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The new Russian-Chinese gas pipeline that opened this week is a perfect symbol of what has become one of the world’s most important relationships: a long-term, strategically conceived, physical bond between two countries united in their desire to resist U.S. domination of the world order.

For Russia, it offers a new source of foreign earnings and reduced dependence on a mistrustful Europe to pad its budget. For China, it brings a new, and cleaner, source of energy that neither the U.S. Navy nor U.S. Treasury can interdict. For both, it represents insurance against any future accidents in relation to other key markets and suppliers.

With all that in favor, who needs it to make money too?

Bigger, but maybe not better

Whatever else it is, the so-called Power of Siberia project is a colossal feat of engineering: over 1,800 miles of pipeline laid from the Chayanda field in Russia’s Yakutia province to the northeastern-most tip of China, crossing land susceptible to earthquakes, extreme temperatures and, most recently, forest fires. When fully on-stream in 2025, it will deliver 38 billion cubic meters (1.36 trillion cubic feet) of gas a year—just under 10% of what the European Union consumed last year.

The pipeline cements a relationship in which Russia feeds China with commodities and the odd bit of sophisticated weaponry, while China ensures a steady flow of money and consumer goods that lessens the pressure of sanctions that the West imposed five years ago to punish Russia for its invasion of Ukraine. That two-way trade topped $100 billion for the first time last year.

But as often is the case with central planning, big doesn’t always mean economically optimal, especially when the fine points of the business are left to two state-owned firms with reputations for poor governance.

Vitaly Yermakov, an analyst with the Oxford Institute for Energy Studies, argues that the only reason the project still has a positive Net Present Value (accountancy-speak for being economically worthwhile) is because Russia’s ruble collapsed in 2016, meaning that the future dollar revenue from gas sales will cover the enormous, ruble-denominated costs it racked up building it.

Profit vs. economic pressures

Gazprom, the world’s biggest gas producer and the only Russian company allowed to export piped gas, originally estimated development costs at $55 billion, but analysts reckon the ruble collapse has capped costs so far at $29 billion. Even so, Gazprom’s net debt had risen from 895 billion rubles before the project started to 2.47 trillion rubles—over $38 billion at current exchange rates—as of September. (The Power of Siberia isn’t the only mega-project draining cash from dividend-starved shareholders.)

IHS Markit analysts Jenny Yang and Anna Galtsova argued in a note this week that it’s impossible to say for sure whether Gazprom will make a profit on the project, as details of the contract pricing are not public knowledge. More will become known as analysts can map future customs data against Gazprom’s declared revenue and tax payments. But many reckon that the project is, at best, only borderline profitable, having been conceived at a time when oil prices—to which Gazprom has always linked its contracts—were nearly twice today’s level.

“Upstream tax exemptions are critical for project profitability,” the two wrote in a research note earlier this week.

The project is completely exempted from the royal tax imposed on all extracted hydrocarbons for 16 years, and loses that exemption in stages over the following eight years, but it hasn’t been formally exempted from the uniform 30% duty that Gazprom pays on its other piped exports.

Gazprom Management Committee Chairman Alexei Miller and Russia’s President Vladimir Putin inspect mock-ups of the Power of Siberia gas transmission system in 2017. (Photo by Alexei NikolskyTASS via Getty Images)

The Russian budget will still get a cut since the export duty that makes Gazprom’s sales to Europe such a cash cow will raise some $2.3 billion a year by 2025, if prices are comparable to those at the European border, OIES’s Yermakov says. (Russia’s mammoth LNG projects currently under development in the Arctic have been exempted from the export duty to ensure their economic viability, further evidence that the mere fact of being an important supplier to China is profit enough in the Kremlin’s eyes.)

Nor does the business of making money on the Power of Siberia’s gas get any easier once it crosses the border, where PetroChina, the buyer of the gas, is equally subjected to social as well as economic pressures.

Reuters in October quoted Ling Xiao, a PetroChina vice president in charge of gas marketing, as saying that although Siberian supplies would be cheaper than piped imports from central Asia, the company “will still be making a loss as (the price) exceeds that of domestic city-gate benchmark rates.”

Heilongjiang and Jilin, two industrial regions in China’s northeastern rust belt that will be the first connected to the pipeline, don’t have the economic strength to absorb all the gas it brings, Galtsova and Yang argue. However, that may not worry state planners whose main concern is to cut toxic pollution in the regions by upgrading a coal-fired energy system to a gas-fired one.

The Chinese section of the pipeline is due to be extended to Beijing and the surrounding Hebei region next year, with a further extension along the eastern seaboard down as far as Shanghai slated for 2021. Galtsova and Yang reckon it will be competitive in Beijing but will struggle to compete with LNG arriving by sea in Shanghai, because of the higher costs of piping it that far.

Driven by diversification

So why bother? In one word—diversification: the same security-of-supply argument that has led European buyers to sign up for LNG from the U.S. and elsewhere in increasing volumes in recent years (and the same reason Russia has spent billions on pipelines bypassing the unreliable transit state of Ukraine).

Russia is diversifying its exports away from a European market that is stagnating (sales volumes aren’t expected to grow for the next five years), that’s rapidly turning hostile toward even the cleanest fossil fuel, and whose antitrust regulators have it on an increasingly tight leash.

A stack flares at the Chayanda oil, gas and condensate field, which supplies the Yakutian gas production centre, a resource base for the Power of Siberia natural gas pipeline. (Photo by Vladimir SmirnovTASS via Getty Images)

China, in turn, is getting relief from the self-imposed pain of Beijing’s tariffs on imports of U.S. LNG, which have cut off a valuable source of energy—albeit a secondary one well behind Australia, Qatar, and Turkmenistan.

Although demand growth has slowed this year, “China’s energy needs are so great that they really need more of every form of energy,” says Stephen O’Sullivan, head of energy research at TS Lombard in Hong Kong.

Even at full capacity in 2025, the pipeline won’t account for more than one-sixth of China’s estimated import needs, according to estimates by Sinopec, China’s other oil and gas champion.

O’Sullivan adds that “there’s no reason why U.S. LNG can’t be competitive,” in China in the long term, arguing that tariffs, rather than changing fundamentals, are responsible for the “abrupt” halt in shipments this year.

“China would like to buy more U.S. LNG because it addresses the (U.S.’s) trade deficit issue,” he points out.

Beijing first imposed a 10% import tariff on U.S. gas last September in response to the first wave of U.S. tariffs on Chinese goods. Beijing raised its tariff to 25% starting June 1, and the Chinese market has been effectively closed to U.S. gas since then. Since U.S. companies have to answer to their shareholders and make a profit, it’s likely to stay that way for the foreseeable future.