Politics Keep Pipeline Hanging

BMI View : The realisation of a Russia-Korea gas pipeline would certainly give the gas exporter a large market opportunity in South Korea, the world's second largest importer of liquefied natural gas (LNG). Although Russia is attempting to push the project ahead, this pipeline is unlikely to materialise unless security in the Korean peninsula drastically improves ; we do not think this will take place quickly enough to meet the 2017 start-up date that Russia has eyed for the project.

Russia is not giving up on the prospect of a pipeline that would deliver gas to the Republic of Korea ( South Korea ) via the Democratic People's Republic of Korea ( North Korea ) . In early February 2013, Russian ambassador to Pyongyang Alexander Timonin told the press that talks for this project are still ongoing. South Korean news agency Yonhap also reported that this pipeline was one of the topics of discussion during Russian president Vladimir Putin's meeting with Incheon mayor Song Young-Gil in Moscow on February 8 2013 .

The Russia-Korea pipeline project was first conceived in the late 2000s by Russian state-owned gas export monopoly Gazprom and Korea's state-owned gas firm Kogas . In a Memorandum of U nderstanding (MoU) signed in June 2009, both companies agreed to study the feasibility of a pipeline that would allow Russia to send gas to South Korea via North Korea; the line would travel through the eastern coastal provinces of Gyeongseong and Wonsan in North Korea to Goseong, Incheon and Pyeongtaek in South Korea. The pipeline was to have a capacity of 10 - 12bn cubic metres (bcm) per year. Gazprom had hope d that gas to Korea would start flowing by 2017.

Far East Dream

Pipeline gas exports to Korea form part of Russia's Far East push, both in terms of developing its Far Eastern areas and of diversify ing its gas markets away from its increasingly troubled core market in Europe. Asia's growing gas demand has made it an increasingly attractive market and Putin ordered the country's hydrocarbons industry to direct its focus to this growth market in November 2012. In August 2012, the Ministry of Far East Development was set up under the watch of Viktor Ishayev for this express purpose.

A 1,400km pipeline linking Russia's Sakhalin Island to Hokkaido in Japan, the world's largest liquefied natural gas (LNG) importer, is currently being studied. Russia also has plans for the Altai pipeline, connecting gas from Western Siberia to growing gas importer China, though this project is being held hostage by Russia's persistent failure to secure a gas sale and purchase agreement (SPA) with the latter over pricing disputes.

A gas pipeline would increase Russia's share of South Korean gas imports, all of which are obtained via LNG trade. In 2012, it only made up about 5.9% of the peninsula country's total LNG imports. Given South Korea's status as the second largest LNG importer in the world, t he Russia-Kor ea pipeline would complement other proposed Asian pipeline projects and consolidate Russia's position in one of the world's biggest regional gas markets.

Stepping Up The Korean Game
Russian Share Of South Korea's LNG Market Vs. Competitors For 2012 (%)

A Pipe Dream

For South Korea, a pipeline gas deal with Russia could see the country minimise the costs of its gas imports. In 2012, LNG imports rose 3% year-on-year (y-o-y) , but the total cost has soared 18.5% y-o-y from US$22.27bn to US$26.39bn as tight LNG global supplies combined with growing global demand to exert upward pressure on LNG prices in 2012. This is a trend that could likely continue in the short term. The longer-term trend in LNG prices is much more uncertain, as potential LNG producers such as Chevron are maintaining their insistence on 'competitive' pricing for long-term supply contracts before they embark on new LNG projects.

A pipeline gas deal with Russia could help South Korea reduce the long-term uncertainty in the cost of its gas imports. Professor Kwon Won-son of Hankuk University estimates that pipeline gas could cost only a thir d of that of LNG imports. Outgoing South Korean president Lee Myung Bak was more conservative with his estimate , but still saw that Russian gas could be 30% cheaper than LNG , according to Bloomberg ; this was a key rationale for his endorsement of the Russia-Korea pipeline in 2011 , despite being more hawkish in his attitudes towards North Korea than his predecessors.

Import Pressures
Comparison Of South Korea's LNG Imports & Costs in 2011 & 2012

Politics Beckons

However, the materialisation of this pipeline will remain strongly tied to the resolution of tensions between North and South Korea. Former strongman Kim Jong-Il and his successor Kim Jong Un have agreed in name to the passage of the pipeline through North Korean territory, but the exorbitant transit fee s the country is demand ing in return will hinder the progress of the project. According to a Choson Ibo report in October 2012, talks between the two countries have stalled over Pyongyang's demand for US$300-500mn per year in transit fees - more than two - to three-times that of the US$150mn that Seoul is offering based on 'international norms'. Without lower transit fees, the cost advantages of Russian pipeline gas relative to LNG imports would be reduced.

Of more significance is the political advantage that North Korea would have over the south if the pipeline is built without a peace agreement between the two. At 10bcm per annum, according to our projections the pipeline would effectively transport about 15% of South Korea's total gas consumption needs in 2022, which the North could hold hostage in return for other political concessions.

Gas Need Makes Easy Hostage Target
South Korea's Gas Production, Consumption & Net Import Requirement

Despite a change in leadership in 2012, North Korea is showing few signs of toning down its belligerence towards the South and the region at large. It has threatened to carry out a new nuclear test and if this goes ahead, it would no doubt increase Seoul's doubts about Pyongyang's intentions once again ( see our online service, January 30 2013, 'Nuclear Test Threat Is Credible'). While its stance could be aimed at strengthening the political authority of Kim Jong Un, it would not facilitate a political environment conducive to negotiations for a Russia-Korea pipeline.

The inauguration of incoming South Korean president Park Geun-hye could usher in improved inter-Korean relations ( see 'The Outlook For 2013', January 3 2013). Even so, the improvement would come slowly as both are likely to adopt a 'wait and see' attitude. This means that, in the short term, any meaningful progress on the Russia-Korea project is unlikely to be made in the foreseeable future, making Russia's planned operational start-up in 2017 less likely.

This article is tagged to:
Sector: Oil & Gas, Infrastructure
Geography: North Korea, North Korea, South Korea, Russia, North Korea, North Korea

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