Analysis

Gazprom’s deal with China

After over a decade of deliberation, Russia and China have signed one of the largest gas supply contracts in the world. Andrew Ryan analyses the details.

China's growth has led it to search for gas from any source.

China’s growth has led it to search for gas from any source.

The deal will see Gazprom supply state owned China National Petroleum Corp (CNPC) with almost $400 billion worth of natural gas, to be delivered via the much touted ‘Power of Siberia’ pipeline. The supply contract will see Gazprom deliver 30bcm a year (with the potential to move up to 60bcm) for 30 years with flows expected to start as early as 2018.

Gazprom and CNPC have signed several Memoranda over the years, variously agreeing on the route of gas, volumes, starting date and take-or-pay levels. However, the single factor which they were unable to agree on over the years was price. The pricing mechanism of the new contract, which retains elements of oil linkage, is highly confidential. However, Gazprom CEO has been quoted saying that the deal’s value approaches $400 billion, which suggests an anchor price of around $10/MMBtu. This compares to current US prices of around $5-6/MMBtu, UK prices of $7.5/MMBtu and Ukrainian prices of around $14/MMBtu.

A good deal?

China is an incredibly energy-hungry economy with gas consumption increasing by almost 14% between 2012 and 2013. Thus far, its domestic production, despite more than doubling in the last decade, is unable to keep pace with rapid demand, which has grown exponentially since 2009. These increases alone are sufficient to spur high gas demand, but when coupled with a government imperative to reduce air pollution in major cities caused by coal fired power plants; they serve to generate massive growth in demand for alternatives.

China is keen to purchase natural gas from almost any source. It has purchased several stakes in North American Liquefied Natural Gas (LNG) projects, and has signed numerous long-term off take agreements with everyone from oil trading houses to upstream independents. Naturally, the strong demand-side impetus should correlate to a relatively high gas price. Currently, China pays around $11/MMBtu for gas from Turkmenistan, and has paid anything from $12 to $22/MMBtu for LNG.

Consequently, $10/MMBtu from Russia thus appears a relatively good deal for both parties, particularly in light of two things: firstly, the high prices paid by other Asian buyers: the average price of gas imported into Korea was $14.62/MMBtu and $16.38/MMBtu for Japan. Secondly, the new development of several massive Siberian gas fields which could be operated more economically by delivering their gas to China rather than Gazprom’s more traditional markets in Europe. These serve the dual purpose of providing gas for China whilst also diversifying away from many of Russia’s Soviet-era legacy fields.

Does Gazprom need Europe?

This supply deal comes at a very tense time in relations between Russia and the West due to the annexation of Crimea and subsequent sanctions posed on Russian citizens by the EU and US. This is a powerful sign that Gazprom is able to broaden its export markets and may not be wholly reliant on European markets.  Interestingly, the latest Gazprom export statistics show that Europe was the only market where Russian exports actually increased from 2012 to 2013: demand volumes reached 174.3 bcm – only 40% of China’s 420Bcm projected gas demand in 2020. If Europe needs Russia, perhaps Russia does not need Europe.

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