More on the Pipeline



No sooner had we posted a skeptical note on the political economy of pipelines than we appeared to be undercut by the flow of events. President Lee Myung Bak said that the pipeline project could move forward at a faster-than-expected pace. On a single day—September 15-- Alexey Miller, chairman of Gazprom’s management committee, hosted separate meetings with both Choo Kangsoo, CEO of South Korea’s Kogas, and Kim Hui Yong, the DPRK’s Oil Industry Minister. Miller signed an “MOU” with the North Koreans and a “Roadmap” on the project with the South Koreans.

The Korea Herald reports speculation that Seoul and Moscow seek to make progress by November when Lee and Medvedev will meet at the G20 summit in Cannes on Nov. 3-4, the APEC summit in Hawaii on Nov. 12-13 and the East Asia Summit in Bali on Nov. 18-19.

Is this thing going to happen? Not so fast. The little details that are leaking out actually confirm a number of our doubts and concerns:

  • There is one report that at the August summit, Kim Jong Il was seeking as much as $500 million a year in transit fees from the pipeline deal. So we did a little back-of-the-envelope calculation. The project anticipates pumping 10 billion cubic feet of gas a year when completed. Current prices are about $145 per thousand cubic feet. In short, Dear Leader wants $500 million transit fees on $1.45 billion worth of gas. As the report deadpans, this was about five times what the Russians had expected.
  • It appears that the transit fee issue was ultimately linked to debt relief. The Soviets/Russians had extended about $11 billion to the North Koreans; needless to say, it has not been serviced. In parallel negotiations resumed in June, the Russians recently agreed to write off 90 percent of the debt, investing the remainder in “joint business projects to be launched in the North down the road.” This may be good for the pipeline project, but shows that the Russians are doubling down on the Kim Jong Il regime, as my colleague Marc Noland also noted in an earlier post.
  • But perhaps most interesting are the terms that the South Koreans are seeking in order to mitigate the risk associated with the project. Recall that the Russians are already shipping LNG to the South and will have an expanded ability to do so with the recent completion of the Sakhalin-Khabarovsk-Vladivostok gas transmission system, albeit at higher cost. The South Koreans are building an LNG storage site at Samcheok, Gangwon Province. According to none other than Hong Joon Pyo, chair of the ruling Grand National Party, South Korea is insisting that the Russians take responsibility for building and maintaining the pipeline. Moreover, they want guarantees that if North Korea turns off the spigot, then the Russians would provide the gas by sea at a 30% discount.

Russia has a strong interest in expanding its Asian sales ever since the Sakhalin-2 project went online in the Pacific in 2009. Most of the Sakhalin-2 gas goes to Japan and South Korea is a natural market. The pipeline is a win-win for all parties. But the fact that the GNP has gone soft on the project should give the Russians pause. How much are the Russians willing to pay for it, politically, economically and in terms of risk?

In a must-read post on 38 North Georgy Toloraya suggests that the answer may be “a lot.” Toloraya argues that Russia is looking East and North Korea is seen as a strategic entry point where the Russians can make their presence felt. This does not strike us a promising strategy to say the least. But the evidence is mounting that Moscow is pursuing it. If the Russians are willing to absorb the risk, Hong Joon Pyo may well be right: why should South Korea object? Let the Russians handle the North Koreans. Good luck.

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