Gazprom aims to close China trade deal by year-end

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Russia and China have been giving out strong signals that they could conclude a long-awaited natural gas trade deal by the end of this year. Gazprom and China National Petroleum Corporation (CNPC) this month signed an agreement setting out the major terms and conditions of pipeline gas supply into eastern China that they described as “legally-binding”.

Gazprom CEO Alexey Miller (pictured above) said: “The fact that the major terms and conditions were signed during the G20 summit [in St. Petersburg] indicates the parties’ aspiration to successfully end the negotiations and sign the contract before the end of 2013.” Significantly, the agreement was signed in the presence of Russia’s President, Vladimir Putin, and the President of the People’s Republic of China, Xi Jinping.

Powerful motives: Sceptics argue that the negotiations have been dragging on for more than a decade, with pricing being the main sticking point. Pricing still appears to be the final issue that needs to be resolved. That said, both Russia and China have good reasons for wanting to sign a pipeline gas trade deal.

Gazprom has been talking for two decades about developing gas resources in eastern Russia, for both domestic supply and to export gas to Asia. However, until relatively recently, it was doing very well out of exporting gas to Europe.

The past five years have seen three major developments that have called long-held demand and pricing assumptions into question. One is the economic crisis in Europe. The second has been the development of climate and energy policies that have boosted investment in subsidised renewable energy. The third has been the shale gas production boom in North America.

To begin with, the main impact of the shale boom was to back out LNG supply that was initially aimed at the US market. Much of that LNG found its way to Europe, where it became a lower-priced alternative to oil-indexed supplies from Russia, Norway and Algeria. Over the past couple of years, demand in Asia-Pacific – especially after Fukushima – has sucked LNG away from Europe, reducing the competitive impact. However, Gazprom is aware that the prospect of large-scale exports of US LNG poses a competitive threat.

A breath of fresh air: China’s reasons are just as compelling. It is easy for outsiders to underestimate how anxious China’s leaders are to clean up one of the most heavily polluted countries on the planet.

A key part of their strategy is to increase the use of gas, demand for which is growing at an accelerating rate – certainly faster than China’s indigenous production. Despite this growth, gas contributes only a small percentage share of China’s total energy consumption – around 4.7% in 2012, which compares with coal’s share of 68.5%. There is a growing realisation that, unless action is taken, pollution can only get worse.

Fuelling the gas-hungry dragon: Some believe that China’s gas demand could reach 500 Bcm/year by the end of this decade and 800 Bcm/year by the middle of the 2020s. Sourcing gas on that scale would require China to look to all possible sources of supply.

In 2009 Gazprom and CNPC signed a framework agreement on the major terms and conditions for 68 Bcm/year of pipeline gas supply via two routes: one coming into China from the west and the other from the east. Given the anticipated growth in China’s gas demand, long-term contracts for that amount of pipeline gas start to look like attractive options, even if the price is indexed at least partly to oil prices.

However, the eastern route currently looks easier to realise than the western route, because the latter would require construction of a long and costly dedicated pipeline, which will only go ahead if sales agreements are signed. The eastern route will mostly use infrastructure that Gazprom is already working on constructing or which has recently been completed.

Map of gas pipelines in Russia

GAZPROM’S EASTERN GAS PROGRAMME – Gazprom is currently working on ambitious schemes to develop new gas production centres and transmission pipelines in the eastern part of the country.

China currently has some very low-priced LNG contracts agreed during the buyers’ market of the early 2000s but future supplies are likely to cost more than Europeans currently pay for pipeline gas from Russia.

China hopes to replicate, at least in part, North America’s shale gas boom but these are early days. It is far from clear that China will be able to tick all the boxes needed to emulate North America’s success.

Gazprom’s Eastern Gas Programme: Another crucial factor in an agreement being reached soon is that Gazprom is making substantial progress in developing the production centres and pipeline infrastructure that would be needed in eastern Russia to make exports to China via the proposed eastern route a reality.

Gazprom is currently bringing on stream the Kirinskoye field offshore Sakhalin island, the gas from which will be partly transported via the recently completed Sakhalin-Khabarovsk-Vladivostok pipeline. The company is also working on developing two major new production centres in Yakutia and Irkutsk. Gas from these fields will be transported eastwards by a proposed 4,000 kilometre pipeline, recently named the “Power of Siberia”.

Russia’s priorities for this gas are to supply domestic consumers in the east, then to supply a 15 mtpa LNG project to be constructed at Vladivostok, and thirdly to supply China. If Gazprom’s current aspirations are met, the LNG plant could be completed by 2017 and gas exported by pipeline into eastern China from 2018. It may have been a long wait – but the end now looks in sight.

by Alex Forbes

(Photo and map courtesy of Gazprom)

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