica Downs: Modified by This Author

State(Council

NDRC

Energy(Bureau

Energy(Leading(Group((ELG)Represented(with(9(Sparate(Ministries

State(Energy(Office((SEO)

Major(NOCs

SINOPEC(+(Sinopec(Ltd.

CNOOC(+(CNOOC(Ltd.

CNPC(+(Petro(China

23 Ibid., 18.24 Ibid., 16-24, 35-47. 25 Ibid., 16-24, 35-47.26 16-24, 35-47.27 Erica Downs, “China, Brookings Institute, The Brookings Foreign Policy Studies Energy Security Series (2006): 16-25, 35-47, http://www.brookings.edu/~/media/Files/rc/reports /2006/12china/12china.pdf (accessed February 10,2009).

28 Estimated that China imports 4.7 million barrels total. 372,370/4.7 = 12.62% of total29 Ibid., 43.30 David Sandalow, Freedom From Oil (New York: McGraw Hill, 2008), 51.

China’s Energy Decision Making Bureaucracy

why invest in it in the first place? Erica Downs,a former U.S. Central Intelligence Agency(CIA) analyst working at the BrookingsInstitute, pointed out that Chinese NOCs arequick to use the term “energy security” asjustification to provide them with below-market rate loans, infrastructure aid andgovernment support to E&P destinations, andtax dollars and political support in favor ofassisting them to seek upstream investmentsthat eventually result in more profit thanenergy security.31 This manipulative use of theterm energy security works because someChinese leaders support these NOCs with theflawed belief that equity oil and NOC E&Pinvestments increase Chinese energy security.32

China’s NOC pursuits of upstream oilinvestments are not alone. South Korea followssimilar policies and oil supply perceptions,albeit South Korea’s energy situation andanxiety may be fostered by an instinct-drivenfear that China could one day consume somuch oil that South Korea might not be ableto afford any without having physically-guaranteed supply: a resource race.

South Korea’s Policies

After the second 1970s era oil shock, SouthKorea began an oil import diversificationstrategy with the goal of reducingvulnerability to price spikes and supplyshortages by focusing on long term supply.33

By diversifying from the Middle East, SouthKorea sought to invest in long term contractsand “promote overseas resource development

in the upstream” sector through Korea’sprimary oil NOC, the Korea National OilCorporation (KNOC).34 Dr. Ji-Chul Ryu pointsout in “Energy Security in the North Pacific,”that by the end of 2006, Korean companiesinvested $10.38 billion in overseas E&P with20.8% funded by the Korean “government(tax payer) [owned and] funded” company,KNOC.35 Most of the discourse in “EnergySecurity in the North Pacific” refers to Korea’supstream investments with the implicitpremise that these investments benefit theKorean consumer, although this is not possiblegiven transportation costs and other less costlymeans available to supply oil: an issue clearlyillustrated in [Figure 2 ] below.

With South Korea’s KNOC investments notdirectly contributing to South Korean energysecurity through supply due to the costlynature of transportation making it moreprofitable to sell the oil on the market, itbecomes clear that public rhetoric on Koreanupstream investments enhancing Korean

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Issue & Focus

[Figure 2]36 Map Provided by KNOC

31 Ibid., 39, 41.32 Ibid., 39, 41. 33 Ji-Chul Ryu, “Korea’s Perspective on Energy Security,”in Energy Security in the North Pacific, ed. Fereidun Fesharaki and others. (Gyeonggi-do, KoreanEnergy Economics Institute, 2009), 298-297.

34 Ibid., 300.35 Ibid., 298-297.36 Korea National Oil Company, “E&P World Wide: Operations”http://www.knoc.co.kr/ENG/sub03/sub03 _1_1_1.jsp Sep 2009. (accessed February 15, 2010).

KNOC’s E&P Operations World Wide

energy security is not accurate. Anothercomponent to Korea’s energy security strategy,long term contracts, although no longerrelevant in the world’s liberal oil market, proveto be the prevailing strategy in South Korea[Figure 3].

From 2000 to 2009, long term contracts accountfor an average of 66% of oil imports comparedto an average of 33% of spot-price purchasedimports.38 Similar to Chinese officials, SouthKorean leaders likely also believe that bysecuring physical supply they will beprotected from a physical supply shock orsome future resource race scenario where oilneeds to be imported through these long termcontracts in a market where the world pricesystem fractures. [Figure 4] offers support forthis argument, which establishes that thepurpose of long term contracts is not to securea lower import price, but to diversify importsfrom spot-price purchases to long termcontracts.

If long term contracts do not offer lower prices,and oil can be fairly purchased at world priceon a spot market, why pursue long termcontracts if they offer no economic benefit?Perhaps Northeast Asian nations areextending their physical security fears andmutual suspicion into their energy strategies,creating an energy security race and securitydilemma bubble as they prepare for some sortof resource run falsely believed to bepotentially mitigated by long term contractguarantees. If this is their purpose for securinglong term contracts, it will not necessarilyachieve its objective even if the world pricingsystem were to collapse since only the U.S.maintains the capacity to secure the world’ssea lanes. Moreover, even with secure sealanes, exporters of oil will likely capitalize onskyrocketing prices under such a scenario andbreak the terms of these long term contracts,selling to the highest bidder.

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[Figure 3]South Korea Cumulative Monthly Oil Imports37

Thousand(BblPer(Month

2000

-01

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Spot(Purchased(Imports

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Long(Term(Contract(Imports

[Figure 4] Average Prices of South Korea's Monhtly Cumulative Oil Imports39

Spot(Purchased(Avg(Import(PriceLong(Term(Contract(Avg(Import(Price

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＄140.00

＄120.00

＄100.00

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＄60.00

＄40.00

＄20.00

＄0.00

37 Korea’s Oil Import Data from Petronet.co.kr.38 Calculations made form Korea’s oil import data provided by Petronet. 39 Korea’s Oil Import Data from Petronet.co.kr

South Korea Cumulative Monthly Oil Importsin Thousand Bbl Per Month:

Long Term Contrats Vs. Spot-Purchased

Average Prices of South Korea's Monhtly Cumulative Oil Imports:Long Term Contract Vs. Spot Purchased Compared

Media Outlets, Reporters, Journalists,and Authors

Perpetuating this energy security dilemmabubble, media outlets and journalists continueto report on oil upstream investments as zero-sum increases in a single nation’s energysecurity. It does not require a global survey ofmedia reports on oil to conclude that publicmedia discourse perpetuates national-lensdriven fears among the masses. This becomesparticularly true when media outlets coverstories on Chinese oil companies investing inAfrica or when Chinese NOCs attempt toparticipate in mergers and acquisitions,including the example of the failed Chinesecompany attempt to purchase Unocal. In 2004, Time magazine ran a major essaywritten by Mathew Forney, titled “China’sQuest for Oil.” The author attempted to framethe efforts of Chinese oil companies to acquireupstream E&P investments as a nationalobjective aimed at “[securing] long-termsupplies independent of the world’s fickleprices.” Not understanding the nature of oilcompanies and oil economics, the authorfailed to share with the reader that oil cannotbe delivered to distances that exhaust its usebefore it arrives to its destination, thusexplaining why an oil discovery in theCaspian often results in a local or regional saleon the market place. As Erica Downs pointedout, not only do Chinese companies competewith one another, sometimes undercuttingChinese foreign policy, they also frequentlysell their oil in locations like Africa to the

market place rather than return it to China.40

On January 20, 2010, the Financial Timereleased an article by Christian Oliver titled“S Korea’s KNOC eyes $6.5 [billion] oildeals.”41 The journalist wrote that “Seoulofficials have stressed they will strive to avoidbeing muscled out of resource deals bypowerful Chinese competitors...The movesto increase energy security go hand in handwith Seoul’s pledge to reduce wastefulconsumption.”42 This author’s statementsreflect the way most of the masses in theworld view oil: as a commodity that theirgovernments have to race to secure before itruns out. As Mikkal Herberg at the NationalBureau of Asian Research in Seattle pointedout, “"Frankly it’s a delusion [to believe equityoil and NOC E&P increases energy security]...there’s no more security in an equity barrelthan a contract barrel.”43

None of the aforementioned views in themedia reflect the economic reality of oil globalsupply and demand equilibrium, particularlysince oil long term contracts do not result inlower oil import prices. Moreover, companies,including NOCs, sell oil to the highest bidderand not necessarily via equity oil to theirhome tax-reporting countries. Coupled withworld leaders and NOCs that do not bluntlycorrect politically beneficial energy securitymisinformation such as the belief thatupstream investments or offshore drillingincreases only one nation’s energy security, itappears that both media outlets and worldleaders participate in fostering a consciousnessin people that contribute to wrongly creating

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40 Erica Downs, “China,”Brookings Institute, The Brookings Foreign Policy Studies Energy Security Series: (2006). 24-47, http://www.brookings.edu/~/media/Files/rc/reports /2006/12china/12china.pdf (accessed Feb 10, 2010)..

41 Christian Olive, “S Korea KNOC eyes $6.5bn oil deals,”Jan 20, 2010. (accessed January 20, 2009).42 Ibid. 43 Chris Baltimore, “U.S. officials scoff at China equity oil quest”Red Orbit, July 26, 2005, Tuesday, http://www.redorbit.com/news/politics/187564/us_offi-cials_scoff_at_china_equity_oil_quest/index.html (accessed February 10, 2010).

some of the following myths about oil: - Oil prices can be mitigated through increases

in domestic supply- Countries acquire oil rather than companies

who discover it for market sale- Companies that acquire oil sell it to their

home country- Acquiring physical supply benefits countries

in a zero sum relationship - NOC and private company upstream

investments will increase domestic supplyAlthough all of the above myths areempirically and verifiably, ceteris paribus,untrue, leaders who might be aware of thiseconomic fact are not exactly in an “ethical”hurry to spill the beans to their voters whomight support them on the issue of energyindependence through tax-payer funded E&Pinvestments, deregulating offshore drilling, etal.

Oil Pricing and One Single WorldSupply

Oil Price Discovery and World Supply

Oil prices derive first from physical supplyand demand fundamentals. Oil futurescontract-an agreement to purchase oil ata future date-traders analyze thesefundamentals by introducing information ona commodity exchange market-primarily onNYMEX-by introducing information andfactors they believe will affect future price inthe near and long-term future.44 Through theintroduction of this information, tradersparticipate in the process of price discovery.45

On NYMEX, spot market prices for West

Texas Intermediate oil are discovered, and therest of the world spot markets (Brent,Singapore, Dubai, et al.) and Over-The-Counter (OTC) market traders-includingmajor investment banks-base their pricesaccordingly, varying in price by only a fewdollars, depending on average crude quality,transportation costs, and other factors.46 Everybarrel of oil in the world at any given point intime, depending on its quality, is sold at thesame price, and so oil price equilibrium reflectsone world global supply and demand. IfSinopec discovers oil in Africa, this newquantity, depending on its production per day,goes into the information pool that NYMEXtraders use to discover world oil price. Anupstream discovery by one company or acountry’s NOC is essentially an increase in oilproduction for everyone. A resource race is almost impossible underthese market conditions between countriessince companies, not countries, discover andproduce oil. Those who can afford oil willpossess it, and those who cannot afford it atmarket price, whatever that value might be,will not possess it with or without long termcontracts and equity oil. There is no other wayaround a resource race than to pay for oil atits market price.

Economic and Financial Integration

Of the newest issues in oil supply security,economic and financial integration appear tobe the least integrated factor into each of theaforementioned nation’s energy oil supplyand energy security calculations. In an era ofgoods and financial services economic

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44 U.S. Government, “Interim Report on Crude Oil”Inter Agency Task Force on Commodity Markets, Commodity Futures Trading Commission (2008). 17-29.http://www.cftc.gov/ucm/groups/public/@newsroom/documents/file/ itfinterimreportoncrudeoil0708.pdf (accessed January 10, 2010).

45 Ibid, 46 Ibid.

integration, if one globalization-connectedcountry’s economy experiences a supplyshortage or price shock, seemingly distant andunrelated, but economically integrated,countries will feel the effects of these shocksin their own trade and financial sectors.47

Insofar, nations dependent on the globaleconomy are mutually vulnerable to the effectsof oil price and supply shocks.48 To supportthis hypothesis, this paper turns to the 2008Financial Crisis as generalizable evidence.Insofar, if America’s subprime mortgage crisiscould ripple through seemingly unrelatedeconomies across around the world fromSouth Korea to Russia to London, one shouldexpect the same linkages to spread the effectsof an oil supply or price shock to seeminglyenergy-independent economies, from Koreato China to Brazil. Thus, long-term contracts,upstream NOC investments, equity oil, andoffshore drilling will do little to provide energysecurity in our emerging era of globalization.

Oil Security Dilemma Bubble

Defining a security dilemma as an unwanted,but existent, fear of intentions between selectnations, it would appear such a dilemmaexists in the minds of leaders in South Korea,China, and some in the U.S. By pursuing longterm contracts, NOC E&P investments,offshore drilling, freedom from oil strategies,energy independence initiatives, and otherpolicies, slogans, and tactics designed to createnational, not international, energy security,these leaders are investing energy into anobjective that will not result in its intendedoutcome: insulation from the negative

economic and security externalities associatedwith oil. Insofar, none of these efforts willmitigate the mutual risks inherent associatedwith oil in a globally integrated economyoperating with one world supply and demandprice mechanism. Therefore one might ask“why do some economies pursue differentaspects of these initiatives? Perhaps China andSouth Korea are continuing policies that reflecttheir experience with WWII and the Cold Warsince they observed Japan, the U.S., and Russiavie for physical control of oil sources. PerhapsSouth Korean leaders are demonstratinga knee-jerk reaction to “balance” China’saggressive, but economically pointless, equityoil import initiatives. Perhaps China views theU.S. through a Cold War lens and SouthKorean leaders are reacting to this view byseeking to mitigate the costs of a great powerrivalry through their own upstreaminvestments. Perhaps each nation is trappedin an unwanted fear of the other’s oil supplygains, which is interesting considering one’scountries import gains are included in thecalculation of oil import prices in anothercountry, thus making the race pointless: asecurity dilemma bubble that will eventuallyburst. Although the “why” question isimportant, this paper turns to a broadermatter: the implication of this physical supplyview of oil. Long term contracts, equity oil, NOC upstreaminvestments, oil import diversification orindependence, and energy independence willprove ineffective in providing energy securitydue to the following prevailing facts:- Most NOC investments results in sales to

the market place

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47 Kevin Kane, “American Freedom from Oil: A Bipartisan Pipedream, “ The Oil Drum, December 16, 2009. http://www.theoildrum.com/node/6045 (accessedFebruary 15, 2009).

48 Ibid.

- Long term contracts do not insulate aneconomy from price changes or shocks

- Only the U.S. possess the naval capacity topatrol sea lanes for oil tankers shipments

- Equity Oil increases domestic supply,reducing spot market purchases, and thusincreasing world supply, which benefitsworld energy security, not necessarilynational security.

- Economic and financial Integration makean oil independent economy vulnerableto shocks realized in a oil dependenteconomy

- Oil prices are based on one world supply

In today’s market place with one worldsupply, nations are unable to insulatethemselves from the economic and securityrisks inherent with oil regardless of theirindependent initiatives, even if they eliminateoil imports. Those who see long term contractsand NOCs that participate in E&P as amedium to increasing energy securityinitiatives are creating a psychological energysecurity bubble in the minds of those whopassively accept this view. China and SouthKorea are not alone in their energy securitybubble with some American leaders implicitlysuggesting that by eliminating oil imports theycan be free from the Middle East, and byreducing profits of oil companies, they canlower prices. Full of misinformation, perhapsmedia outlets and certain leaders are eitherremarkably misinformed or shrewd politicalcalculators looking for support from a gulliblepublic still viewing oil supply from a ColdWar lens. Either way, many leaders andcommentators continue to set the world ona psychological path towards a resource racethat physically is not taking place. It’s all intheir imaginations. It is a bubble that willburst with no return on tax dollar investment.

Conclusion

This paper introduced a sample of diverseviews towards oil and its relationship toenergy security, including China, South Korea,and a split between U.S. rhetoric and actualpolicy. Although China and South Korea’slong term contracts, equity oil, and NOC E&Pinvestments do not increase energy security,it would appear that a temptation exists forsome nations to follow their lead in a knee-jerk reaction. Eventually nations, mediaoutlets, and leaders that view oil through aCold War lens may discover that oil securitycannot exist without every consuming andsupply nation enjoying the same security, atruth evidenced by the fundamentals of worldsupply and demand and our knowledge ofthe linkages inherent with economic andfinancial integration. Those who presentlyview oil equity, NOC E&P, domestic drilling,and other efforts to increase national supply,rather than international supply, areperpetuating a view in the minds of otherenergy consuming nations and theirpopulations that this pursuit of oil supply iszero-sum, thus potentially creating an energysecurity dilemma bubble that will burst oncethe world experiences a shock that reveals ourmutual vulnerability to one single world oilsupply and price.

Works Cited

1. Carter, Jimmy. “State of the Union Address1980.” Jan 23, 1980. http://www. jimmycarterlibrary. gov/documents/speeches/su80jec.phtml (accessed Feb 09, 2010).

2. Baltimore, Chris. “U.S. officials scoff at Chinaequity oil quest” Red Orbit, July 26, 2005,Tuesday,http://www.redorbit.com/ news/politics/187564/us_officials_scoff_at_china_equity_oil_quest/index.html (accessed February

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10, 2010).3. Downs, Erica. “China,” Brookings Institute,

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15. U.S. Government. “Interim Report on CrudeOil” Inter Agency Task Force on CommodityMarkets, Commodity Futures TradingCommission (2008). 17-29. http:// www.cftc.gov/ucm/groups/public/@newsroom/documents/file/itfinterimreportoncrudeoil0708.pdf (accessed January 10, 2010).

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Abstract

Biofuel could be the fuel of future.However, the potential would be realized

at great costs as how biofuel is producedrenders a wide range of production costs. Thebiofuel production process is improving withbetter breeds of plants. Conflicts in demandbetween biofuel and food may be eased asmutually exclusive feedstock like Jatrophacrop is being developed. However, high socialand environmental costs make few biofuelprograms economically viable. This studyexamines the impacts of biofuel productionon the global economy by three aspects,namely, economic, environmental, and social.In addition, it identifies factors like globaloutput, the size of agricultural land, the shareof renewable energy out of total primaryenergy supply, CO2 emissions, and povertyrate as key determinants of biofuel productionin the world. Using these factors, it analyzesthe relationship between biofuel productionand these factors. Biofuel can contribute toglobal output growth, but bring about adaunting trade-off between energy and foodby creating bouts of food shortage. Biofuel

may not be as great as it seems until therepercussions of using biofuel are contained.

Introduction

Energy is important to a society. It is requiredfor industrial purposes, operating machineries,and even everyday cooking. Ever since theIndustrial Revolution just before the dawn ofthe twentieth century, most of our energysupply has been coming from fossil fuels, anonrenewable source of energy, which isfound in deposits beneath the earth and takesmillions of years to form. It is the mostabundant and the cheapest fuel available. Tillnow, about 90 per cent of the world’s totalenergy demand has been fulfilled by fossilfuels. The main types of fossil fuels, alsoknown as conventional fuels, are coal, naturalgas, and crude oil. The burning of fossil fuelsproduces heat (or energy) but emits a largeamount of greenhouse gases (GHG) into theatmosphere, contributing significantly toglobal warming, which leads to climatechange. Addressing the fear of depletion offossil fuels one day, researchers over the yearshave been on the search for environment-friendly alternative sources of energy. Biofuelis the alternative source that gets the nod frommost governments; it not only helps alleviatethe oil-dependency problem but is alsoconsidered to emit a lesser amount of carbondioxide into the atmosphere, making it apopular alternative source of energy globally. Biofuel, also called bio-ethanol or bio-diesel,is produced from living organisms, namely,

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Effect of Biofuel Production on the Global Economy:Economic, Social, and Environmental Perspectives

Youngho Chang Division of Economics, Nanyang Technological University [email protected]

Co-Author: Sarah Ho, Patricia Seah

photosynthetic plants and food wasteproducts. The plants used to produce biofuelare normally food crops, which are mainlycorn, sugarcane, wheat, and grain. Globally,biofuel is commonly used for heating homesand as a source of transport fuel. However, an apparent problem in the worldnow is that food security is being threatenedby the increasing production of biofuel. Higherprices of food are caused by many factors, oneof which is the decreasing supply of food dueto farmers growing fuel crops instead of foodcrops. Instead of allocating more land to growthese food crops, the existing land area isshared among food and fuel crops. This maycreate bouts of food shortage. This study analyzes the impact of usingbiofuel on the global economy and alsoexamines the extent of such an impact. Thisimpact is discussed in section 2 based on threeaspects, namely, the economic impact,environmental impact, and social impact.Section 3 shows some of the key determinantsof producing biofuel at a macro-scale andanalyzes the extent of the impact of thisproduction on the global economy. Using thekey identified factors, section 4 constructs arelationship between the factors of productionand the production of biofuel, and evaluateshow these factors affect the production ofbiofuel. Section 5 concludes this study with averdict on whether or not biofuel can be thefuel of the future.

Three Aspects of Using Biofuel-Economic, Social, and Environmental

Biofuel production and consumption has beenwidely studied since a long time. Some are infavor of biofuel production as it can increaseworld energy supply, but some are stronglyagainst it as it does not increase energy supply.The latter group finds that biofuel also poses

more harm to the environment than fossilfuels do.

Economic Impact

Biofuel increases the availability of fuel supplyin the world, thus making an impact on theglobal economy. Since the economy of acountry largely depends on its fuel supply,when the production of biofuel increases, thesupply of fuel increases and economic growthis boosted, which results in an increaseddemand and consumption of fuel and energy.The cultivation of biofuel crops provides manyfarmers with (1) a higher income due to higherfeedstock prices (2) and increased jobopportunities. In the following subsections, on one hand,some existing studies show that biofuels aremore energy efficient than conventional fuelsand are considered as net energy positive. Onthe other hand, some studies may disagreeand believe that biofuels yield negative netenergy. Some studies even insist that countriesshould be indifferent between biofuel andconventional fuels as the total energy supplyremains the same regardless of which fuel isbeing produced.

Net Energy Positive

If biofuel is more energy efficient thanconventional fuels, that is, lesser energy isrequired to produce a unit of biofuel ascompared to that required to produce anequivalent unit of conventional fuel, it is saidthat the total energy supply increases. Thus,biofuels are considered as net energy positivefor an economy. It was found that the coproducts of ethanolhave positive economic values and have anadvantage over competing products thatrequire energy to produce. Further, cornethanol production yielded a positive net

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energy of about 4 to 9 mega joules per liter ofethanol (MJ/l) (Farrell et al., 2006). Hence,lesser petroleum is needed to produce onemega joule (MJ) of ethanol as compared toproducing one MJ of gasoline.

Net Energy Negative

Some studies have shown that biofuels yieldnegative net energy. The energy required toproduce a unit of biofuel is more than theresulting energy produced by it, renderingbiofuel an energy inefficient fuel. Hence, theincreased use of biofuel decreases the totalenergy supply of an economy. It is also said that producing biofuel is adrain on our resources and pockets. Thestudies that suggest biofuel yielding netspositive energy did not take into considerationthe energy input required to grow thecrops and the conversion process. The corn-ethanol conversion such as fermentation anddistillation requires a huge amount of fossilenergy. The fossil energy used in corn farmingis large and equivalent to 0.4 (Wang et al.,1997) to 0.7 (Pimentel, 2003) metric tonnes ofgasoline per hectare (ha) and per crop. Largeamounts of fossil fuels are expended toconvert corn into pure ethanol. Corn requires29% more fossil fuel energy than the fuelproduced (Pimental and Patzek, 2005). In addition, due to the relatively low energycontent of ethanol, the energy content of 1.6liters of ethanol is equivalent to 1 liter ofgasoline. Thus, producing ethanol to providethe same energy content as gasoline is moreexpensive. The cost of producing 1.6 liters ofethanol is $1.78 as compared to $0.53, the costof producing 1 liter of gasoline (USCB, 2004-2005).All these existing studies have shown that theproduction of biofuel depends on the stockgrown and the production method. Differenttypes of biomass will release different amounts

of energy “depending upon the productivityof the crop, its responsiveness to fertilizer andirrigation inputs, the need for chemicalpesticides, and the difficulty of harvesting andrefining it into a fuel” (Worldwatch Institute,2007). As the energy balance is related to theamount of fossil fuels used, it is extremelyimportant to choose crops for biofuel so as tomaximize energy efficiency.

Environmental Impact

Biofuel has been increasingly heralded asan ecologically friendly alternative toconventional fuels that are dwindling insupply. When fossil fuels are processed andused, they release carbon dioxide (CO2) amongother gases. However, CO2 emissions frombiofuel production have been considerednegligible as compared to those from fossilfuels due to photosynthesis of plants. Althoughbiofuel diminishes GHG emissions, it is said tohave higher aggregate environmental costs.

Net Carbon-Negative

Carbon-negative biofuel is the fuel thatabsorbs carbon from the atmosphere whengrowing and releases a lesser amount throughburning. Since the plant material used toproduce biofuel is grown using atmosphericcarbon, the net emissions of CO2 are lower forbiofuel than fossil fuels. To achieve net carbon-negative biofuel, a portion of the biomass isreturned to the soil. Instead of converting theentire biomass into fuel, a portion of it isreduced to biochar through a process calledpyrolysis. Carbon capture and storage is anapproach to make biofuel carbon-negative. Asthe name suggests, CO2 is captured and storedthrough a biological, chemical, or physicalprocess, like the burial of biochar. Also knownas carbon sequestration, this approach aimsto mitigate the accumulation of GHG in the

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atmosphere. Biofuel made from biomassgrown on wasted agricultural lands incurslittle carbon debt without releasing largeamounts of GHG. Fairless (2007) has assured that Jatropha,another biofuel crop, contributes to greeningbarren land and reducing GHG emissions.Biopact (2006) also supports the idea thatbiofuel is carbon-negative. Since corn hasextremely low energy balances, the amountof CO2 emitted into the atmosphere is verylittle, whereas for sugarcane, CO2 emissionsdecreased up to 80 per cent. Tilman et al.(2006) also mentioned that biofuel from low-input high-diversity proved to emit lesserGHG as net ecosystem CO2 sequestration (4.4megagram hectare-1 year-1 of carbon dioxidein soil and roots) exceeds fossil carbon dioxiderelease during biofuel production (0.32megagram hectare-1 year-1).

Net Carbon-Positive

Carbon-positive biofuel is the exact oppositeof carbon-negative biofuel; it releases morecarbon into the atmosphere. It is especially sowhen biofuel crops are harvested usingfarming practices that result in huge GHGemissions. For example, maize requires aheavy input of fertilizers. Biofuel does emit alesser amount of CO2 as compared toconventional fuels. This, however, comes at acost. Other environmental impacts like waterquantity and quality, soil erosion, and loss ofbiodiversity have become a rising concern. In ethanol production, 99.5% pure ethanolmust be achieved. This is done through thefermentation and distillation of sugarcanes.During this process, water is being added toand extracted from the crushed sugarcane. Asconsiderable amount of water is beingremoved, more fossil energy inputs arerequired to acquire 99.5% pure ethanol. Intotal, 10 liters of wastewater is extracted for

every liters of ethanol produced. Accordingto Moreira (2007), for every kg of CO2 avoided,a minimum of 217 liters of water is used. In2005, 3.9 billion liters of ethanol was produced.Thus, the amount of energy, economic, andenvironmental costs incurred to dispose thislarge amount of wastewater can be estimated.The diffuse run off from sugarcane plantationssignificantly deteriorates the quality of riverwater. Another pressing concern is soil erosion.For every kg of CO2 avoided, soil loss rangesfrom 4.1 kg to 8.1 kg, which further deterioratesriver water. Sugarcane production emits other types ofGHG, namely, methane (CH4) and nitrousoxide (N2O). According to Lima et al. (1999),CH4 and N2O emissions are 26.9 kg and 1.33kg per ha of sugarcane produced, respectively.These correspond to 672 kg and 399 kg of CO2

equivalent emitted, respectively. The pollution caused by corn production inthe U.S. is rather serious, especially soil erosionand the use of pesticides, resulting in waterpollution worse than that caused by any othercrop (NAS, 2003).

Net Carbon-Neutral

Net carbon-neutral biofuels absorb CO2 asthey grow, and when burnt, release the sameamount of carbon back into the atmosphere.However, studies asserting biofuel as a carbon-neutral fuel are rare. Rosa and Ribeiro (1998)portrayed biofuel to be carbon-neutral, as CO2

released through the combustion of motor fuelis reabsorbed by growing more sugarcane.They strongly advocate that the use of ethanolcan significantly mitigate GHG.

Social Impact

Biofuel production may have posed someenvironmental problems and could be amongthe moral issues that need more global

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attention. Increase in biofuel production tomeet the soaring demand poses new foodsecurity risks. Higher food prices, subsidiesfor biofuel, and environmental degradationamong others will all be felt disproportionatelyby the developing world. When grain pricesincrease, the feed cost for livestock increases.This in turn drives up food prices. As lesserland is available for food crops, the supply offood falls and prices of food naturally increase.This will cause a ripple effect wherebyconsumers will shift demand to other grains,which increases the demand for grains andalso causes the price of rice to increase. The China Statistics Bureau announced inApril 2007 that domestic food prices increasedby 6.2% in the first quarter as compared to thesame period last year. Most Chinese were hitby soaring food prices, especially the poor andnet-food-purchasing households, who spenda large part of their income on food. Mitchell (2008) showed that many studiesfound that biofuel production is a major driverof food prices. This is mainly due to the factthat biofuels demand more of crops such asmaize, sugarcane, soy, and wheat. As thisdemand increases, assuming that supplyremains constant, prices will increase. TheInternational Monetary Fund has also madean estimation that the increase in demand forbiofuel has accounted for 70 per cent of theincrease in maize price and 40 per cent in thecase of soybean price. Fairless (2007) explored Jatropha, which growson lands that are not suitable for food crops.According to the India’s Ministry of RuralDevelopment, Jatropha thrives on erodedplantation or wasteland and thus does notcompete with food production. In addition,Jatropha survives up to 50 years, “fruitingannually for more than 30 years andweathering droughts with aplomb.” As such,the India Planning Commission has

recommended a project to cultivate Jatrophaon a wide-scale basis. Jatropha, as comparedto soya bean, produces more oil, amountingup to 1300 liters of oil per hectare.However, the potential of Jatropha is stillunpredictable as it has not been domesticallygrown. As the optimum living condition andefficient production methods of Jatropha areyet to be found, this crop is still in the infantstages of R&D.

Analytical Framework

There has been much controversy aboutbiofuel in the recent years. There are variousopposing views on biofuel. Some believe thatbiofuels will replace conventional fuels dueto their environmental benefits, while somethink that biofuels do not alleviate the problemof rising oil prices, but worsen it and placefurther strain on the economy. There are manyfactors that contribute to the use of biofuel. Inthis section, we identify and analyze the keydeterminants of biofuel at a macro-level ratherthan a micro-level, that is, we identify andanalyze the main forces behind the productionof biofuel over the years. Before analyzing the key determinants, wefirst identify two groups of people that havedifferent views on biofuel: environmentalistsand businessmen. Although environmentalistsmay agree that burning biofuel emits lessercarbon as compared to gasoline, butconsidering the overall biofuel production(from growing to extracting), biofuels causegreater harm to the environment. If thiscontinues in the future, environmental damagemay get so serious that we may have to ceasethe production of biofuel. Businessmen thinkotherwise; they believe that biofuel has thepotential to open up new markets and createnew investment opportunities, which willhave a positive impact on the economy. Inother words, the production of biofuel

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depends on which sector people value more.If monetary benefits outweigh environmentalcosts, biofuel will be produced.

Economic Impact

The Gross National Income (GNI), agriculturalland, and share of renewable energy out oftotal primary energy supply are identified asthe three key determinants behind theincreasing production of biofuel. The GNImoves in the same direction as biofuel; whenpeople get wealthier, they demand moregoods, which require more energy. From theraw materials to the manufacturing to thetransportation of these goods, energy isrequired at every stage. Agricultural land isan important factor of biofuel productionbecause fuel crops are the same as food crops.If there is more available land, production willmost likely increase. As long as energydemand surpasses the supply of energy fromfossil fuels, biofuel has to come into place.

Gross National Income

The GNI per capita gives a measure of theannual national income per person. Howincome and biofuel production are relateddepends on what people demand when theirincome increases. As people get more affluent,they wish to sustain a more comfortable life.For example, they tend to consume luxurygoods that consume more energy, such as airconditioners and cars, showing incomeelasticity of demand to be more than one.Thus, as income rises, the current demand forenergy most likely increases. As the energydemand exceeds the supply of oil, thisshortfall has to be met by burning more fuel.Biofuel may not necessarily be burned to meetup with the demand, but it is plausible.Therefore, the relationship between GNI and

production of biofuel is likely to be positivelyrelated.

Agricultural Land

When biofuel is extensively produced, one ofthe main issues the public is concerned aboutis food security. Before biofuel was widelypromoted, food security was already a criticalproblem that was experienced mainly by thepoorer countries. In 2007-08, there has been adrastic increase in worldwide food prices.With soaring food prices, this makes foodsecurity more unstable than before as morepeople cannot afford the higher prices.Agricultural land is likely to be related tobiofuel production in a way that fuel cropscompete with food crops grown on the limitedarable land intended for food crops. With acontinued demand for ethanol and high pricesof corn, the additional acres of land areexpected to go toward biofuel production. Asthe prices of fuel crops increase, farmersallocate more arable land to grow more fuelcrops instead due to higher profits, therebyincreasing the supply of biofuel. Thus, we usethe area of agriculture land as a variable to seehow much increase of land will affect biofuelproduction.

Share of Renewable Energy out ofTotal Primary Energy Supply

Of the primary energy supply, about 23 percent is supplied by renewable energy. Thisfigure is expected to increase as nonrenewableenergy like fossil fuels gradually runs out. Outof the total renewable energy source, biofuelby far has the largest share. It has the largestpotential to expand since more and more R&Dis being spent on its production. Hence, ifmore renewable energy is used to supplementthe total primary energy supply, more biofuelis likely to be produced.

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Environmental Impact

The environmental factors that determine theuse of biofuel are the levels of atmosphericcarbon concentration and CO2 emissions. As weknow that global warming is the main concernof the world, most governments aim to tacklethis problem. We all want to achieve a greeneconomy; hence, burning of fossil fuels shouldbe reduced, and a more environmentallyfriendly fuel should be produced.

Carbon Dioxide Emissions

The economic development around the worldhas brought in the use of technology andmachineries. All these require energy to work,and producing of energy from fossil fuels willrelease many GHG, mainly CO2. AtmosphericCO2 has increased and so has globaltemperature. The burning of fossil fuels is waytoo harmful for the environment, emitting alarge amount of CO2 and thus worsening theimpact of GHG on the environment. Biofuelis more environmentally friendly in a way thatit emits lesser CO2 into the atmosphere. If CO2

emissions from burning fossil fuels exceed theideal level of emissions, fossil fuels have to bedisplaced by biofuel to provide the energysupply, thus increasing the production ofbiofuel.

Social Impact

The use of biofuel not only has an economicand environmental impact but also a socialimpact on the world. As more and morenations industrialize, demanding more energy,increasing attention should be given todiverting food crops to fuel crops. This leadsto food insecurity in the world, as the land leftto grow food crops is diminishing. Hence, thesupply of food declines, and people have topay more for a lesser amount of food. Thepoor are hit the most due to shortage of food,

and more importantly, the high prices of foodmean that the poor end up spending a largeshare of their income for food.

Poverty Rate

Whether people are eating well depends onthe availability of food, and whether they evenhave something to eat depends on the foodsupply. As more land is dedicated to growingfuel crops, lesser arable land is available togrow food crops. Further, in the face ofmeeting energy and food requirements, thedemand for energy is better met as it is ratherevident that more farmers are growing cornfor biofuel purposes instead of producing cornas food stuff.The poverty rate has been fluctuating and ison the rise for the past few years. Most of thepoor people live in underdeveloped countriessuch as sub-Saharan African regions. Weexpect the relationship between the povertyrate and biofuel production to be negative. Ifthe poverty rate falls, implying that morepeople have access to basic food, we say thatfood production is sufficient. Thus, more landcan be allocated to grow fuel crops, increasingbiofuel production.

Sample Range

The sample runs from 1981 to 2006,comprising of yearly data, that is, 26observations in all. All data used are worldfigures. From 1981 to the 1990s, biofuel wasnot a popular source of energy. In the twenty-first century, advancement in technology,specialized expertise, and other factors haveled to more R&D on biofuel production.Hence, we chose data over a period of 26years to see the change in trend in the use ofbiofuel and key determinants affecting theproduction of biofuel. The data has been obtained from varioussources: Energy Information Administration

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(EIA), World Bank, and Food and AgriculturalOrganization of United Nations (FAO). <Table 1>shows the descriptive statistics of data usedfor the regression analysis.

Results

The five key macro-level determinants ofproduction of biofuel are GNI, agriculturalland, share of renewable energy (SRE) out oftotal primary energy supply (TPES), CO2

emissions, and poverty rate. The dependentvariable is the production of biofuel. Weconstruct a linear relationship between biofuelproduction and the factors:

LLQQBBIIOO == αα1111LLAAGGLL ++ αα22 LLGGNNII ++ αα33 LLSSRREE ++ αα44 LLCCOO22 ++ αα55

LLPPOOVV ++ CC,, ----------------------------------------------((11))

where QBIO denotes the production ofbiofuel; AGL, the area of agricultural land;GNI, the world gross national income; SRE,the share of renewable energy out of totalprimary energy supply; POV, and the worldpoverty rate; further, C is a constant, and α1, α2, α3, α4, α5 are estimated parameters. L standsfor a logarithmic function. After running the ordinary least squares (OLS)regression, our results are as follows (thenumbers in parenthesis show the t-statisticsof the variables):

LLQQBBIIOO == 4400..6622 LLAAGGLL -- 33..0077 LLGGNNII -- 00..7788 LLSSRREE ++ 88..6633

((44..6644)) ((--33..0066)) ((--00..7711))

LLCCOO22 ++ 33..3355 LLPPOOVV －－668800..8844 ------------------------ ((22))

((88..0077)) ((44..0044)) ((--55..1199))

Results for Economic Determinants

As expected, agricultural land is positivelyrelated to biofuel production. A 1 per centincrease in land area will lead to about 40 percent increase in production. This implies thatland is an important determinant of biofuelproduction. When there is more land area,producers will allocate part of it to grow fuelcrops, hence increasing the supply of biofuel. However, the regression result for GNI is

inconsistent with our expectations. A 1 percent increase in GNI will cause the productionof biofuel to fall by approximately 3 per cent.The most probable explanation would bewhen people get wealthier, they demand morefossil fuels like crude oil rather than biofuel.Resources and attention are given to supplymore fossil fuels rather than ethanol, as fossilfuels are more readily available and cheaper. Since the share of renewable energy out of thetotal primary energy supply is insignificant,it appears not to influence the productiondecision of biofuel against our expectations.Hence, SRE does not seem to be good enoughto explain the production of biofuel.

Results for Environmental Determinants

The regression result for CO2 emissions isconsistent with our expectations. An increasein CO2 indeed leads to higher production ofbiofuel. As an increase in CO2 emissions addsto the atmospheric carbon concentration level,most governments take action, as this seriousproblem conflicts with their goal to fight globalwarming. Therefore, they greatly support theproduction of biofuel. The negativity of theenvironmental impact of fossil fuels spurscountries to produce biofuel, even if it coststhem millions of dollars. Hence, from theresults, a 1 per cent increase in CO2 emissionswould lead to an increase of 8.6 per cent in theproduction of biofuel.

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<Table 1> Descriptive Statistics of Data

QQBBIIOO ((BBiilllliioonn BBTTUU))

GGNNII((UUSS$$))

SSRREE ((%%))

AAGGLL ((‘‘000000 hhaa))

CCOO22 ((MMiilllliioonnMMeettrriicc TToonnss))

PPOOVV ((%%))

Mean 120,276.2 4,465.5 38.3 4,864,692.0 22,489.2 13.8Maximum 411,564.0 7,448.0 46.9 4,983,411.0 29,195.4 15.7Minimum 7,000.0 2,377.0 32.1 4,664,932.4 18,169.0 12.2Median 90,133.0 4,665.0 38.9 4,909,712.4 21,846.8 13.7Std Dev 97,106.5 1,405.6 2.81 106,223.14 2,967.5 0.86

Results for Social Determinants

The poverty rate appears to be positivelyrelated to biofuel production. What mayexplain this discrepancy is that a large numberof people living in poverty are in theunderdeveloped countries. Even if the worldpoverty level were to rise, it may mean that

this increase is entirely brought about by theunderdeveloped countries. Developing anddeveloped countries still demand more energysupply, hence increasing biofuel production. <Table 2> presents a summary of the literaturereview, our key determinants, and results. Itprovides a comparison between existingstudies and our expectations.

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<Table 2> Summary of Existing Studies, Key Determinants, and Results

BBiiooffuueell SSttuuddiieess KKeeyy DDeetteerrmmiinnaannttss RReessuullttss

Positive Negative Neutral

EconomyImpact

- Farrell et al (2006):Corn ethanol productionyielded a positive netenergy of about 4 to9 mega joules per litreof ethanol (MJ/l).

- Pimental and Patzek (2005):Corn requires 29% more fossilfuel energy than the fuelproduced.

- (USCB, 2004-2005): the energycontent of 1.6 litres of ethanolis equivalent to 1 litre ofgasoline.

- GNI: Positively relatedIncrease in income →increase in energy demand→ increase in biofuel

- Agriculture: Positively related.Increased in ethanoldemand →, additional landgoing toward biofuel.

- % of renewable energy/totalenergy: Positively related

- GNI is inconsistent with ourtheory. 1% increase in GNI→ 3% fall in production ofbiofuel

- Agricultural land is positivelyrelated to biofuel production.1% increase in land area→ 37% cent increase inbiofuel production.

- % of renewable energy/totalenergyis insignificant.

EnvironmentalImpact

- Fairless (2007):Contributes to greeningbarren land andreducing GHG emissions

- Biopact (2006): Due tolow energy balances,very little amount of CO2

emitted- Tilman et al (2006):Biofuel from low-inputhigh-diversity proved toemit lesser GHG.

- Moreira (2007): For every kgof CO2 avoided, a minimumof 217 L of water is used.

- Lima et al. (1999), CH4 andN2O emissions are 26.9kg and1.33 kg per ha of sugarcane.(NAS, 2003): Corn productioncaused soil erosion. The useof pesticides results in waterpollution worse than anyother crop.

- Rosa andRibeiro(1998): CO2

releasedthrough thecombustionof motorfuel isreabsorbedby growingmoresugarcane.

CO2 emission: Positively related.Global warming is the mainconcern of the world. Toachieve a green economy →increasing demand of biofuel

CO2 emission is consistentwith our theory. 1% increasein CO2 emission → 8.5%increase in biofuel production- Negativity of environmentalimpact of fossil fuel spurscountries to produce biofuel

Mutually Exclusive Interrelated

Social Impact

- Fairless (2007):Introduction of Jatrophathat grows on lands thatis not suitable for foodcrops. Hence foodprices are unaffected.

- China StatisticsBureau (2007):Domestic food prices increased6.2% when biofuel productionincreased.

- Mitchell (2008): Biofuelproduction is a major driverof food prices.

- IMF (2008): Increased demandfor biofuel has accounted for70% of the increase in maizeprice and 40% in the soybeanprice.

- UN (2007): Liquid biofuelproduction could threaten theavailability of adequate foodsupplies by diverting land and11 other resources away fromfood crops.

Poverty rate: Negatively related.Decreased in poverty →increase in access of basicfood → food production issufficient → more landallocated to biofuel

- Poverty rate is found to bepositively related to biofuelproduction

- Though number of poorincrease, people fromwealthier countries stilldemand more energy.

Conclusion

Biofuel could be the fuel of future. However,this could come at great costs. It depends onhow biofuel is to be produced. Biofuel andfood may be mutually exclusive in specificfeedstock like Jatropha crop. However, underglobal perspectives, they are more interrelated.There would be a positive economic impactfrom biofuel production but negativeenvironmental and social impact as well. This study analyzes how the productionof biofuel influences the world throughthree aspects, namely, economically,environmentally, and socially. It is undeniablethat the production of biofuel can increase theworld’s energy supply. As conventional fuelsare in danger of depletion, biofuel becomesthe next source of energy. However, all thiswill come at a great price. Whether biofuelwill replace conventional fuels and becomethe fuel of the future remains ambiguous.Having said that, whether biofuel willcontinue to be produced in the futuredepends on which sector of the economywill people value more. As is mentioned,environmentalists and businessmen could bea deciding factor behind the production ofbiofuel. Technology could make biofuel more feasiblein the future. Better methods of producingethanol will lessen the amount of carbonemissions. Cellulosic ethanol technology thatproduces environmentally friendly renewabletransportation fuel that is produced from widevarieties of feedstock. Unlike corn ethanol, itdoes not require fertilizers to grow, thusreducing pollution. As pointed out by theWorldwatch Institute (2007), the biofuelproduction process is improving with betterplants breeds, more parsimonious farmingmethods, and larger processing facilities,leading to an increase in the amount of

output fuel. In addition, with the help ofadvancement in technology, even “fibrousresidues extracted during cellulosic conversionwill probably become more important energysupplies” bringing the biofuel’s energy balanceto be near infinity. Biofuel and food may be mutually exclusivein specific feedstock, like the Jatropha crop.When we look at it as a whole, however, theyare more interrelated regardless of howadvanced technology is. This is mainly due tothe limitations of land and labor; biofuel andfood are believed to be correlated as theproduction of one will affect the other, bothgoing in different directions. We predict that few biofuel programs areeconomically viable due to high social andenvironmental costs, upward pressure on foodprices, intensified competition for land andwater, and possible deforestation. The overallimpact on the global economy will benegative, mainly due to unstable and decliningfood security. Its production will have apositive economic impact, but negativeenvironmental and social impact. Biofuelcould provide a huge market for agriculture,but with environmental and social costsattached.

References

1. Biopact, December 2006 “Carbon negativebiofuels: from monocultures to polycultures”[Online],

2. Availableat:http://news.mongabay.com/bioenergy/2006/12/carbon-negative-biofuels-from.html

3. De Oliveira, M.D., 2008, “Sugarcane andEthanol Production and Carbon DioxideBalances”, Biofuels, Solar and Wind asRenewable Energy Systems, Springer Scienceand Business Media B.V. 2008

4. Fairless, Daemon, October 2007, “The littleshrub that could-maybe” Nature, Vol. 449,

74


Issue & Focus

pp.652-655, Nature Publishing Group5. Farrell, Alexander E., Richard J.P., Brian T.T.,

Andrew D.J. Michael O’H. and Daniel M.K.,January 2006, “Ethanol Can Contribute toEnergy and Environmental Goals”, Science,Vol. 311, pp. 506-508 American Associationfor the Advancement of Science

6. Food and Agriculture Organization of theUnited Nations, 2008, “The State of FoodInsecurity in the World 2008, High food pricesand food security-threats and opportunities”

7. International Energy Agency, 2007, “BiofuelProduction”, IEA Energy TechnologyEssentials

8. Lima, M.A., Ligo, M.A.V., Cabral, O.M.R.,Boeira, R.C., Pessoa, M.C.P.Y. and Neves, M.C.,1999, Emissao de gases de efeito estufaprovenientes da queima de residuos agricolasno Brasil, SP-Brazil: EMBRAPA MeioAmbiente (cited from De Oliveira, 2008)

9. Mitchell, Donald, 2008, A Note on Rising FoodPrices, Policy Research Working Paper 4682,Development Prospects Group, The WorldBank.

10. Moreira, J.R., 2007, Water Use and Impactsdue Ethanol Production in Brazil. Presentedat International Conference at ICRISATCampus, Hyderabad, India, 29-30 January2007

11. NAS, 2003, Frontiers in AgriculturalResearch: Food, Health, Environment, andCommunities, Washington, D.C., NationalAcademy of Science

12. Patsek, Tad W., S-M. Anti, R. Campos, K. W.Ha, J. Lee, B. Li, J. Padnick, S-A. Yee, May2005, “Ethanol From Corn: Clean RenewableFuel For The Future, or Drain on ourResources and Pockets?” Environment,Development and Sustainability, (2005), pp.319-336, Springer 2005

13. Pimentel, David, 2003, “Ethanol Fuels, EnergyBalance, Economics, and EnvironmentalEffects are Negative,” Natural ResourcesResearch, 12(2): 127-134

14. Pimentel, D. and T. Patzek, 2008, “EthanolProduction Using Corn, Switchgrass andWood: Biodiesel Production Using Soybeanand Sunflower”, Natural Resources Research,14(1): 65-76

15. Pimentel, D. and T. Patzek, 2008, “EthanolProduction Using Corn, Switchgrass andWood; Biodiesel Production Using Soybean”,Biofuels, Solar and Wind as RenewableEnergy Systems, Springer Science andBusiness Media B.V. 2008

16. Rosa, L.P. and Ribeiro, S.K., 1998, “AvoidingEmissions of Carbon Dioxide through theUse of Fuels Derived from Sugarcane,”Ambio, 6: 465-470

17. Tilman, David, Jason H. and Clarence L.,December 2006, “Carbon-Negative Biofuelsfrom Low-Input High-Diversity GrasslandBiomass“, [Online], Available at: http://www.sciencemag.org/cgi/content/short/314/5805/15

18. USCB, 2004-2005, Statistical Abstract of theUnited States 2004-2005. U.S. Census Bureau.Washington, D.C.: U.S. Government PrintingOffice

19. Wang, M.Q., C.L. Saricks, and M. Wu, 1997,Fuel-Cycle Fossil Energy Use andGreenhouse Gas Emissions of Fuel EthanolProduced from U.S. Midwest Corn, preparedfor Illinois Department of Commerce andCommunity Affairs, Center for TransportationResearch, Argonne National Laboratory,Argonne, Ill, U.S.A.

20. Worldwatch Institute, 2007. Biofuels forTransport: Global Potential and Implicationsfor Sustainable Energy and Agriculture,Earthscan.

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76


NEA Statistics

● Nuclear Share of Total Electricity Generation in 2008

Source : IAEA, ‘Energy, Electricity and Nuclear Power Estimates for the Period up to 2030’, 2009 Edition

● Total Energy Requirement by Fuel Type in 2008

Source : IAEA, ‘Energy, Electricity and Nuclear Power Estimates for the Period up to 2030’, 2009 Edition

NorthAmerica

0

20

40

60

80

100

120

EJ

LatinAmerica

WesternEurope

EasternEurope

Africa Middle(East.&(South(Asia

South(East(Asia&(the(Pacific

Far(East

RenewablesNudearHydroBiomassGasesLiquidsSotids

100

8060

4020

0

FRAN

CE

LITHU

ANIA

SLOV

AKIA

BELG

IUM

UKRA

INE

SWED

EN

SLOV

ENIA

ARME

NIA

SWITZ

ERLA

ND

HUNG

ARY

KORE

A,(R

EPUB

LIC(O

FBU

LGAR

IA

CZEC

H(RE

PUBL

IC

FINLA

ND

GERM

ANY

JAPA

N

USA

SPAIN

ROMA

NIA

(RUS

SIA

CANA

DA UK

ARGE

NTINA

SORT

H(AF

RICA

MEXIC

O

NETH

ERLA

NDS

BRAZ

IL

CHINA

INDIA

PAKIS

TAN

Nucle

ar(S

hare(%

)

56.4

72.9

53.8

47.4

42.0

76.2

41.7

39.4

39.2

37.2

36.6

32.9

32.5

29.7

28.8

24.9

19.7

18.3

17.5

16.9

14.8

13.5

6.2

5.3

4.0

3.8

3.1

2.2

2.0 1.9

NEA Statistics


77

Center for Energy Research, Northeast Asia (CERNA)Korea Energy Economics Institute (KEEI)

“Northeast Asia Energy Focus” (NAEF) is published quarterly by the Center for Energy Research,Northeast Aisa, (CERNA) of the Korean Energy Economics Institute (KEEI). This journal aims to stimulateresearch on issues pertaining to Northeast Asia and to shed light on the role played by Korea in regionalcooperation and development.

NAEF is now soliciting papers for the next publication on a wide range of Northeast Asia Energy issues,including regional energy cooperation. The submission guidelines are as follows:

1. Manuscripts must deal with energy issues relevant to Northeast Asia. 2. Manuscripts must be in English and typed on A4 paper with a 12-point typeface. 3. The preferred length of a manuscript is approximately 9~10 pages or 3,500~4,000 words. 4. Deadlines

- Deadline for intent submission: March 25, 2010 - Deadline for manuscript submission: April 25, 2010

An accepted manuscript will receive an honorarium of US $400-$500 according to the quantities of paperand the exchange rate. For further information, please contact Mr. Cheol-Seon Hong at [email protected].

Publisher: Ki-Yual Bang, Korea Energy Economics Institute, 665-1 Naeson-dong, Uiwang-si, Gyeonggi-do, Korea, 437-713

Editor: Nam-Yll KimTelephone: +82-31-420-2149Fax: +82-31-420-2163Website: http://www.keei.re.kr (KEEI) http://www.neasiaenergy.net (KEEI/CERNA)

CALL FOR PAPERS“Northeast Asia Energy Focus”

KOREA ENERGY ECONOMICS INSTITUTE

CERNA Center for Energy Research, Northeast Asia

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