At the G20 summit in St. Petersburg the heads of Gazprom and CNPC, Alexei Miller and Zhou Jiping, signed an agreement on the main terms of delivery of gas from Russia to China via the eastern route. Gazprom says that all the main terms have been agreed upon: the volume of exports and when they are to begin, the take-or-pay level, the period of supply buildup, the level of guaranteed payments, the gas delivery point on the border, etc.
This interim agreement is similar to one signed three years ago. As a matter of fact, Russia has been trying to come to an agreement with China on gas deliveries since 2004. However, so far the companies have not been able to agree on the price of deliveries. Objectively speaking, China is interested in buying Russian gas. In recent years demand for gas in China has been increasing by an average of 15-20% each year. Forecasts for the growth of gas consumption in the PRC vary. According to a report by Deputy Director of the Economic Center at the Energy Research Institute of the PRC’s National Development and Reform Commission Jiang Xinmin, in 2020 gas consumption in China will be 400 billion m3, and import will be 200 billion m3. According to the head economist of CNPC's Economics and Technology Research Institute, Sü Bo, gas consumption in 2015 will be 230 billion cubic meters, and it will reach 350 billion in 2020. Planning projections for 2030 were announced for the first time in Jiang Xinmin's report: consumption at 500 billion m3, and imports at 250 billion m3. Jiang Xinmin’s statement that China will be 50% dependent on imports by 2020 also stands out.
What is important here is China's continued interest in Russian gas, showing that there is still a niche for it on this market. In addition, in terms of supply security, the common border is an ideal option for the Chinese, who are concerned about energy security issues. At the same time, the existing gas price regulation system in the PRC, where import companies are forced to buy gas at higher prices than those at which they can resell it on the market, makes the search for a price consensus significantly more complicated. In Sü Bo's assessment, last year the company's losses from the difference between the prices for importing liquefied natural gas and pipeline gas and domestic prices amounted to around $8 billion ($1.3 billion in 2010).
That is why there have been some quite exotic demands from the potential importer, like linking the formula for the price of Russian gas to the Henry Hub index. The average spot price there for the beginning of September was $130-140 per thousand cubic meters, while the spot price in Europe, to which Gazprom proposed linking its prices, was significantly higher – around $390-400 per thousand cubic meters.
Gazprom has stated many times that it does not intend to link the Chinese contract to the Henry Hub index, and the new agreement stipulates that it will not be linked. It is not yet clear what the cost base for the contract will be, and both parties are very cautious in speaking on this issue. «Certain advances have been made in the price negotiations; now we are developing a special price formula which will be different from those currently in use,» reported official Gazprom representative Sergei Kupriyanov. «Our Chinese colleagues call it innovative». According to him, the price will be determined by a separate agreement.
Another important change in the main terms for delivery of Russian gas to China was the rescheduling of the start of pumping from 2018 to 2015. That means that the political will of the leadership of the two countries played a role. They decided to speed up the process of the start of delivery, which changes the resource and logistics scheme and could affect other Gazprom projects. Sergei Kupriyanov reported that deliveries are to start in 2015, there is to be a 30-year contract, and the delivery volumes will be 38 billion m3 per year. He noted that in the early stage the gas will go through the Sakhalin – Khabarovsk – Vladivostok pipeline. According to the new scheme, at first gas from Sakhalin will go to China, and this, in turn, could complicate (or postpone) the implementation of a project to expand the capacity of the Sakhalin LNG plant, as the existing production volumes on the island are not enough for everything. Of course, later the «Power of Siberia» gas pipeline, which will go from Yakutia to Vladivostok via Khabarovsk, will take on the greater part of deliveries to China. Deliveries of gas from the Chayandinskoye and Kovyktinskoye fields (with total reserves of 3.7 trillion m3) to the Asia-Pacific region are planned via this pipeline. The total capacity of the pipeline is to be 61 billion m3 per year. However, today this pipeline is still in the project stage (the investment decision was only made in October 2012), and commissioning is planned for 2017.
The Asian participants in the LNG market are very worried by the problems of high prices on this type of fuel and forecasted world shortages of it. According to data for mid-summer 2013, the spot price of LNG with delivery to Northeast Asia had gone up by $0.45/mmBtu since the beginning of May to $14.75/mmBtu ($521/thousand cubic meters). As a result the price for Asia has exceeded the price for Europe by $3.20/mmBtu ($113/ thousand cubic meters). The tendency for spot prices to exceed contract prices continues, beginning in winter 2013, and reflects a new situation on the LNG market. The decommissioning of nuclear power plants in several large energy-consuming countries, as well as an abrupt rise in LNG consumption in Latin America and the Middle East, has begun to create a deficit in the liquefied natural gas market. The supply shortage will continue at least until 2015. According to estimates, supply will increase in this period by around 20 million tons, which is clearly insufficient. The introduction of new capacities in Eastern Africa, Australia and possibly in North America is expected only after 2015.
Currently the growth of premium in the price for delivery to Asia is already leading to a reduction in deliveries of LNG to Europe and to a general redirecting of volume to higher-priced destinations, as Europe has an alternative in the form of gas delivery through pipelines. The current tendency clearly confirms this concept: according to Argus, deliveries of LNG to Europe decreased by 39% in Q1 of 2013 and by 31% in 2012 as compared to levels a year earlier.
Gazprom is taking these tendencies into account in trying to achieve a price level comparable to that which is current in Northeast Asia. In this it is presuming that strategic partnership in the field of energy is a kind of package deal. For example, in June of this year after the St. Petersburg Economic Forum the Chinese received a big «gift» in the form of significant additional volumes of oil. Furthermore, negotiations are underway for the participation of Chinese companies in production projects in Eastern Siberia (CNPC and Rosneft will jointly operate the large Srednebotuobinskoye oil and gas condensate field in southwestern Yakutia).
During the St. Petersburg G20 summit, the Russian-Chinese energy package was enlarged by one more large deal. NOVATEK and CNPC signed a contract for the sale of 20% of the stock of Yamal LNG.
The agreement on the newest main terms for gas delivery to China is not a sensation, but it is definitely a gratifying event, and one that brings obligations. There is still hope that, as promised (again), the negotiators will be able to sign a final contract for gas delivery by the eastern route by the end of 2013. It «only» remains to agree on a price for these deliveries. The involvement of both countries' budgets will be essential. Russia will have to subsidize the export of gas to China, considering the expense of developing distant gas fields and the cost of infrastructure. The cost of the «Power of Siberia» pipeline alone is estimated at 60 billion rubles even before the start of construction (i.e., at the minimum). CNPC, in turn, is taking multibillion dollar losses from the import of Turkmenian gas due to strict regulation of domestic prices in China; therefore, without additional concessions from the state, the company's interest in buying Russian gas as well is not apparent.
This is a matter of a strategic partnership between Russia and China, and the task of building the economic foundation for such a partnership goes beyond the interests of individual companies, even large ones. On the Russian side, both Gazprom and Rosneft are acting as operators in achieving important state goals…
It is entirely justifiable to say that both parties are participating in a large international state-private partnership project. The acquisition of a powerful new market for gas in light of the development of resources and infrastructure in Eastern Siberia opens such prospects to Russia that any budgetary expenses are apparently justified in this case. Which of course, as Gazprom remarks, does not mean subsidizing China, which has the largest gold and currency reserves in the world.
Igor TOMBERG is head of the Centre for Energy and Transport Research, Institute of Oriental Studies, Russian Academy of Sciences, and a professor at MGIMO (Moscow State Institute of International Relations)
