Tag Archive | "gas pipeline"

Will Gasoline Prices Shake Pyongyang?

By William Brown

Maybe not, given the still small use of cars in North Korea, but last week’s momentary doubling of prices at Pyongyang service stations, according to Daily NK reporting, on rumors China would cut off crude oil supplies in the event of a nuclear test, should have caught the attention of Kim Jong-un and his economic and security advisors.  Diesel prices, apparently, behaved similarly.  Prices had given up about half their gains by the end of the week amid no indications of either a nuclear test or an actual crude cutoff.  Still, more than any other sanction imposed on the country, a cutoff of Chinese crude oil, translated into price hikes, angry customers, and slashed revenues, would cause big problems for Kim Jong-un as he pursues his byongjin linethe so far successful parallel development of the country’s nuclear and economic strength.

China Exports to NK

Looking forward, the price volatility suggests the North Korean landmass might not be the only thing shaking following its next nuclear test, and opens new avenues for affecting change in North Korean society.  With widespread markets for commodities and services, and prices that apparently adjust to changes in supply and demand conditions, North Korea is in a far different place than either of Kim’s two predecessors could have imagined; more prosperous and productive, but also much more vulnerable.  Speculation, driven even by rumors, could see a resumption of destabilizing inflation, a plunge in the value of the won, and trouble for the government reminiscent of the botched currency revaluation in 2009, as Kim was getting ready to take power.  Kim seemed to have learned important lessons from that episode, and has managed to get a grip on inflation and currency devaluation, probably by allowing productivity enhancing market activities to continuously expand.  But as a reminder of how little we know about the government’s ability to control markets, the volatility in gasoline and diesel prices stand in perplexing contrast to relative stability following China’s announced cuts in coal purchases just a month earlier, and the loss by now of about $1 million a day in national income.  One would have thought this would spur traders to dump won and buy dollars but this, apparently, has not happened. At least according to the same Daily NK reporting.

China Exports to NK Graph 2

Tinkering with North Korea’s crude oil supply, and the income it provides, would be of far greater importance than the coal shutoff and would be treated very cautiously by Beijing.  In a possible trial balloon in late April, Beijing allowed the first-ever hints of halt to its free delivery of about 50,000 tons of crude oil per month (valued at about $20 million at current Chinese export prices) if Pyongyang continues to test its nuclear weaponry, thus threatening to topple a longstanding pillar of the Mao Tse Tung – Kim Il Sung “lips and teeth” relationship.

Since the collapse of the Soviet Union, China has stood by North Korea, providing all the crude oil that the country refines and uses, in a small rail and pipeline served by a Chinese-built refinery across the border from Dandong in North Korea’s northwest, not far, ironically from the satellite launch site. The Soviets provided crude oil to a similar refinery just inside the northeast border, supplied by ship, but this has gone largely unused since trade collapsed in the early 1990s. Much smaller amounts of petroleum products are imported, again mostly from China but, aside from an annual gift to help with agriculture, these imports are probably on commercial terms.  There are no hints that these product shipments would be subject to a Chinese boycott and, since they are profit driven, they would likely continue and even expand.

Chinese authorities have long been sensitive about the crude shipments, telling foreign academics and officials that this is a national security issue and thus any discussion is off the table.  China was a net crude oil exporter when the presumed aid agreement was signed and oil flowed freely from the newly found Daqing oil field in Heilongjiang. But now China is a huge oil importer, and the supergiant oilfield is in decline, so the oil it gives North Korea is the same as if it were imported, and paid for by taxes on Chinese people, something Beijing probably does not want to advertise.  And, by now, the uncollectable North Korean debt on this deal must have accumulated to tens of billions of dollars.  Curiously, in 2014, Chinese Customs authorities stopped recording the crude exports even though sources indicate the oil continues to flow as normal. Placing the data off the books may have been meant as a warning that the supply is not endless and that Pyongyang needs to earn its way, or at least stop creating international tensions.  These new warnings, however, are more direct and open to the public, guaranteed to add to the Chinese public’s musings over support to Kim Jong-un.

Though rich in coal and hydropower energy resources, and uranium, North Korea has no oil or gas resources and is entirely dependent on outside sources for transportation fuels. It has been adept at using its coal for petrochemical and fertilizer purposes, and much of the rail system is electrified, though in poor condition.  With liberalized markets, demand for taxi, truck, and bus transportation has exploded in recent years, but is highly sensitive to price hikes and supply disruptions.  In fact, the markets probably could not survive without gasoline and diesel-fueled transportation and agriculture would be severely harmed.

The rumors began when the unofficial English language affiliate of People’s Daily, Global Times, included an editorial on April 12 suggesting China might go along with new UNSC sanctions and cut crude supplies if North Korea tested a nuclear weapon[i].  This was followed on April 21 when a leading academic, and an authority on the subject, told a Japanese newspaper that China should consider such a cutoff.  Soon thereafter, gasoline supplies in Pyongyang appeared to have been restricted and prices jumped from an average of 8,400 to 9,600 won per kilogram (about $3.00 a gallon at the unofficial but widely used exchange rate) to 17,625 won ($6.10) on 27 April, before falling back to 14,800 ($5.20) by  May2, according to Daily NK. Diesel prices rose even more, from 4,720 to 17,150 won per kilogram. Although these prices seem high for a country as poor as North Korea, the market productivity engendered by a truck or a taxi, compared to a bicycle, is enormous and thus well worth the expenditure. Moreover, with no state subsidies, the prices must be higher than in neighboring China to induce the imports. No official statements confirm that China is willing to halt the oil shipments, and the price jumps might engender more concerns in Beijing, as well as Pyongyang, over potential instability.

Gasoline has long been dealt with inside the communist state’s fixed price system and thus transferred only by ration or through the central planning mechanism.  Private use was strictly not allowed.  But in recent years, as markets have sprung up for other products, gasoline has come to be sold at market prices, first by military or other government organizations which apparently have needed the cash—often U.S. dollars or Chinese yuan—and now, during the Kim Jong-un era, in relatively normal gasoline stations sponsored by several government and military government organizations which apparently are drawing on their state plan allocations or they are able to purchase products in China, sell them in North Korea, and make a profit.  This has allowed a rapid increase in private automobile traffic, including many taxis and commercial delivery vehicles and some private automobiles. As compared to when all such transportation was by bicycle or bus, the gasoline use has spawned a huge rise in productivity and marketization. Whereas this commercialization has given a substantial boost to the otherwise still moribund, and sanction laden, general economy, security officials, and communist ideologs, must feel threatened.

Information is sketchy about where the gasoline comes from and how the private sector or the government organs earn the hard currency needed to import it. Chinese trade data shows a steady increase in gasoline shipments to North Korea, recently eclipsing a slow rise in diesel and other middle distillates imports.  But these are still much lower than the crude oil shipments and, presumably, much of the gasoline now comes to the market via unsanctioned transfers from the refinery.  This makes sense since North Korean state enterprises that receive their rations from the refinery are hard pressed to come up with the increasing amounts of money needed to purchase goods and services in the markets, and thus they must be tempted to sell, rather than consume, their planned oil allocations.  This, of course, creates havoc for the planning system which seems to have largely broken down.

China would have several options should it want to use oil to penalize Pyongyang for a nuclear test.  A short-term halt in crude oil shipments, a permanent end to the credit arrangement forcing Pyongyang to pay for the imports, or a cutoff of all crude and product shipments. Each would have different impacts and Beijing would likely try to decide which would have the most desired impact—deterring the nuclear program while not leading to instability. One way to do that would be to end the credit arrangement but, since it has become such a valued and important commodity, continue to allow or even induce more private trade in petroleum products. North Korea buyers would have to come up with more hard currency and would try to do this by increasing their private exports, so trade might even expand to the advantage of the Chinese and to the North Korean private sector.  The impact on the North Korean government, on the other hand, would be severe as it would not only have to pay hard currency for its own considerable use of petroleum, but would also no longer be able to earn hard currency from its domestic sales.

Pyongyang, of course, could react by closing off private sales and use valuable hard currency to import petroleum for its own use.  It would likely try but have a hard time finding a foreign supplier for the old Soviet refinery, which can be served by ocean tanker, perhaps in return for some of the plant’s output.  Cutting private sales might be necessary, but it would go against the grain of Kim Jong-un’s policies to date.  Whatever can be said about his stubbornness in pursing nuclear weapons, and in terrorizing his subordinates with selective executions, Kim has generally made good on his promise to push forward economic development.  He inherited an economy with hyperinflation and a disintegrating domestic currency, but by allowing productivity enhancing markets to expand he has been able to control inflation and the won, at least for the moment  All of this would likely be lost, however, should Chinese crude oil deliveries suddenly stop.  In this context, even if short lived, the jump in gasoline prices must be enough to give him and his advisors pause over when to undertake the next nuclear test.

William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service and a Non-Resident Fellow at the Korea Economic Institute of America. He is retired from the federal government. The views expressed here are the author’s alone.

Photo from Joseph’s photostream on flickr Creative Commons.

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All Eyes on Chinese Trade with North Korea, But There is a Problem

By William Brown

China surprised many Washington pundits by signing on in February to what looks like fairly tough trade sanctions on North Korea.  Most importantly, it agreed to put a halt to its purchases of coal and metal ores to the extent that these provide foreign exchange to North Korea’s military and to the nuclear and missile programs. The move is significant because anthracite coal exports have long been a staple in Pyongyang’s export mix, earning over $1 billion last year in sales to China, and much of these seem to be managed by North Korean military units.  Other specific prohibitions include Chinese sales of aviation fuel to North Korea, the rationale presumably that all but the smallest North Korean rockets are propelled by a kerosene type fuel imported largely from China or produced domestically using crude oil provided by China.  There are lots of loopholes, so all eyes should be on China in the next few months to see if it is meeting the spirit, if not the often ambiguous letters, of these sanctions.  As China says, they are not supposed to hurt the livelihood of people, instead aimed simply at convincing Pyongyang to change course on nuclear weapons, or at least come to table to discuss them.

So what should analysts be looking at?  China’s Customs Bureau publishes extensive and timely export and import data on its trade with North Korea and this will be the first line in understanding Chinese actions and intentions. But right at the outset there is a big problem. As figure one shows, this official Chinese reporting stream shows a complete halt to Chinese crude oil exports beginning in January 2014 and lasting at least through February 2016. March data will become available in a few weeks.  Objective analysis shows clearly that China did not cut off crude exports in 2014 and these numbers are, to put it politely, misleading.

China Crude Oil Exports

Beijing has provided no explanation for zeroing out reported crude shipments, despite media reports that show they continue as they have for decades.  North Korea Daily reporters, for example, have visited the transshipment site on the Chinese side of the border where officials told them crude continues to flow as normal.  Commercial imagery also shows the refinery is working and there are no other reasonable sources for the crude feedstock.  The crude, about 50,000 tons a month, probably originates in the big Daqing oilfield in Heilongjiang province and travels across the border through a short, 11-mile pipeline, to Ponghua, the country’s only continuously operational refinery.  In past years there was an occasional month or two in which no crude was reported but these were always followed by double shipments in later months.  The refinery has no seaport although there is a rail connection.  North Korea has one other very old refinery, near the Russian border, which is served by a port facility, but it operates rarely with no dedicated source of crude.   So if the Chinese data is accurate, North Korea has had no crude oil supply for over two years and has been depending entirely on very modest imports of petroleum products to fuel its entire economy.  Clearly this is not the case so there must be something awry with the data.  Beijing chooses not to explain this situation and U.S. and other foreign officials, for some reason, have not asked for an explanation, at least not one they have openly reported.  In my view this is enough of a problem to question the validity of all Chinese trade with North Korea and thus to question whatever new data shows up in March and April.

Without what would seem to be an easy Chinese explanation, we are left to speculate.  A likely hint is provided by a similar occasion in 2009 when Chinese Customs suddenly stopped reporting its usual detailed monthly trade data for North Korea.  The data break lasted for four months, August through November, and was never, in my understanding, explained to users of the Chinese data.

China Merchandise Exports to North Korea 2009  

With some effort one can figure out, however, that all of this data–detailed 8-digit Harmonized Code commodity information on exports and imports, volume and value, and prices–were tucked into a rarely used partner category “Other Asia, Not Elsewhere Specified” so that the data was never actually lost or misreported.  In December figures in that category dropped back to near zero and all of the detailed commodity data showed up again as Chinese trade with North Korea. (The above graphic only shows the aggregate but details tell the same story.)

China Exports to Other Asia 2009

Although not conducive to building confidence in Chinese statistical methods, this procedure at least did not distort China’s overall trade with the world.  A Chinese official whom I queried said simply that Pyongyang probably complained that China was revealing state secrets in reporting the bilateral data so for a few months Beijing acquiesced.  Later, and after I asked the question, the Chinese must have thought better of it and again publish the data with North Korea as the trade partner.

I have searched at length to find another place in the Chinese data where the crude oil shipments to North Korea now could be hidden in the same way and perhaps for a similar diplomatic reason, but cannot find it. China is a net importer of crude oil but it exports occasionally to Japan and other countries. The country’s total crude oil exports are now apparently distorted by the absence of the North Korea data.  Does this omission also reduce China’s overall commodity export figure, or even its GDP calculation?  At about $150 million a quarter, this would have only a tiny 0.1 percent negative impact on quarterly GDP, but again why would Beijing mess up its data in this way.

Analysts speculate that China may have suddenly put the trade “off books” or that they now account for it as an aid shipment.  But either clearly would distort Chinese data in ways that should bring more skeptical attention to its entire economic data reporting scheme.  After all, if a political decision can alter data with North Korea, why can’t balance of payments or GDP numbers be similarly distorted by the whims of the politburo?  The crude oil has most likely always been an aid shipment—an (eternal) gift from the people of China to the DPRK as offered by Chairman Mao in the 1960s—but that doesn’t mean it should not be accounted as an export. Proper double entry accounting means it should be an export commodity in the trade account offset by a negative in the remittances line in the current account, or, if the commodity is paid for by a long-term zero or low interest loan, it should be offset by a negative (outflow) in the capital account.  Presumably, China’s National Bureau of Statistics, overseer of Chinese national accounts data, is making this adjustment; that is, it is making a change to the foreign aid or the external credit line, but this would mean it is probably distorting information on Chinese foreign aid and national oil production and consumption, needlessly confusing users of its data by such “off-books” accounting.

The only legitimate reason for excluding Chinese crude oil shipments from its Customs data that I can think of would be if China had changed its pattern and is now transshipping third party crude oil to North Korea, possible since China is a large net oil importer anyway.  But given there is no port facility at Ponghua, this would lead to the seemingly absurd situation where the imported crude would have to travel inland to the transfer facility and then onward to North Korea.  And again, if this is the case, why not announce it?

The aviation fuel issue is interesting as well but the sanction here is less than meets the eye. China exports a variety of petroleum products to North Korea, probably mostly on commercial rather than long-term aid program terms, and in low volumes compared to the crude oil.  These alternate between gasoline, light diesel, and kerosene or “jet fuel” products.  A significant volume of jet fuel is reported to have been provided in 2014 but essentially none since then, while shipments of diesel and gasoline have increased.  But clearly this is not all of North Korea’s aviation fuel requirement.  Jet fuel or aviation gasoline can easily be produced from the crude oil provided to the Ponghua refinery so more diesel imports mean the refinery can shift from diesel production to jet fuel production.

These data issues are not meant to question China’s North Korea policy.  I for one think China has acted fairly reasonably with its troublesome neighbor and long-time ally. We do not give it much credit, for example, for not shipping military equipment to Pyongyang for more two decades, watching Pyongyang’s stock of everything from jet fighters, to radar systems, to ground equipment deteriorate and fall into obsolesce.  If we are not careful, China could do a lot to make Pyongyang happy, for example in air defense, that would upset our military posture in South Korea.  Moreover, its trade with North Korea is nearly balanced–aside from the crude oil and assuming we can trust the rest of the data–suggesting it is providing little aid or investment credit.  And to the extent that China-North Korea trade is doing fairly well, it is in product lines that seem to be helping a market economy develop in North Korea, such as textiles.  But without public explanation of the crude oil shipments, or better, a return to full reporting of these shipments, confidence in Beijing’s North Korea policy and indeed the transparency of all its economic data will be lacking.  And whether or not Pyongyang thinks it is a state secret, China’s public deserves to know what it is giving to North Korea.

So, if the data for March and April on Chinese coal and ore imports from North Korea suddenly turn to zero, will we trust that is indeed the case?

William Brown is an Adjunct Professor at the Georgetown University School of Foreign Service and a Non-Resident Fellow at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Joseph’s photostream on flickr Creative Commons.

 

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North Korea Looking Abroad

By Matthew Nitkoski

Nearly six years ago, the last attempt at multilateral engagement with the Democratic People’s Republic of Korea ended with the secretive Kim regime vowing to continue its uranium enrichment program. In the intervening years, neither allies nor enemies have been able to convince Pyongyang to halt its nuclear efforts and the fragile North Korean economy has continued to face debilitating sanctions. Unwilling to reverse course on its military program, the isolated Kim regime has begun reconsidering its foreign policy position and has made new attempts to increase trade and investment with its Asian neighbors.

North Korea’s desire to find new trading partners is partially spurred by its deteriorating relationship with China. Xi Jinping has yet to meet with Kim Jong-un, but has already had several high-profile meetings with South Korean President Park Geun-hye. Already strained diplomatic relations between Pyongyang and Beijing have been further weakened by a series of high-profile murders by North Koreans sneaking across China’s border. These grisly events have given Chinese citizens pause when considering their relationship with Kim’s regime. Recent internet commentary reflects the country’s worsening opinion and the ongoing debate in Chinese society over support for North Korea.

For its part, the Chinese Communist Party is weary of supporting a regime that gladly receives food and economic assistance, but is unwilling to accept diplomatic advice. With Chinese imports accounting for around 60% of the nation’s food and energy, Kim Jong-un is also eager to reduce his dependence on Beijing. With Beijing pursuing improved relations with Seoul over issues as diverse as trade policy and cybersecurity, Pyongyang has sent out a number of diplomatic missions to garner economic support as it reforms itself and seeks self-sufficiency.

The Kim regime has primarily focused on improving trade relations with Russia, and both Moscow and Pyongyang have taken positive steps towards enhancing their economic ties. Although Russia is suffering its own economic woes due to sanctions and a collapsing currency, Moscow has made a serious effort to signal its intentions. In 2014, Russia finalized the cancelation of $10 billion of North Korea’s $11 billion debt that had accrued during the Soviet Era. The Kremlin expects that this gesture of goodwill will facilitate the construction of a gas pipeline covering the Korean peninsula, but also acknowledges that North Korea could contain profitable investments opportunities.

Moscow is continuing its efforts to improve ties with Pyongyang and, last week, the Russian Chamber of Commerce created the Council for Cooperation with North Korea. Established with the ambitious goal of doubling trade figures to $2 billion by 2020, the Council indicates that both Moscow and Pyongyang are serious about developing cohesive economic ties. Kim Jong-un has responded positively to these advancement and is rumored to be considering a trip to Russia to attend ceremonies marking the 70th anniversary of the end of the World War II. This high level diplomatic visit would serve as a capstone to a period of increasingly friendly relations between the two countries.

North Korea has also recently made attempts to engage various Southeast Asian countries in an attempt to diversify its economic relations. In August of 2014, North Korean Foreign Minister Ri Su-yong visited Laos, Vietnam, Myanmar, Indonesia, and Singapore and, while his official itinerary and talking points remain secret, many view this as an overt attempt to strengthen economic ties. Last month, Pyongyang reiterated its interest in the fast-growing region by sending Vice Foreign Minister Ri Kil-song to seven Southeast Asian countries. These renewed attempts at economic cooperation coupled with plan to develop 13 special economic zones signal North Korea’s willingness to experiment with reform and become more self-reliant in the face of souring relations with China.

The recent round of missile tests are a clear signal that Kim Jong-un will maintain his hawkish military stance. With renewed six-party talks predicated on North Korea’s nuclear disarmament, Pyongyang is seeking ways to circumvent the long-standing economic sanctions by strengthening economic ties with its Asian neighbors. Kim Jong-un is wary of any foreign interference in domestic affairs, and his moves to diversify the North Korean economy are clear attempts to reduce his country’s reliance on Beijing. The recent statement by Daniel Russel, the Assistant Secretary of State for East Asian and Pacific Affairs, could act as encouragement for Kim Jong-un as he balances reform with firm party control.

Last week, Assistant Secretary Russel advised that, “A change in North Korea does not need to be a regime change as the example of Burma shows.” Kim Jong-un clearly understands the unique challenges he will face as the leader of North Korea, and these recent attempts at engaging the international community signal his intent to develop the state economy. While it seems unlikely that the regime will suddenly revise its status quo, these political overtures are clear indications of North Korea’s attempt to stake out its own claims for economic opportunity and solidify its political independence.

Matthew Nitkoski is a MA candidate in International Affairs at the Elliot School for International Affairs at George Washington University and an intern at the Korea Economic Institute of America. The views expressed here are the author’s alone.

Photo from Adam Barker’s photostream on flickr Creative Commons.

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Overcoming North Korea to Build a Eurasian Economic Space

By Troy Stangarone

At a recent international conference in Seoul, South Korean President Park Geun-hye called for a “Eurasia Initiative” to link Europe and Asia via trade, transit, and energy.  However, achieving President Park’s vision will require developing a means of integrating North Korea into the broader Eurasian framework and mitigating the risk of Pyongyang arbitrarily shutting down energy and transit links as it did this past summer with the Kaesong Industrial Complex.

Under President Park’s proposal, Eurasia would become one economic space linked together by rail and road links from Busan to Europe that would carry goods and resources, such as energy, from producers to consumers while tying together the infrastructure needed for electricity, gas, and oil. Trade barriers would be gradually taken down by linking together free trade agreements such as the Trans-Pacific Partnership, the Regional Comprehensive Economic Partnership, and the Korea-China-Japan FTA. Together, these efforts would link South Korea to the rest of Eurasia in a way that has not existed for more than six decades.

Since the end of the Korean War, South Korea has been cut off from parts of Eurasia by ideology and territory. During the Cold War, South Korea, like much of the West, had limited economic ties with the Soviet Bloc and the scars from the Korean War meant that South Korea was formally cut off from China until 1992. Today, South Korea exists as a virtual island, physically cut off from Eurasia by North Korea. As a result, even as trade has boomed with China and other nations, for physical goods it must take place via either air or sea rather across land routes.

The biggest advantage of transcontinental rail links for South Korea is greater connectivity to China. While the connections would allow South Korea to drastically cut the transit times for goods to Europe from 45 days by ship to 14 days by rail, the cost of shipping via rail means transcontinental shipments are likely to be more of a niche delivery system for the foreseeable future. However, because China is South Korea’s largest trading partner and much of the trade between South Korea and China consists of parts to be assembled for other markets, increased access into China could yield significant gains for South Korean producers.

Creating a true transcontinental railroad, however, requires South Korea to be able to ship across North Korea into the rail systems in Russia or China. South Korea previously worked to reconnect the Gyeongui line , which once linked Seoul and Pyongyang, to ship goods between the South and its factories in Kaesong with the goal of eventually shipping them north through China or Russia to other markets. Despite having tested the track, a short period of freight shipments came to an end in 2008. On the northern end, Russia recently completed a link at the port in Rajin that will give rail in North Korea, and potentially South Korea, access to the Trans-Siberian Railway. However, significant investment will likely be needed in upgrading infrastructure in North Korea to make this a reality.

Additional access to Northeast Asia over land would also help to address South Korea’s energy needs. Without natural endowments of gas or oil, South Korea is dependent on energy imports to power its economy. However, despite being the world’s second largest importer of liquefied natural gas (LNG), South Korea pays some of the highest prices for LNG in the world. Integrating energy resources across Eurasia would allow it to tap into Russia’s vast supplies of natural gas.

The idea of a pipeline to export Russian natural gas seemed like a potential reality only a few years ago. In 2011, the first steps were taken, including a preliminary contract between Gazprom, Russia’s state controlled gas company, and Kogas, Gazprom’s South Korean counterpart. Crucially, the project also had the support of Kim Jong-il, as it would have provided North Korea with lucrative transit fees.

However, political risk from North Korea may not be the only obstacle to the project. In the time since the original agreement was reached, the commercial logic may be beginning to change. Innovations in shale gas exploration have begun to change global energy markets with the United States set to become a net exporter of energy and one of the world’s largest sources of LNG. At the moment, gas from Russia would potentially reduce costs for South Korea, who current plays a little more than twice what Europe pays for LNG. If South Korea’s contract with Russia were for the same price Europe pays, it could realize significant savings.

However, it is unclear how long South Korea would be able to realize these savings. Russia has historically sought to tie its price for gas to the price for oil, unlike countries such as Norway which charge based on spot prices. In Europe, which accounts for 70 percent of Russia’s gas exports, the current pricing structuring is beginning to make Russian gas less competitive on European markets. If the changes in the U.S. industry and other markets produce a unified market for gas prices, which does not exist currently, South Korea could be tied into higher prices in the long run if it is unable to strike a deal with Russia that includes spot prices. Additionally, South Korea may be able to secure LNG from the United States for competitive prices without the political risk a pipeline through North Korea could entail.

Ultimately, notwithstanding concerns over cost, it is political risk that will hold back either of these projects. As the shutdown of the Kaesong Industrial Complex demonstrated earlier this year, North Korea is willing to shut down projects for non-commercial reasons despite the potential economic costs it would incur.

For the gas pipeline, the political risk is likely manageable. In its preliminary deal with Russia in 2011, assurances were given that if North Korea cut off the pipeline the gas would be delivered via tankers. If structured this way, North Korea would ultimately only hurt itself through lost revenue. Though, self-insurance in the form of adequate LNG reserves to tide South Korea over until the switch to tankers could be made would likely be needed to remove the temptation from Pyongyang.

In terms of rail access, managing the political risks might be more difficult. Shutting down the flow of goods into or out of South Korea may be more tempting for Pyongyang during a crisis. However, as much of the rail will likely supply factories in China, it may well raise the cost of North Korea closing rail or road access north by incurring China’s displeasure as well.

While both of these projects could benefit South Korea and deepen its economic ties to its neighbors, they will require a sustained building of trust between North Korea and its immediate neighbors to be realized.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his alone.

Photo from Visionstyler press’ photostream on flickr Creative Commons.

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What Happens to the North Korea Pipeline Now?

By Troy Stangarone

Nutritional aid might not be the only cost of North Korea’s recent failed satellite launch.  Only a few months prior to Kim Jong-il’s death there had been significant discussion of building a pipeline to transmit Russian gas through North Korea to the South. North Korea had indicated that it would be willing to take part in the project and South Korean President Lee Myung-bak had agreed to work closely with Russian President Dmitry Medvedev to push the project forward. Now, only a few months into the new regime under Kim Jong-un there are real questions if the project is viable.

On the surface, the pipeline made sense for all parties involved at the time and Kim Jong-un had indicated his support for the project in April. The Russian Far East is rich in natural resources, including natural gas, and tapping the South Korean market would allow Russia to diversify its exports away from European markets and place pressure on China in their stalled gas talks. For South Korea, which is dependent on imports for its energy needs, the pipeline promises a supply of natural gas potentially 30 percent below what it currently pays. For North Korea, which is seeking to prop up its economy the project presents the prospect of a significant infusion of hard currency from the estimated $100 million dollars in annual transit fees the pipeline would provide. Everyone would seem to have something to gain.

Under Kim Jong-il, one could have been fairly confident that the political risk surrounding the project could be managed based on the experience of the Kaesong Industrial Complex. While Pyongyang has sought raises for workers beyond the contractual agreement between North and South Korea in the complex, it has also refrained from interfering in the complex’s operations during periods of heightened tensions between the two sides.

Russia and South Korea in their talks in the fall had also taken steps to try to disincentivize North Korea from interfering in the pipeline. Russia would be responsible for the transit fees, and has indicated that it’s willing to structure the contract so that it is responsible for delivering the gas to South Korea if Pyongyang were to interfere with the pipeline. Additionally, South Korea has proposed running the pipeline to Seoul before it cuts back up to Pyongyang, meaning North Korea would cut off its own gas supply if it were to interfere with the pipeline. These steps would take away potential leverage that North Korea would gain from the pipeline, but still leave the possibility that Pyongyang could try to tap the pipeline upstream for its own uses. The project had been promising enough that Gazprom and Kogas held talks as recently as April 9 to discuss the commercial parameters of the project.

However, with North Korea having defied international consensus to conduct its satellite launch, made suggestions that it will turn parts of  Seoul to “ashes”, and a third nuclear test in the offing it would only seem prudent for all of the parties involved to reassess their positions in the project. Even if the rhetoric coming out of Pyongyang is dismissed as par for the course, the prospect of a significant financial return for the regime from the pipeline has not tempered the regime’s actions. At the very least it would seem there is a significant prospect of the project being delayed. After the missile launch the United Nations Security Council statement stated that “If North Korea chooses to again defy the international community, then the Council has expressed its determination to take action accordingly.” Pushing forward with the pipeline project in this environment could send both the wrong message to the new regime in Pyongyang and lead to the unfortunate appearance of providing the new regime with a significant cash infusion at a time when it has taken multiple actions condemned by the international community.

Troy Stangarone is the Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.

Photo from Leftik’s photo stream on flickr Creative Commons.

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What Putin’s Return Means for Russia and the Korean Peninsula

By Dr. Richard Weitz

During his campaign for the Russian presidency, Vladimir Putin wrote several lengthy articles detailing his views and policy recommendations. In his foreign policy treatise, Putin devoted a surprising amount of attention to North Korea.

Putin writes that, “We have consistently advocated the denuclearization of the Korean Peninsula – exclusively through political and diplomatic means — and the early resumption of Six-Party Talks.” At the same time, Putin says that. “I am convinced that today it is essential to be particularly careful. It would be inadvisable to try and test the strength of the new North Korean leader and provoke a rash countermeasure.

“In coming years, “We will continue conducting an active dialogue with the leaders of North Korea and developing good-neighborly relations with it, while at the same time trying to encourage Pyongyang to settle the nuclear issue. Obviously,” Putin adds, “it would be easier to do this if mutual trust is built up and the inter-Korean dialogue resumes on the peninsula.”

In some ways Moscow is well-situated to serve as a key mediator in international efforts to resolve the disputes between North Korea and South Korea. Not only does it have good relations with both Koreas, but Russian economic and security interests would be bolstered by a lengthy period of harmony and stability in the Koreas.

For starters, Russia shares ethnic and historical ties with Koreans as well as a 17-km long border with the DPRK. This proximity ensures Russian interest in participating, even indirectly, in any multilateral dialogue concerning the Koreas.

More importantly, Russian policy makers seek to enhance Russia’s integration with the flourishing East Asian region. Securing additional South Korean, Chinese, and Japanese investment and trade would help revitalize the Russian economy, especially the lagging but strategically significant region of the Russian Far East (RFE). Russia’s trade relations with the major East Asian nations of Japan, South Korea, and China falls far behind these three countries’ economic interactions with each other.

Russian entrepreneurs envisage converting the DPRK into a transit country for Russian energy and economic exports to South Korea and other Asia-Pacific countries. Such a development would further Russia’s integration into East Asia as well as revitalize Moscow’s ties with North Korea. They have discussed linking a trans-Korean railroad with Russia’s rail system, which would allow Russia to become a transit country for South Korean trade with Europe, which now involves mostly long-distance shipping. Furthermore, Russian planners want to construct energy pipelines between Russia and South Korea across DPRK territory.

This bright scenario has one major problem: it cannot occur without a reduction of tensions on the Korean Peninsula. For this reason, Russian diplomats have regularly engaged in high-profile Korean diplomacy.

Unfortunately, a decade of Russian diplomacy has had little impact on regional affairs. Breaking with precedent, Vladimir Putin visited Pyongyang in July 2000 to bolster and reenergize ties. The new Russian president also hoped to bolster his diplomatic credentials. But his efforts failed to secure a tangible agreement, souring Moscow on Pyongyang for several more years.

Almost a decade later, both Russia and China each sent two high-level delegations to Pyongyang in 2009. The DPRK’s leader, Kim Jong Il, decided to meet with Premier Wen Jiabao and PRC Defense Minister Liang Guanglie, however, he did not so much as greet Foreign Minister Sergey Lavrov or Russian parliamentary leader Sergey Mironov.

Russia’s problem is that its economic and political influence in the Asia-Pacific region is too limited. The territorial dispute with Tokyo over the South Kuriles/Northern Territories excludes a genuine Russian-Japanese partnership. Although Russian ties with Beijing and Washington are better, Chinese and U.S. diplomats focus their Korean diplomacy on Pyongyang, Seoul, and each other. In order to increase their regional influence, Russian officials must become more conciliatory towards Japan, and less beholden to China.

Dr. Richard Weitz is a Senior Fellow and the Director of the Center for Political-Military Analysis at the Hudson Institute. The views expressed here are his own.

Photo from Jonathan Davis’ photo stream on flickr Creative Commons.

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A Renaissance in Russia-North Korea Relations?

By Troy Stangarone

During the Cold War, Russia served as North Korea’s primary trading partner and provider of security guarantees. As the Cold War came to an end, however, Russia reoriented its foreign policy towards the West and relations with North Korea were downgraded as Moscow sought closer ties with Seoul. That may be changing. In recent months there have been indications that relations could again be warming between Russia and North Korea.

Today, North Korea has become dependent upon China. China’s share of North Korea’s trade has grown from 41.6 percent in 2007 to 57.1 percent last year. This is similar to North Korea’s dependence on the Soviet Union when the Cold War was coming to an end. In 1988, trade between the Soviet Union and North Korea had grown to $2.8 billion, accounting for 56 percent of North Korea’s two-way trade.

With the ending of the Cold War the relationship began to change. Military cooperation and Russia’s obligation to defend North Korea slowly came to an end, and trade began to dry up after Mikhail Gorbachev converted all of the Soviet Union’s trade relations to commercial terms. What had been North Korea’s most important trade relationship has fallen to a mere $62 million in two-way trade in 2010 according to the WTO’s Trade Map.

That has begun to change recently as North Korea seeks aid and investment for its economy in advance of 2012. However, increased economic ties between Russia and North Korea have long been blocked by Pyongyang’s inability to pay off Soviet era debt, but the two sides have recently found a way to address this issue. Under the current proposal, Moscow would forgive 90 percent of North Korea’s debt and reinvest the remaining 10 percent in projects in North Korea.

At the recent summit in Ulan-Ude, Russia provided North Korea with 50,000 metric tons of grain as food aid and the two sides agreed to explore the development of a gas pipeline through North Korea that would supply Russian gas to South Korea. The project would potentially provide North Korea with $100 million in transit fees per year, or about five times as much as it currently receives in wages from the Kaesong Industrial Complex with South Korea.

Russia is also undertaking other economic development projects in North Korea. It recently repaired a rail line connecting Khasan in Russia to Rajin in North Korea, where it is building a container terminal.  It has also expressed an interested in ultimately connecting the Trans-Siberian Railway to the Inter-Korean Railway, perhaps as part of the gas pipeline project.

On the security front, Russia and North Korea have also announced they will conduct joint naval exercises in 2012. The exercises will focus on joint search and rescue operations.

As cooperation between Russia and North Korea has increased, Seoul has grown weary. Improved ties between Moscow and Pyongyang, however, are unlikely to be a challenge for South Korea. Russia’s interests in North Korea ultimately have little to do with North Korea itself, but rather a means to a larger ends.

After the Cold War, Russia’s influence in Asia and the Korean peninsula began to wane and its cooperation with North Korea is part of its efforts to restore its influence in the region, while at the same time integrate the Russian Far East into East Asia.

The Russian Far East has some of the world’s largest deposits of oil and natural gas and the pipeline to South Korea will help Russia diversify beyond its current Europe customers and help to put pressure on China in its negotiations with Russia. Even linking the Trans-Siberian Railway with the Inter-Korean Railway is more about connecting Russia to South Korea than greater ties with North Korea.

If Russia is to find new markets for its natural resources, as well as potentially entice South Korean capital to help modernize Russia, it needs stability on the Korean peninsula and a direct connection to South Korea. This will require it to improve its ties with North Korea, which could also enhance its influence in the region, meeting both of Russia’s goals for its policy towards the region. Ultimately, though, increased ties with Pyongyang are more about South Korea than North Korea.

Troy Stangarone is the Senior Director of Congressional Affairs and Trade for the Korea Economic Institute. The views expressed here are his own.

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Five Considerations for a Gas Pipeline Through North Korea

By Troy Stangarone

After more than a year of heightened tensions over the sinking of the Cheonan and the shelling of Yeonpyeong Island a proposed gas pipeline from Russia to South Korea through North Korea is potentially changing the factors on the ground.  Ever since Kim Jong-Il and Russian President Dmitry Medvedev agreed in principal to construct a pipeline through North Korea in late August, a project that only a few months ago would have seemed inconceivable is quickly moving towards reality as all three sides move closer to an agreement.

The project dates back to a 2008 summit between Russia and South Korea where a tentative deal was reached for Russia to supply South Korea with 7.5 million tons of gas a year for a 30 year period starting as early as 2015. The initial plan left open the option of supplying the gas via either pipeline or tanker, but with a pipeline being the preferred option due to the lower cost of transport. While a potential economic win for South Korea, there are five potential issues to consider for any pipeline through North Korea.

Could the pipeline change inter-Korean relations? This is ultimately a commercial agreement and should be judged on those merits. While some officials in South Korea and Russia have suggested that the pipeline deal could lead to a change in inter-Korean relations, any expectations beyond the easing of tensions needed to complete the project may be expecting too much. In fact, because the pipeline would be an easy money earner for North Korea, it could undermine incentives for greater North-South cooperation.  The only incentive for North Korea would be to ensure that the checks continue arriving, not that it considers a major rethink of its relations with South Korea.

Can North Korea be trusted with a pipeline?  The simple answer is no. Disputes between the North and South will make the pipeline a tempting target for North Korean officials to use as leverage against South Korea. This is not merely a reflection of the North Korean regime. Few would argue that North Korea is a more open or dependable regime than the Ukraine which has in the past shut down gas flows to the European Union in disputes with Russia. At the very least, North Korea can be expected to try and extract higher transit fees in the future has it has done with the Kaesong Industrial Complex. At the worse, it may attempt to use the pipeline for leverage over South Korea on other issues.

Can South Korea minimize or eliminate North Korea’s leverage over the pipeline? The simple answer to this is yes, and early indications are that South Korea is attempting to protect itself against North Korean attempts to leverage the pipeline. One idea that has been suggested is for Russia to provide a 30 percent discount on gas as compensation if North Korea were to interfere with the pipeline. However, there are other steps South Korea could take as well. If Russia were contractually obligated to ensure that the agreed upon amount of gas is delivered to South Korea via pipeline or tanker and Russia were required to cover any requests for an increase in transit fees, it would reduce any leverage North Korea might gain from the pipeline and the risks for South Korea.

Is this the best way to engage North Korea? If long-run goal is to encourage reforms in North Korea and reduce tensions between the North and South, this is not the best option. For North Korea the deal is primarily about the infusion of hard currency. It is expected to make $100 million dollars in annual transit fees and land leases for the project. This would represent about five times the revenue that North Korea earns annually from salaries in the Kaesong Industrial Complex. However, unlike the project at Kaesong, no meaningful skills or best practices are transferred to North Korea.  There is no need for a greater interaction between North and South Koreans if they are not involved jointly with the construction or maintenance of the pipeline.

Does the pipeline make commercial sense for South Korea? This will be the deciding factor on whether South Korea moves forward with the pipeline project. As a nation with no domestic energy reserves the pipeline project could potentially secure the equivalent of nearly 30 percent of South Korea’s gas imports from 2009. In addition, the project has been estimated to reduce its price for natural gas by up to 30 percent. Those are compelling economic incentives for South Korea to move forward with the project. However, there is one other issue to consider. With new retrieval techniques expanding the global supply of natural gas, will the potential for reduced prices in the future make a 30 year contract with Russia at a fixed price less attractive in the long-run?

Troy Stangarone is the Senior Director for Congressional Affairs and Trade for the Korea Economic Institute. His views are his own. 

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The Peninsula blog is a project of the Korea Economic Institute. It is designed to provide a wide ranging forum for discussion of the foreign policy, economic, and social issues that impact the Korean peninsula. The views expressed on The Peninsula are those of the authors alone, and should not be taken to represent the views of either the editors or the Korea Economic Institute. For questions, comments, or to submit a post to The Peninsula, please contact us at ts@keia.org.