« Back to Menu

Corridors of power

­­When Xi Jinping made his first trip to Pakistan last year, his hosts celebrated their friendship as being higher than mountains, deeper than oceans, sweeter than honey, and stronger than steel.

Wang Yi, China’s Foreign Minister, couldn’t resist a rhetorical flourish of his own in outlining Pakistan’s importance for the Belt and Road policy.

“If One Belt, One Road is like a symphony involving and benefiting every country, then the construction of the China-Pakistan Economic Corridor is the sweet melody of the symphony’s first movement,” he proclaimed.

Pakistan has been one of the pioneers for the plan since signing for $46 billion of energy and transport projects in a corridor linking Kashgar in western China with Gwadar in Pakistan’s western province of Balochistan.

The first phase of investment focuses on the deepwater port at Gwadar (close to the Strait of Hormuz, a key shipping lane for oil). Dam construction has kicked off with the Karot hydropower plant, where China’s Three Gorges Corporation started work in January, and roads, railways and pipelines are being planned northwards towards the Chinese border.

$46 billion

The investment currently committed for the
China-Pakistan Economic Corridor

The headline commitments are about three times the total overseas investment that Pakistan had received in almost a decade, with three-quarters of the funding coming directly from the Chinese firms and most of the remainder in soft loans to Pakistan’s government. Belt and Road looks like an unprecedented opportunity – the power projects will double Pakistan’s energy capacity and the new roads and ports will boost its economy.

 

Corridor or cul-de-sac?

The political realities in Pakistan highlight some of the challenges for Belt and Road in less predictable parts of the world.

For a start, there is tension with India at the northern end of the corridor, because the route passes through territory that New Delhi claims as its own.

Indian diplomats have told Chinese counterparts that they “resolutely oppose” the China-Pakistan Economic Corridor because it runs through the disputed area and Pakistan’s army chief has openly accused India of trying to sabotage the plan.

There’s also unrest in the corridor’s southern tip in Balochistan, where separatists and Islamic militants have been confronting the Pakistani state for years. In August another bomb blast in Quetta, the Baloch capital, killed 95 people.

Pakistan-Corridor

magnifying glass

Pakistan has put together a special force in response to Chinese concerns about security, with a report to parliament in September suggesting that the protection squad is providing two troops for every Chinese worker.

Tracking the progress of all the investment in the corridor – where the money is going, and when construction is going to be completed – is another challenge. Even the governor of Pakistan’s central bank has been confused about the financing for the plan, complaining that he didn’t know “how much is debt, how much is equity and how much is in kind”, and the uncertainty makes it harder to forecast the long-term economic benefits for the host country.

Additionally, there have been arguments about how the corridor should be routed inside Pakistan, with rival claims from different parts of the country. Critics from poorer regions say the government of Nawaz Sharif is steering too much of the investment towards his home province of Punjab. On the other hand, some Baloch leaders have campaigned against the corridor, because they fear an influx of workers from other parts of the country.

The homegrown tensions have led to reports that the Chinese are getting frustrated at the progress of construction in the corridor and the media drew attention to a case this summer in which a Chinese firm had waited for months for news on its bid to build a $2 billion gas terminal in Gwadar.

Seemingly, officials were sitting on the application because they didn’t have the funds to meet Pakistan’s small share of the financing.

The story was denied but the rumours have been robust enough for China’s ambassador to put out a statement that it is “satisfied with the smooth implementation on the corridor”.

They have even prompted claims that the Chinese have asked for a greater role for Pakistan’s army in delivering the projects, in hope that the military will move things forward more quickly. Sharif and his allies won’t want to give up control, however, because they are basing much of their re-election campaign around the investment, including a commitment to put a stop to Pakistan’s power blackouts.

 

The power broker

China’s energy investment in Pakistan is at an early phase. Pipeline politics are more advanced in landlocked Central Asia, which is already delivering oil and gas directly to the Chinese market. Turkmenistan is the main gas exporter through the Central Asia-China Gas Pipeline, which supports a fifth of China’s natural gas consumption. Uzbekistan also supplies gas through the network, cementing its energy ties with a $15 billion energy deal with China in 2013. And hundreds of Chinese companies are active in Kazakhstan, controlling about a fifth of oil production, with stakes in a series of fields, including the gigantic Kashagan project in the Caspian Sea. The Chinese have built one of the world’s longest oil pipelines running from the Caspian to Xinjiang too.

“Our philosophy is simple: we should get on board that train… we want to benefit from the growth of China and we don’t see any risks to us in that growth,” explained Erlan Idrissov, the Kazakh foreign minister.

20 million

Maximum throughput, in tonnes, annually for the Kazakhstan-China oil pipeline. The conduit is yet to reach full capacity

When the first pipeline from the oil fields to Xinjiang was announced more than a decade ago there was scepticism that it would pay its way. Today, the 20 million tonne conduit is still six million tonnes short of its annual capacity, although it should start to transport oil from the giant Kashagan field when it begins production in November.

China had originally turned its attention to Kazakhstan after the Russians reneged on a commitment for a larger oil contract and the situation was similar for the first gas pipeline, when talks to deliver Siberian gas were delayed for years by squabbling in Moscow.

The Chinese simply ran out of patience: China National Petroleum Corporation (CNPC) bought a concession in Turkmenistan and announced plans to ship the gas home through Uzbekistan and Kazakhstan. The project was completed in 18 months, the fastest ever for a pipeline of its size.

These initial gas and oil pipelines preceded the formal launch of Belt and Road, although Chinese energy firms have upped their investments in Central Asia’s energy resources since Xi Jinping’s landmark tour in 2013, when tens of billions of dollars of new deals were signed.

Analysts say that Chinese readiness to pre-invest in projects like these is crucrucial, because the economics are often marginal, deterring interest from other parties. Complicated cross-border deals also need a driving force to bring together the parties and hammer out the compromises required for the plan to progress from theory into action. CNPC has often taken on the leadership role, buying stakes in upstream oil and gas projects, and coordinating the investment in the pipelines that deliver the supply.

Of course, CNPC also brings a market for gas, through its listed arm PetroChina, which owns the majority of the domestic transmission network in China. Advocates for natural gas say that a shift away from dirty coal is going to have a dramatic impact on demand and Zhao Zhongxun, deputy director of CNPC’s planning department, told the media this year that it expects sales of more than 750 billion cubic metres of the fuel between now and 2020, a 40% increase on the past five years.

 

Network effect

Commercial critics of the pipeline projects say that geopolitics are playing more of a role than economics and that the Chinese aren’t as focused on the rates of return on the projects themselves. And clearly, the investment in energy has wider strategic importance. Beijing’s planners want a supply chain with more producers, as well as a variety of transport options that reduce their vulnerability to the worst choke points on the trading map.

For instance, another country that is newly connected to China’s energy grid is Myanmar, following the completion of two pipelines (one for oil, one for gas) between terminals on the Indian Ocean coast and Yunnan province. The Burmese get transit fees and a share of the gas for domestic consumption. For the Chinese, it’s a chance to bring a portion of their energy on a shorter overland route, rather than the fuller journey by sea.

80%

The Pentagon’s estimate of the share of China’s seaborne oil imports that pass through the Strait of Malacca

Last year the Pentagon estimated that China had imported about half of its oil from the Middle East in 2013, with 43% of the supply passing through the Strait of Hormuz. Transport through the Strait of Malacca was even more concentrated, with more than 80% of imports of seaborne oil and 30% of seaborne gas navigating the narrow channel between Indonesia and Malaysia.

In this context, the bigger picture may take precedence over the profitability of some of the individual deals in Belt and Road, and China’s state-owned enterprises will bear some of the financial pain of supporting the wider strategy. On the other hand, the state firms have tremendous leverage of their own when they negotiate terms with their international partners, bringing much-needed finance to get the projects started, and the promise of final demand in China.

Recent dealings with the Russians on another new pipeline tell a similar story. Moscow has tried to counter Beijing’s push into Central Asia by promoting trade integration with its former allies. But the plan has struggled for traction because the Russians lack China’s financial firepower and Gazprom turned back to CNPC as a partner for another massive contract for gas from the Russian Far East. The Power of Siberia production-and-pipeline deal – originally said to be worth as much as $400 billion over a multi-year contract – is supposed to be operational by 2019, although Gazprom is said to be trimming back spending and slowing down construction. In part that’s because the long-term earnings look like being less than Moscow hoped, especially if energy prices continue to trade below their peaks. Demand for gas has lost a little steam in the Chinese market in the last two years as well, because of the slowing of the wider economy.

But another factor in the slowdown is that China now has choices of gas provider, including the pipelines from Central Asia. The price projections for the Siberian gas put it substantially above the contract costs for gas from Turkmenistan, Reuters has reported, which is putting pressure on the financial forecasts. That looks likely to delay the Power of Siberia’s launch, especially while growth in demand for gas is more muted in China. But in an indirect sense, the lower prices are a function of more diverse supply as well, which is an important part of Belt and Road’s long-term rationale.


© ChinTell Ltd. All rights reserved.

Exclusively sponsored by HSBC.

The Week in China website and the weekly magazine publications are owned and maintained by ChinTell Limited, Hong Kong. Neither HSBC nor any member of the HSBC group of companies ("HSBC") endorses the contents and/or is involved in selecting, creating or editing the contents of the Week in China website or the Week in China magazine. The views expressed in these publications are solely the views of ChinTell Limited and do not necessarily reflect the views or investment ideas of HSBC. No responsibility will therefore be assumed by HSBC for the contents of these publications or for the errors or omissions therein.