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Russia and China agree $400bn gas deal

Russia’s $400bn gas deal with China will have ramifications across the world

In the end, China was wise to wait. Almost two decades in the making, the $400 billion gas supply deal it signed with Russia during president Vladimir Putin’s visit to Shanghai on 21 May brings the world’s biggest energy exporter into the heart of the Chinese economy – at the price Beijing wanted to pay.

China needs Russia’s gas. But Russia needed China’s market more. The Ukraine crisis, and Russia’s latest fall-out with the West – followed by renewed discussions in European capitals about how to wean the continent off Gazprom’s gas – weakened Putin’s negotiating position in Shanghai. China pounced.

The details of the deal are still vague. The headline $400bn for supplies of 38bn cubic metres a year (cm/y) implies that China National Petroleum Corporation (CNPC) will pay $350 per 1,000 cm for the gas, with shipments through a new pipeline, Power of Siberia, to begin sometime after 2020. Volumes through that route could eventually rise to 60bn cm/y.

The price may even be lower than the border price for Russian gas in Europe, though some analysts expect China to pay more as volumes ramp up. But, at a cost equivalent to about $10.50 per million British thermal units (Btu), it is also well beneath recent prices for liquefied natural gas in Asia. Relaxation of price controls in China mean CNPC may do well out of the deal, too. On the eastern seaboard, domestic prices have already reached $15/m Btu. A tidy profit is there for the taking, if CNPC can keep the total cost for shipment to those markets beneath that level.

The financial benefits to Gazprom are less clear. Some analysts say the border price with China will barely let it break even, given enormous upstream and infrastructure spending the company will make to bring the project on line. Development of the Chayandinskoe gasfield, the pipeline, and processing costs could amount to more than $40bn, says Wood Mackenzie, a consultancy. 

But there are other, wider implications of the deal. In Russia, the pipeline will be at the centre of the government’s plans to develop East Siberia and the country’s far east, generating investment and jobs. It will also be a boon for Rosneft, which plans to produce up to 30bn cm/y from its own fields in Siberia – and could export 20bn cm/y of its own gas through the Power of Siberia. Indeed, it is understood that Igor Sechin, Rosneft’s boss and one of Putin’s closest confidants, lobbied hard for the deal’s signing in Shanghai, while Gazprom was willing to wait.

The geopolitical significance of the deal with China should not be lost on Western officials, either. As Petroleum Economist went to press, Gazprom had reached a tentative agreement with Kiev over supplies – preventing, for now, another interruption in shipments through Ukraine. But the latest gas spat, combined with deterioration in relations between Moscow and the West, has prompted another round of European fretting about how to wean itself off Russian gas – which accounted for a third of the continent’s consumption last year.

In reality, unless Europe wishes to shred its climate change goals, burn more coal and pay punishingly high prices to compete for liquefied natural gas (LNG) with Asian buyers, its short-term alternatives to Russian gas are negligible. But, in any event, having secured China as a client means Russia has a hedge against the unlikely prospect of Europe pulling off such a strategic move in the long term, too. In energy at least, Moscow has reclaimed some strategic high ground in its phony war with the West, and deepened its already burgeoning economic ties with China.

In part, that is because the Power of Siberia will have a multiplier effect for Russian exports to Asia, points out Keun-Wook Paik, a fellow of the Oxford Institute of Energy Studies and author of Sino-Russian Oil and Gas Cooperation: The Reality and Implications. As well as supplying gas to China, the pipeline will also link the Kovykta field with Gazprom’s planned 10m tonne a year (t/y) Vladivostok LNG plant. It, too, will supply gas to Asia. A project that analysts liked to scoff at a decade ago is now viable.

On top of that, more LNG capacity is also likely to come from expansion and greenfield plants on Sakhalin Island. Yamal LNG’s output will also find a market in Asia. Excluding Pechora and Baltic LNG, two more speculative projects, Russian LNG export capacity could reach about 37m t/y (51bn cm/y) by 2020. Most of the output would be destined for Asia. All told, Russian supplies to the region could reach more than 100bn cm/y by the middle of next decade.

This will also change the dynamics of Asian LNG trade. Russian piped gas at $10.50 will set a new benchmark for prices of seaborne shipments to China’s coast. Gouging needy importers, like Japan, will be more difficult to repeat in future. Australia’s costly greenfield LNG plants will be particularly exposed to the new pricing. Canada, where 200m t/y of new LNG capacity has been proposed, almost all of it on the west coast targeting Asia’s market, could struggle as a late arrival into this new pricing environment. Even the mighty Qatar, with its high-price strategy, will suffer. “Qatar’s days of [LNG price] exploitation are numbered,” says one analyst.

It all leaves China in a position of strength. Suppliers will face more competition as they negotiate long-term deals with the world’s biggest energy user. Greater gas use, a goal of the government as it seeks to curb pollution while sustaining economic growth, can proceed more cheaply than before. For Beijing, Russia’s troubles with the West couldn’t have come at a better time. Says Paik: “The Ukraine crisis has delivered a big present to China.”

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