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The Peninsula

Overcoming North Korea to Build a Eurasian Economic Space

Published October 23, 2013
Category: South Korea

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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