Photographer: Mikhail Klimentyev/AFP/Getty Images
Photographer: Mikhail Klimentyev/AFP/Getty Images

As soon as Russian President Vladimir Putin annexed Crimea last month, U.S. and European politicians started to talk about cutting Russian energy exports to punish him. Surely a country in which oil and gas are expected to account for 48 percent of budget revenues in 2014 would think twice if faced with curbs on its hydrocarbon exports?

As U.S. Senator John McCain called Russia "a gas station masquerading as a country," and the U.S. congress moved to expand liquefied natural gas exports to displace Russian sales in Europe, Chinese officials must have rubbed their hands with glee. For 10 long years they had talked to Russia about building a gas pipeline from Siberia to China, but could never agree on a price. Now, thanks to the Ukraine crisis, there was a chance for a breakthrough.

China is the biggest energy-consuming nation in the world, but ranks only fourth in natural gas consumption, because more than two-thirds of its energy comes from coal. China burns about as much of the stuff as the rest of the world put together and it desperately needs cleaner energy. The Chinese government has made plans to produce gas from coal, but the process releases lots of carbon dioxide and guzzles water, which is scarce in many regions of China. Importing gas is therefore the best option, but it is expensive unless delivered through a pipeline: China paid an average of $11.13 per million British thermal units for LNG in the first half of last year, according to Platts, about twice the price paid in the U.S.

There is a roughly 1,200 mile pipeline running to Xinjiang province in China from gas-rich Turkmenistan in Central Asia, built almost entirely with Chinese money. China paid about $9.8 per million BTU for gas from that pipeline last year.

Russia can undercut that price if it wants to. The average production cost of the Russian near-monopoly, OAO Gazprom, is just $1.3 per million BTU. Gazprom can also potentially deliver more gas than Turkmenistan and Uzbekistan, which last year accounted for less than half of China's 53 billion cubic meters of imports. Last year, China and Russia agreed the latter would provide up to 35 billion cubic meters a year for 30 years through a pipeline from eastern Siberia. The Russian side has insisted that the project, which would involve an estimated $34 billion investment, makes no economic sense at a price below $10 per million BTU. Some sources put Russia's comfort price even higher, at $13.5 per million BTU.

The Chinese suspected, however, that Russia just wanted to make as much from this new market as it did in Europe. In 2013, the average price Gazprom charged for gas exported beyond the former Soviet Union reached $11.9 per million BTU. So the negotiations stalled and Gazprom did not include the Chinese pipeline in its 2014 investment program.

The time-tested Chinese tactic of waiting by the river until an adversary's corpse floats past now seems to be paying off. After the Crimean adventure, Russia faces much more pressure to do a deal, because traditional customers in Europe look to be bent on diversifying their energy supplies. China wisely refrained from criticizing the annexation and kept negotiating the pipeline project. On Wednesday, Gazprom chief executive Alexei Miller and China National Petroleum Corporation head Zhou Jiping apparently made progress on the price issue. The deal may be signed within weeks.

Both countries should have closed the gap long ago: Russia needs to diversify its markets and China is desperate to make the switch from coal to gas. Russia, however, had different priorities, investing in more pipelines to Europe where it was guaranteed high prices. Now, Russia needs the deal no less than China does as it looks for defensive moves in a Chess game with the U.S.

Energy resources have always been a geopolitical tool for Russia and Putin knows how to use it. Putting a squeeze on Russia by trying to strangle its energy exports will now be difficult: If Europe starts buying less of its natural gas imports from Gazprom, Gazprom can sell more to China. Any American attempt to respond by displacing Russian exports to China would be sure to fail, because its LNG supplies would be more expensive and less abundant than Russian pipeline deliveries.

To contact the author of this article: Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor responsible for this article: Marc Champion at mchampion7@bloomberg.net