World Policy Journal: Gas and Geopolitics in Northeast Asia: Pipelines, Regional Stability, and the Korean Nuclear Crisis

World Policy Journal
Volume XIX, No 4, Winter 2002/03

Gas and Geopolitics in Northeast Asia:
Pipelines, Regional Stability, and the Korean Nuclear Crisis
Selig S. Harrison^*

The enormous potential of East Asia's energy market has been an American preoccupation almost from the time Secretary of State John Hay proclaimed the Open Door policy in 1900. It even became the theme for an improbably successful novel, Oil for the Lamps of China, by Alice Tisdale Hobart, a bestseller in the United States during the early 1930s. Drawing on her own experiences as the wife of a Standard Oil executive in China, Hobart turned the clash of corporate and Confucian cultures into a drama so compelling that it inspired two Hollywood movies and won her a loyal audience for a dozen other novels, travel books, and a memoir, most of them set in the Far East.

Seventy years later, a real-life Asian drama is unfolding about gas and geopolitics that is likely to be unfamiliar even to devotees of financial journalism. This time, Russia, not the United States, is cast in the lead role. With the emergence of Russia as a major oil and gas exporter, China, Japan, and the two Koreas have turned to nearby Russian sources of petroleum in Siberia and Sakhalin Island.

Apart from their need to keep pace with rapidly growing energy needs, all of these countries are anxious to offset their dependence on faraway Arab producers. They not only want a hedge against possible supply disruptions resulting from war and revolutions; equally important, they want to reduce what they find to be an increasingly uncomfortable reliance on the United States for the protection of tanker traffic through potentially hazardous sealanes. For environmental reasons, the addition of Russian natural gas to their energy mix is particularly attractive as a way to cut down on an appalling level of pollution resulting from the use of coal and oil.

Russia's gas reserves are the world's largest, comprising 31 percent of known global reserves, in contrast with its oil potential, which ranks seventh on the global scale. Already the largest supplier of natural gas to Europe, where its exports have reached the saturation point, Russia will become the major source of gas for all or most of Northeast Asia within a decade if promising negotiations for gas pipelines from eastern Siberia and Sakhalin Island reach fruition.

There is a catch. Though these pipelines could greatly enhance regional stability and provide a cheap alternative to oil imported from the Middle East, the United States seems uneasily wary of pipeline networks in Northeast Asia. In the case of Korea, the Bush administration for ideological reasons actively opposes pipelines crossing from North to South Korea. This rules out participation of Exxon-Mobil, a U.S. firm, in a projected pipeline from its gas fields off the coast of Sakhalin. Yet U.S. support for such a pipeline could be the key to easing the confrontation between the Bush administration and North Korea over nuclear weapons.

More broadly, the very idea of a tightly knit Northeast Asia has alarmed some U.S. analysts. "Pipelines that promote greater regional integration in Northeast Asia," warned a National Bureau of Asian Research study, "might exclude U.S. involvement except in a marginal way...and could evolve into regional blocs."¹ Conceivably, if overall U.S. relations with Russia, China, and Japan should seriously deteriorate, this could prove a prescient warning. However, in the absence of such a sharp downturn, the United States would benefit from a cooling off of regional tensions that could enable Washington to scale down a costly U.S. military presence. Access to cheaper energy would weaken incentives for expanding civilian nuclear power programs that could be converted to producing weapons. Moreover, to the extent that Northeast Asia can satisfy its petroleum needs from indigenous sources and from Russia, competition with the United States for access to existing sources, pushing prices up, would be reduced.

A High-Stakes Struggle

Startling projections of future growth in energy demand underline why Northeast Asia's reliance on nearby petroleum sources would be beneficial to the United States. China, in particular, with its rapid economic expansion propelling the rising number of gas-guzzling cars and trucks on its highways, is steadily escalating oil imports. Most expert projections suggest that the level of imports, now 1.6 million barrels a day, will reach 4 million barrels a day by 2010 and 7 million by 2015, close to the current U.S. level and equal to three-fourths of Saudi Arabia's current output. Natural gas accounts for only 2.5 percent of China's energy mix, with coal providing 68 percent. But Beijing is seeking to raise the share of natural gas to 10 percent by 2020 through increases both in domestic production and in imports. The increase in imports will involve not only gas delivered by pipelines but also liquefied natural gas (LNG) transported by tanker and then reconverted to natural gas. The shift to gas is driven both by the pollution resulting from a coal-based economy and by the geographical accident that China's coal deposits are in the north and west, while energy demand is centered in the south and east. Expanding the use of coal would require a costly expansion of China's aging railroad network.

Japan and South Korea, respectively the world's second and fourth largest oil importers, are also global leaders in the use of liquefied natural gas. Japan is now the world's largest importer, accounting for 61 percent of global demand, and the consumption of LNG in both Japan and South Korea is rapidly increasing. However, the extent of this increased demand depends on whether, and when, projected gas pipelines are built, and whether the price of pipeline gas is competitive.

With untold billions of dollars in profits at stake during the decades ahead, an intense struggle is now developing between rival contenders for dominance in this burgeoning energy market. On one side are leading LNG exporters like Shell, El Paso, and Conoco, anxious to maintain and increase the existing level of their exports from established gas fields and processing terminals in Indonesia, Australia, Brunei, Alaska, and the Persian Gulf. On the other are Russian and foreign gas companies with substantial investments in exploration and development in eastern Siberia and Sakhalin, notably Yukos, Transneft, Tyumen (TNK), British Petroleum, and Exxon-Mobil. These ventures will pay off only if their production is conveyed by pipelines to North-east Asian consumers. This struggle overlaps with internal conflicts in all of the countries concerned that will determine whether the pipelines can be built at a tolerable cost, and thus whether the gas can be sold at a price competitive with liquefied natural gas.

In Russia, the state-controlled gas giant Gazprom is seeking to assert planning and coordinating authority over both internal and external pipeline development, with the power to decide which gas fields, and which pipelines, should get priority in governmental transportation and infrastructure investment within Russia. This has provoked resistance from the companies that would be adversely affected by Gazprom's anticipated priorities. The Ministry of Energy is at loggerheads with the two provinces that would supply pipeline gas to Northeast Asia. They have yet to agree on who should control the price of gas exports and how high the price should be, a key issue in negotiations with China on a pending pipeline agreement. These two Siberian border provinces, Irkutsk and Sakha, together with the companies that control their gas reserves, are competing for the biggest share of pipeline exports.

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Regional leaders in China's northern provinces near Russia, and in its interior provinces where it is hard to deliver LNG, are more eager to see pipelines built than those in coastal provinces. In Japan, powerful utility companies led by Tokyo Electric, with monopoly control over regional electricity markets, want to continue their exclusive reliance on liquefied gas imports. Consumer groups, by contrast, are campaigning to break the grip of the monopolies and to bring prices down by promoting competition between LNG and pipeline gas from Sakhalin.

In South Korea, middlemen allied with companies that are developing LNG terminals to receive gas from Sakhalin, notably Shell, are waging a propaganda offensive designed to prove that liquefied gas will be cheaper than pipeline gas from either Siberia or Sakhalin. The government gas monopoly, Kogas, supports development of a pipeline that would run from Kovykta in Irkutsk province through China to North and then South Korea. Kogas is taking part in a $120 million tripartite Kovykta feasibility study, jointly financed by China, Russia, and South Korea, that is scheduled for completion next July. South Korean president Kim Dae Jung, soon to retire, who favors closer ties with Russia and likes the idea of a pipeline crossing through North Korea to the South, has been pushing the Kovykta project. But South Korea has yet to resolve interlocking controversies over whether it would be cheaper to get pipeline gas from Kovykta or from Sakhalin, which is not as far away, and the relative share that pipeline gas and LNG should have in its energy mix in relation to oil and nuclear power.

The Battle Over Routes

The Kovykta complex of six gas fields, one of the world's largest, is located in a remote, undeveloped part of Siberia to the west of Lake Baikal, 225 miles north of Irkutsk. "At the moment, you have mostly tigers, bears, and earthquakes there," exclaimed Mikhail Lipilin, vice president of Russia's biggest pipeline construction combine, Rozneftegaztroy, in a Moscow interview. "There's no infrastructure, no helicopter pads, nothing." Undaunted, British Petroleum paid $571 million in 1997 to acquire the Russian company that controlled the Kovykta reserves and has since invested $100 million on exploration in a joint venture with two Russian companies.

Originally, British Petroleum envisaged a pipeline of some 2,400 miles running through Mongolia, northeast China, and North Korea to Inchon in South Korea that would have cost $8 billion to build. But China, which has tenuous relations with Mongolia and regards it as overly subject to U.S. influence, insisted on a pipeline route that would circumvent Mongolia. Since this route traverses a "permafrost" area and will be at least 600 miles longer than one running through Mongolia, the pipeline will cost some $2 billion more to build. The feasibility study now nearing completion will pin down the cost more precisely, setting the stage for negotiations between Russia, China, and South Korea on the price of the Kovykta gas. Once the price is settled, broader discussions can begin on how the project will be financed.

Russia, China, South Korea, and the private companies involved hope that Japan and multilateral lending institutions will join in a consortium to develop the Kovykta complex and the pipeline. Japan was initially part of the feasibility study but backed out after a dispute over how it would be conducted. So far, Japan has been reluctant to commit itself on how much gas it would buy and whether it would provide financing on the low-interest terms that the other governments involved are prepared to offer. But officials of the Japan National Petroleum Corporation told me in Tokyo that Japan wants to join the consortium if the feasibility study looks promising.

Since some $2.5 billion will be needed to develop the fields after exploration is completed, British Petroleum and its Russian partners want definite commitments from China and South Korea on how much gas they will buy before making development outlays. Proven reserves in the Kovykta fields total at least 1.6 trillion cubic meters–sufficient to provide 20 billion cubic meters of gas annually to China for 25 years, plus another 10 billion for South Korea and 10 billion to meet the growing gas needs of Irkutsk and neighboring areas of Siberia.

Though South Korea is ready to consume 10 billion cubic meters right away, China may not be able to absorb its 20 billion until about 2010. This gives Beijing bargaining room in negotiations over the price. Precisely how much gas China will need from Siberia, and how soon, will depend in part on such uncertain factors as when other possible gas pipeline links with Turkmenistan and Kazakhstan come on line, and whether China's projected cross-country gas pipeline from Xinjiang actually begins to supply gas to consumers in eastern provinces by 2005 as scheduled.

Beijing is outraged at Russian suggestions that the Kovykta price will be fixed at the same level as liquefied natural gas. Defending the Russian position, Alexander Y. Misiulin, director of foreign economic relations in the Energy Ministry, told me that "the price should be at least as high as LNG. What they can pay Oman, they can pay us. When it comes down to it, they are interested in cooperation with us primarily for geopolitical reasons, for diversification of their sources of supply, not only for economic reasons. Diversification should be reason enough." Stanislav Zhiznin, counselor for economic cooperation in the Foreign Ministry, echoed this theme, adding that Siberia and the Russian Far East badly need gas for their own development, and "we have to get a high price to justify large-scale exports that undercut what they can have."

Chinese officials are more tight-lipped than their Russian counterparts but are privately threatening to upgrade their reliance on LNG if Moscow refuses to compromise on prices. They also caution that Russia's reliability as a petroleum partner has yet to be tested, citing recent signs that Moscow may renege on a long-standing commitment by the Russian oil and gas giant Yukos to build a crude-oil pipeline from Angarsk, near Irkutsk, to Chinese refineries near Daqing. Beijing has been counting on this pipeline to provide 20 million tons of crude oil by 2005 and 30 million by 2010. In the name of "national security," President Vladimir Putin has recently signaled his support for Yukos's politically powerful rival, Transneft, which wants to build a crude pipeline to the Russian port of Nakhodka, near Vladivostok, that would sell oil to all comers, not just to China.

Putin may well be using the Nakhodka option as a bargaining chip in the emerging negotiations with China over the price of Kovykta gas. It seems unlikely that he would back out of the Daqing deal for short-term political gain, since Russian profits from gas exports to China and Korea would skyrocket as their demand grows after 2010. Indeed, projections of future demand are so high that Kovykta alone might not be able to keep pace, and other gas-rich areas in Siberia are already lobbying for their inclusion in a pan-Siberian pipeline export grid in which they would be linked to Kovykta.

At the very least, said Misiulin, Kovykta should be linked to the nearby Yuzhno-Ustkoutska field controlled by Tyumen, adding 330 billion cubic meters to its proven reserves. Richard Karplus, the Moscow-based vice president of Conoco International Petroleum, predicted that the Kovykta reserves will run out within ten years if exports reach the anticipated annual level of 30 billion cubic meters annually. To keep up with the demand, he said, Russia would have to integrate Kovykta exports with gas from three fields in the Vilyush area of the Sakha Republic near Yakutsk, northeast of Kovykta, or with the Urungoye and Yambury fields near Krasnoyarsk to the northwest. The Vilyush area alone has gas reserves of some 2.15 trillion cubic meters, and the Sakha Republic as a whole, 7.6 trillion.

In the late 1960s, when I was covering Northeast Asia for the Washington Post, China, Japan, and South Korea were mesmerized by the enormous potential of Sakha. Studies of a direct southeasterly route, running diagonally across Siberia from Vilyush to China, proliferated. But these studies found that the southeasterly route from Vilyush and other Sakha gas fields would have to go through earthquake-prone areas where subzero temperatures would make pipeline construction tortuous during the winter months, with daylight lasting only six hours and the ground often frozen to a depth of a hundred feet. Even in summer, the studies showed, snow and ice in this part of Siberia are not fully absorbed in the soil, and much of the route would be a muddy quagmire. By contrast, the route from Kovykta, running to the south of Lake Baikal where the climate is less severe, would pose more manageable logistical obstacles. Although technological breakthroughs could eventually make construction easier in northern Siberia, Sakha gas is likely to be linked up with the Kovykta pipeline for the foreseeable future.

Significantly, Gazprom oversees all Russian gas exports and will thus have a big say in what happens to the gas produced in Kovykta, Yakutsk, and Krasnoyarsk, even though British Petroleum and local companies and governmental entities hold the legal rights. "BP shouldn't be snobbish," said Lipilin of Rozneftegaztroy. "They should work with Gazprom, which has to think of the overall national interest." Indeed, he added, BP has no choice, since the Russian government controls 38 percent of Gazprom's equity and its approval will be a prerequisite for the conclusion of any pipeline deals with China and Korea.

Assuming that a price agreement is reached with China and that British Petroleum can come to terms with Gazprom, the last remaining obstacle to the early development of the Kovykta complex will be BP's renegotiation of its existing production-sharing agreement with the Russian government next year. The issue of production-sharing agreements is a hot one both in Russian politics and in Russian-U.S. relations. Russian oil and gas companies and nationalists in the Duma are pressing for loosely defined agreements, or none at all, while foreign companies are demanding strict guidelines pinning down the terms of their taxes and guaranteeing the security of their investments.

Russia sorely needs a big investment influx to make the most of its petroleum riches. In their meeting in November 2001, at Crawford, Texas, President Bush urged President Putin to enact tougher production-sharing legislation. Such legislation, Bush said, was a precondition for White House support of stepped-up U.S. investment, according to Vladimir Konovalov, director of the Petroleum Advisory Forum, a coalition of foreign energy companies operating in Russia. But Putin has so far avoided a showdown with politically powerful Russian oil and gas barons who have reaped inordinate profits during periods of high prices and want to limit foreign investment, even if it slows down growth of oil and gas production. Foreign investors fear that local Russian bureaucrats will jack up their taxes and make other arbitrary changes in the terms of their investments. By contrast, the Yukos, Tyumen, and Transneft magnates would prefer to make cozy deals with often corrupt local authorities, rather than come under the control of Moscow, where foreign interests have their greatest clout.

The Sakhalin Equation

Compared with the huge potential of Siberia, where gas reserves are expected to last for the next century, the reserves so far discovered along the east coast of Sakhalin Island are less spectacular, though their impact on the Russian Far East and adjacent areas of northeastern China, Korea, and Japan is likely to be significant.

The grand total of proven Sakhalin reserves is 915 billion cubic meters, about half as much as at Kovykta. These reserves are divided almost evenly between the oil and gas concession areas off the northeast coast, known as Sakhalin I, where a multi-lateral consortium led by Exxon-Mobil plans to invest $15 billion, and Sakhalin II, to the south, where investments by Shell, Mitsui, and Mitsubishi are likely to exceed $10 billion. Exploration in the Sakhalin seabed has been in progress since 1978, but development proceeded sporadically until late 2001, when Russia liberalized its tax and regulatory policies, and Putin's meeting with Bush signaled an overall improvement in Russian-U.S. relations.

Soon after Putin left Crawford, Exxon-Mobil announced that it would spend $4 billion of the projected $15 billion for Sakhalin development within the next five years, Russia's largest single foreign investment commitment of any kind to date. At present, plans call for oil production to start at Sakhalin I in 2005 or 2006, but Exxon-Mobil will begin with gas production if either South Korea or Japan, or both, should agree to open the gas market on a long-term basis with a commercially acceptable gas price.

Russia favors the construction of a pipeline running from Sakhalin I through North Korea to South Korea, partly because the pipeline route would skirt the Khabarovsk, Primorsky-Krai, and Vladivostok areas on the Russian mainland opposite Sakhalin, where the demand for gas could grow very rapidly. Until now, these cities have been dependent on Chernobyl-type nuclear reactors that pose a safety hazard. Initially, they might not get much gas from a pipeline originating in Sakhalin I, since most of it would have to go to South Korean consumers who can afford to pay the prices necessary to make the pipeline profitable for Exxon-Mobil. However, as untapped additional gas reserves of some 1.4 trillion cubic meters are explored and developed in newly allocated concession areas known as Sakhalin III, IV, and V, there will be enough gas available to divert what is needed to Russian cities along the pipeline route as well as to nearby northeastern Chinese cities, notably Harbin and Dalian, where there is a heavy demand for gas from petrochemical plants as well as consumers.

"If Exxon became serious about a pipeline from Sakhalin to Korea," said Lipilin of Rozneftegaztroy, "Russia will support it because it would be in our long-term national interest, both in terms of our strategic interest in close relations with Korea and as a step toward the gasification of our Far East." Even though Russia is short of cash, added Alexander Fedorovsky, director of Pacific Studies at the Institute of World Economy and International Relations (IMEMO), Moscow could help to make the project financially viable in various ways. Instead of repaying its $1.7 billion debt to South Korea in scarce foreign exchange, he suggested, Russia could pay by getting government-controlled enterprises to contribute part of the work on the pipeline or to provide a share of the gas. For example, Rozneftegaztroy, formerly the Soviet Ministry of

Oil and Gas Construction, could help to build the pipeline, and Rozneft, which holds a fifth of the stock in the Exxon-led consortium, could forego profits on the gas until the debt to Seoul was paid.

Neither the precise routes from Kovykta and Sakhalin I, nor the capacity of the pipelines, have yet been decided. Still, it is clear that Sakhalin pipeline gas would be competitive with LNG and cheaper than Kovykta gas, though how much cheaper remains to be seen. The pipeline from Sakhalin I would not be more than 1,900 miles long, running along the east coast of North Korea to its terminus near Seoul, where it would intersect with an existing South Korean gas network. The pipeline could be built within three to four years at an estimated cost of $3 billion. By contrast, assuming that the pipeline route from Kovykta does circumvent Mongolia, crosses China's Liaoning province to Dandong, enters North Korea at Sinuiju and proceeds along the west coast of Korea to a terminus at Inchon, it would be nearly 3,000 miles long and would cost some $9 billion to build.

The North Korean Option

As it happens, it cannot be assumed that a Kovykta pipeline would cross through North Korea to the South. The Bush administration is flatly opposed to such a possibility. In South Korea, retiring president Kim Dae Jung favors a route through North Korea as a way to cement North-South economic cooperation and to help Pyongyang resolve its energy crisis. But some of Kim's critics in the South want the pipeline to veer south of Dandong to Dalien, where it would go under the Yellow Sea directly to Inchon, bypassing North Korea, even though this would add 250 miles to the route and make the pipeline more expensive, especially since it costs more to lay pipeline under the sea than on land. South Korea formally asked China to support a route through North Korea in December 2000, Zhang Xin, director general of the China National Petroleum Corporation, told me in Beijing. "That is our policy, even though some South Koreans have come to us saying that they would prefer the under-sea route," he said. "They think it's less risky politically. Like the Americans, they're afraid North Korea would have a strangle-hold over the South if the pipeline goes through the North."

Ironically, North Korea itself is cool to the Kovykta project. Given China's burgeoning demand for gas, observes Song Bok Ku, commercial counselor of the North Korean embassy in Moscow, Beijing will not be willing for very long to let Kovykta gas go to Korea. Whatever short-term commitments it might make, he says, "as time goes by, there will be little left for North and South Korea." South Korea's Kogas has sent two missions to Pyongyang to keep North Korean petroleum officials abreast of progress on Kovykta and to conduct preliminary surveys of a possible pipeline route. North Korean officials have promised to keep an open mind on Kovykta until the feasibility study is completed. But the North strongly prefers a pipeline from Sakhalin and has repeatedly conveyed this preference to Russia, most recently during Kim Jong Il's fourth meeting with President Putin at Vladivostok last August.

Russian enthusiasm for a pipeline through North Korea, either from Kovykta or Sakhalin, will be influenced in part by the fate of ongoing negotiations (between Russia and the two Koreas, and between North and South Korea) on extending the Trans-Siberian Railroad through North Korea to the South, explained Alexander Fedorovsky of IMEMO. Russia hopes to reap $3 billion in annual profits from container rail freight traffic from Europe to South Korea through Russia, which would be twice as fast and one quarter the cost of shipping by boat. South Korea has already started to restore its rail links with the North, severed since the Korean War. Russian pressure is one of the main reasons why the North has agreed to cooperate. But Pyongyang lacks the capital and expertise needed to renovate its decrepit rail system on its own, and before embarking on a costly reconstruction effort with South Korean assistance Moscow is demanding a substantial degree of Russian managerial and financial control over the Korean portion of the extended Trans-Siberian rail system. "If the North Koreans cooperate in a realistic way on the railroad, it will open up many other areas of cooperation, especially concerning natural gas," commented Fedorovsky. "The railroad is a test case."

The Nuclear Dimension

For North Korea, the loss of subsidized petroleum supplies from China and Russia since the end of the Cold War has been the root cause of its current economic paralysis. With low-cost Chinese crude oil flowing directly to its refineries from the Daqing oil field, Pyongyang built its economy primarily around oil, even though it has abundant coal deposits and has continued to rely partly on coal. But since 1990, when Beijing and Moscow began to demand payment at commercial rates in hard currency, crude oil imports have dropped by 85 percent. This has immobilized industries dependent on petroleum, including fertilizer factories, which has led to low agricultural production, aggravating the impact of famines in 1995 and 1996. The lack of oil has shut down most tractor operations and many of the power generators in rural areas needed to run irrigation pumps. Industries dependent on coal have also suffered, since coal production has been crippled by the reduction of electricity output from power stations dependent on oil, and electricity is needed for mechanized mining as well as for the electrified rail system used to transport coal out of the mines.

To escape from its energy bind, North Korea is prospecting for oil in the seabed off the coast of Anju and has been counting on 2,000 megawatts of electricity annually from two light-water nuclear reactors that a U.S.-led consortium, the Korean Peninsula Energy Development Organization (KEDO), promised to build for the North under a 1994 U.S. nuclear freeze agreement with Pyongyang known as the Agreed Framework. In return for the promise to build the reactors by a target date of 2003 and to provide 500,000 tons of oil annually pending their completion, North Korea discontinued a graphite-based nuclear program that was designed to produce plutonium for nuclear weapons while simultaneously helping to meet civilian electricity needs. During the ensuing seven years, however, work on constructing the two reactors has not gone beyond the preparation of the site, and the United States also failed to fulfil two other key provisions of the agreement: Article 2, which envisaged normalization of economic and political relations with North Korea, and Article 3, which required "formal assurances" ruling out "the threat or use of nuclear weapons by the United States" against North Korea.

Pyongyang repeatedly threatened to stop honoring the Agreed Framework unless Washington lived up to these obligations. Finally, on October 4, 2002, North Korean leaders told visiting U.S. officials that North Korea would no longer be bound by the accord and that it was seeking to produce enriched uranium for use in nuclear weapons. The enrichment program does not violate the operative provisions of the 1994 accord, which covered only the plutonium-based nuclear programs then underway. However, it does violate a provision in which North Korea pledged to honor an earlier agreement with South Korea that ruled out uranium enrichment. In any case, Pyongyang offered on October 4 to end the uranium program, abide by the safeguards in the 1994 accord relating to plutonium, and negotiate inspection procedures acceptable to Washington. In return, the United States would have to make a formal commitment to "respect its sovereignty," not to attack it with nuclear or conventional weapons, and "not to hinder" its economic development. But the Bush administration did not accept this offer, and on December 12, Pyongyang, seeking to put pressure on the administration to negotiate, announced that it would restart the Yongbyon reactor, frozen under the 1994 accord. At the same time, it offered to discuss "refreezing" the reactor. This offer, too, was rejected by Washington, and it is unclear whether the two new civilian reactors envisaged in the Agreed Framework will ever be built.

Even if North Korea does get nuclear power for electricity, natural gas from a Sakhalin or Kovykta pipeline would help it meet its expanding energy needs as it rebuilds its economy. Gas-fired power stations along the route could tap into the pipeline. Equally important, royalty payments for permission to pass through its territory would provide Pyongyang with critically needed foreign exchange. South Korea, with its expected commitment to buy 10 billion cubic meters annually, will be the main market for pipeline gas from Russia, but North Korea will seek a steadily growing share as a supplement to nuclear power.

Pyongyang is so enthusiastic about the Sakhalin pipeline that the Natural Gas Society of North Korea concluded an unpublicized 18-point memorandum of understanding with a consortium of three Dutch trading companies on April 6, 2001, giving the consortium the exclusive right to build the North Korean portion of the pipeline from the Russian border to the South Korean border. (One of the Dutch companies has since been taken over by the U.S. construction giant Bechtel, which wants to scuttle the deal.) Mindful of South Korean concerns, the memorandum committed the consortium "to construct and operate this project so as to secure an undisturbed flow of natural gas over the Southern borders."

The memorandum specifically envisaged the construction of three gas-fired power stations along the pipeline route with a total capacity of 500 megawatts. Access to the gas needed to operate these power stations would be a condition for permitting the pipeline to transit North Korea to South Korea. By seeking only enough gas for 500 megawatts, North Korea signaled that it sees the three power stations as a supplement to the two nuclear reactors, not as an alternative to them. This is significant because some observers who have long believed that the Bush administration will never build the two light-water reactors, and who question the reactor project on economic grounds anyway, argue that the United States should offer to support the pipeline if North Korea agrees to drop the two reactors and to comply with U.S. demands relating to its nuclear and missile capabilities.

The most explicit proposal for such a deal has come from Bradley O. Babson, a senior consultant to the World Bank on East Asia. Babson told a conference sponsored by the Korea Institute of Energy Economics in Seoul on March 6, 2002, that the 1994 North Korea-U.S. nuclear freeze agreement "is very likely headed for a crisis." The crisis could be triggered, Babson said, by any or all of three contingencies: an impasse over inspection issues; the unwillingness of KEDO members (South Korea, Japan, the European Union, and the United States) to pay for completing the two light-water reactors; or, most probably, by their refusal to cover the costs of the new power distribution grid that would be needed to transmit the electricity produced by the reactors.

Babson did not foresee that the crisis would result from a North Korean acknowledgement of a secret nuclear weapons effort. But his warning was nonetheless prescient, and he made a proposal for a bargain with North Korea that the United States should now adopt, with important modifications. If North Korea satisfies the United States that it has ended its nuclear and missile programs, Babson suggested, Washington and the multilateral development banks should be prepared to help finance not only the construction of the pipeline itself but also gas-powered power plants and gas-based fertilizer factories, and the rehabilitation of the existing North Korean power distribution grid. "The idea of building a gas pipeline to cross North Korea and serve the South Korean market is worth serious consideration," he concluded, "not just from the point of view of meeting South Korea's future gas requirements through regional energy cooperation," but because "it could transform inter-Korean relations and advance the larger goal of regional security."

Supporting this view, a leading expert on Northeast Asian energy issues, Keun Wook Paik, author of Gas and Oil in North-east Asia (Royal Institute of International Affairs), points out that the cost of building the reactors ($4.9 billion) would greatly exceed the projected $3 to $3.5 billion cost of the Sakhalin pipeline. Gas could begin flowing well before the reactors are likely to start producing and transmitting electricity, he adds, assuming that Exxon-Mobil can reach agreement with South Korea on the price of the gas and the annual volume to be purchased. Once the feasibility study on Kovykta gas is completed this summer, he says, Seoul will know whether Sakhalin gas would be cheaper. If South Korea completes negotiations with Exxon-Mobil for Sakhalin gas during 2003, the pipeline could be completed and in operation by 2008.

Like many observers, Paik emphasizes that North Korea's antiquated electricity transmission grid cannot handle the 2,000 megawatts of electricity to be produced by the two nuclear reactors. The cost of constructing a new countrywide grid with a 540 kilovolt capacity would be substantially higher, he estimates, than building a net-work of 250-megawatt gas-fired power stations along the pipeline route linked to small local transmission grids. Each of these power stations with their local grids would cost from $150 to $170 million, he calculates, based on the 2002 price of gas-fired turbines made by Korea Heavy Industries in the South. To cover the most populous parts of North Korea with eight power stations, the cost would be $1.2 to $1.36 billion, but all of them would not have to be constructed at once.

At their own initiative and expense, two leading European engineering firms, Asea Brown Boveri of Switzerland and Siemens of Germany have both conducted extensive studies of North Korea's existing electricity distribution system and of its future energy needs. Even though North Korea is virtually destitute at present, their reasoning is that the security interests of the United States, Japan, and South Korea will sooner or later lead to multilateral aid to ease North Korea's energy problem as part of a broader rapprochement, either through a new countrywide grid linked to the two KEDO reactors or through gas-fired power stations with local grids fueled by a Sakhalin pipe-line– or a combination of both.

In economic terms, there is no need to make an either-or choice between pipeline gas and nuclear power. Both will be needed to meet the growing economic needs of North Korea, South Korea, and a unified Korea. The American interest in a stable Korea would clearly be served by a policy in which the two reactors are supplemented by a Sakhalin pipeline. In political terms, however, the issue confronting the Bush administration is how to head off a North Korean nuclear weapons program. In my view, the best way to do so is to renegotiate the Agreed Framework with new provisions that combine pipeline gas with a scaled-down nuclear power program in return for an inspection regime fully adequate to verify that the nuclear weapons effort has ended.

North Korea and South Korea alike would strongly oppose a revision of the 1994 accord in which both nuclear reactors would be abandoned in favor of pipeline gas. But they might well agree to reduce the KEDO commitment to one reactor, instead of two, if that would keep the nuclear agreement on track.

The Face-Saving Way Out

In order to make such a compromise attractive to the United States, Pyongyang would have to reaffirm its commitment to the existing provisions of the Agreed Framework, under which it must dismantle its frozen nuclear facilities, designed to produce plutonium, coincident with the completion of the reactor project. In addition, North Korea would have to accept new provisions that would dismantle its uranium enrichment program under adequate inspection safe-guards. It would also have to go beyond existing provisions that require International Atomic Energy Agency inspections to determine how much fissile material had been accumulated before 1994. The Bush administration wants these inspections to begin immediately, much sooner than the Agreed Framework requires. North Korea would accept such accelerated inspections, in my view, if the schedule of inspections were linked to progress in the construction of at least one reactor. In return, the United States would drop its opposition to an Exxon-Mobil gas pipeline through North Korea, encourage multilateral assistance for gas-fired power stations, transmission grids, and fertilizer factories along the pipeline route, and support interim KEDO energy aid to the North pending completion of the reactor and the pipeline.

For the Bush administration, inducing North Korea to accept one reactor instead of two, together with strengthened nuclear inspections, could be presented in the United States as a political victory, partially vindicating Republican charges that Clinton gave North Korea too much in the 1994 accord, on terms that were not tough enough.

For Pyongyang, getting at least one of the reactors up and running is a political imperative if only because the Agreed Framework bore the personal imprint of the late president Kim Il Sung and of his son Kim Jong Il, now North Korea's leader. Equally important, since Japan and South Korea both have large civilian nuclear programs, North Korea regards nuclear power as a technological status symbol. Like Tokyo and Seoul, Pyongyang wants nuclear power in its energy mix to reduce dependence on petroleum. Still another factor is that North Korea has a force of 7,500 nuclear technicians, many of them trained in Russia, who have been in a state of limbo since the 1994 accord and have been awaiting new jobs on the reactors that KEDO promised to build.

In the case of South Korea, support for the KEDO program comes in part from vested interests with a stake in contracts to build the reactors. It had already spent some $800 million on preparatory work by the end of 2002, and South Korean companies had lined up contracts totaling another $2.3 billion for the construction work ahead. As a State Department official observed, "The bribes have already been paid." Still, half a loaf would be better than none, and the money spent by the South has gone, so far, only to the infrastructure at the site and to the preparations for building the first reactor.

South Korea likes the KEDO project because it is confident that the reactors will someday belong to a unified Korea. By contrast, Japan made its $1 billion commitment to KEDO grudgingly and has dragged its feet in meeting its obligations. In Japanese eyes, North Korea cannot be trusted to observe nuclear safety standards, and Tokyo fears another Chernobyl in Japan's backyard. Since Tokyo has already spent $400 million on the project, it is reluctant to see it scrapped entirely, but like Seoul, might accept a compromise limiting the project to one reactor.

What Japan Wants

A government-controlled Japanese company, SODECO (Sakhalin Oil Development Cooperation Company), is Exxon-Mobil's principal partner in Sakhalin I, with a 30 percent stake. Therefore, if Prime Minister Junichiro Koizumi's September 16, 2002, summit meeting with Kim Jong Il leads to a normalization of Japanese relations with Pyongyang, Tokyo might well support a pipeline from Sakhalin I through North Korea to the South as part of its rapprochement with Pyongyang. Conceivably, the pipeline route could be extended across the Tsushima Strait to southern Japan. But Japan is not likely to need Sakhalin gas routed through Korea because Exxon-Mobil and SODECO are already planning a direct 870-mile pipeline link from Sakhalin I to northern Japan that could provide 8.2 billion cubic meters of gas annually to Japanese consumers.

As in South Korea, consumer groups in Japan argue that pipeline gas would be cheaper than liquefied natural gas and that it would be prudent, in any case, to reduce what is now excessive dependence on a single source. But the LNG lobby, spearheaded by Shell and powerful Japanese utility companies like Tokyo Electric, is waging a high-powered campaign to subvert the Sakhalin pipeline, or at least to delay its construction. Shell finalized plans last July to start building a $3 billion liquefaction plant in southern Sakhalin, with a $2 billion port facility, linked to its gas fields in the north of the island by a $2 billion pipeline. The liquefaction plant will have two units, each able to produce 4.8 million tons of LNG per year. Shell is going ahead with one of the two units, gambling that it can get South Korea and Japan to buy its liquefied gas by late 2006. If this gamble does not pay off, the second will not be built, and the LNG produced by the first unit will be sent to more distant markets, such as the west coast of the United States, where it would face greater competition.

The Japanese utility companies, for their part, would lose their lucrative regional monopolies were Sakhalin pipeline gas to replace liquefied gas. At present, their power plants are linked to 20 LNG terminals concentrated in three major urban areas: Tokyo, Osaka, and Nagoya. Pipeline gas would have to be distributed through a new internal pipeline network that would disrupt these regional monopolies by opening up new linkages between different areas of the country, including many areas that do not now get gas. South Korea and most other industrial countries already have internal gas pipeline networks for distributing gas, but Japan's energy distribution system has grown haphazardly without such a network.

Kengo Asakura, a leading Japanese energy expert, has proposed a plan for a new 3,300-mile national trunk pipeline that would be linked, in turn, to 9,000 miles of local pipelines. This would be comparable in size to the long-existing pipeline grid in the United Kingdom. The existing LNG terminals would be integrated into the new network, but LNG usage would coexist with pipeline gas. Asakura contends that the national network would stimulate a burst of new industrial activity and consumer demand in energy-short parts of the country, helping to revive the Japanese economy. The LNG lobby seeks to counter this argument by pointing out that the cost of building the new network would be at least $25 billion and could reach $40 billion. Spending this much would be risky, the argument runs, since the parlous state of the Japanese economy could slow down the anticipated growth in electricity consumption by the time the network is completed.

Despite the LNG campaign, it is precisely because Japan faces difficult economic times ahead that the Asakura plan is winning support. Energy prices in Japan are among the highest in the world, and LNG prices, in particular, are inflated by the system of regional monopolies. Japanese exports will lose their competitiveness unless energy prices are reduced. Moreover, there is a growing consensus that it is foolish to be so dependent on politically volatile parts of the world when abundant gas is available so close to home. It was deeply unsettling to Japan when Tokyo Electric Power could not import liquefied gas for six months in 2001 after separatist violence erupted in Aceh, Indonesia. Many Japanese analysts argue that both LNG and pipeline gas from Sakhalin should be part of the Japanese energy mix and that Tokyo should actively encourage both a Sakhalin pipeline and a new internal distribution network by providing low-interest government loans.

The Japanese government is already giving modest support to Sakhalin gas development through the participation of SODECO and a $116 million investment by the Export-Import Bank of Japan. Ultimately, in order to make gas pipeline net-works in Northeast Asia a reality, the governments of China, Russia, South Korea, and Japan would all have to provide large-scale financial support and launch a serious regional political dialogue on pipeline development designed to set common objectives and priorities. Such a dialogue should be institutionalized in a Northeast Asia Energy Forum leading, in turn, to a North-east Asia Energy Charter Treaty patterned after the one negotiated a decade ago by the European Union.

Common Objectives

"A comprehensive regional approach accepted by all of us would be much better than letting the vagaries of the marketplace decide what happens," observed Zhou Dadi, director general of the Energy Research Institute in China's State Planning Commission. "Is some of the Kovykta gas going to the two Koreas and Japan? How much Sakhalin gas will come to Northeast China? How much to Korea? How much to Japan? If everything is left to each company, each country, each interest group, China will have to think of itself and give priority to its own immediate pressures and demands. It would be much better for everybody if we adopt a regional approach."

American encouragement of regional cooperation could make a difference. With or without such encouragement, regional pipeline networks are likely to take shape, but the process would be faster and more solidly based if the United States offered to back up the regional governments and private companies involved with bilateral and multilateral credits and investment guarantees.

"Leave it to the market," say some analysts. But given the size of the required investment outlays, political rivalries, and the struggle between pipeline and LNG interests, reliance on the market alone will not necessarily lead to results that further the goal of regional cooperation. Moreover, even when a project is commercially viable, as in the case of the pipeline from Sakhalin through North Korea to South Korea, the United States is not supportive.

In the short term, White House approval of the Sakhalin pipeline would have an immediate payoff in regional security terms, since it would provide the decisive economic leverage necessary to get North Korea to end its uranium enrichment program, thus defusing an incipient nuclear arms race in Northeast Asia. Looking ahead, American support for a comprehensive pipeline grid linking Russia, China, Japan, and the two Koreas in a network of mutual interdependence would also have profound long-term benefits, opening up broader vistas of economic cooperation and setting to rest, at last, the sublimated tensions left over from World War II and the Cold War.

January 13, 2003

Endnotes

Note *: Selig S. Harrison, former Northeast Asia bureau chief of the Washington Post, is director of the Project on Oil and Gas Cooperation in Northeast Asia at the Woodrow Wilson Center, and the author of Korean Endgame (Princeton). This article is based on a year-long investigation that has taken him to Russia, China, Japan, and the two Koreas Back.

Note 1: Gaye Christofferson, "China's Intentions for Russian and Central Asian Oil and Gas," NBR Analysis, vol. 9, no. 2 (Seattle: National Bureau of Asian Research, March 1998), p. 33. Back.