The West Siberia Gas Supply Deal on the Horizon for Russia and China: Is a Friend in Need a Friend Indeed?
November 24, 2014
On the sidelines of the summit of Asia-Pacific Economic Cooperation (APEC) leaders in Beijing on November 9 came a new memorandum of understanding (MoU) between Russia’s Gazprom and China National Petroleum Corp. (CNPC) for natural gas supply from West Siberia. This MoU, which was announced following a meeting between President Vladimir Putin of Russia and President Xi Jinping of China, entails Gazprom’s commitment to supply 30 billion cubic meters per year (bcm/y) of natural gas from West Siberia to northwest China through the proposed Altai pipeline for 30 years, with a notional start date of 2019. Additional details are sparse, and the deal itself is presumed to be far from concluded. This is the latest development in a series of energy deals between the two countries in recent years that reinforces the notion of a growing relationship between energy-hungry China and energy-export-dependent Russia, whose economy has come under significant pressure from the steep drop in oil prices and Western sanctions over the ongoing crisis in Ukraine. The potential deal in the making also underscores the growing importance of robust Asian markets over stagnant European markets and reflects the eastward shift in Russian energy exports.
Q1: Did the ongoing tension with Europe lead Russia to seek this deal?
A1: For Russia, geopolitical factors likely played some role to compel the discussion on the Altai route, just as they played a facilitating role in the landmark Russia-China gas deal signed in May. The May agreement sets out a contract between the two countries for Gazprom to supply 38 bcm/y—1.34 trillion cubic feet per year (tcf/y)—of natural gas from East Siberia to China for 30 years after 2018. That deal had been negotiated for nearly a decade and was signed on the occasion of the Russian president’s visit to Shanghai. The tension with Europe over Ukraine appears to have encouraged the Russians to soften their insistence on using oil-linked sales contracts in Europe as a benchmark price for the pipeline gas deal with China, which had proposed a lower price comparable to its pipeline gas imports from Turkmenistan, below $10 per million British thermal units (Btu).
While Gazprom puts the total value of the announced deal at $400 billion, the average delivered price is estimated to be at $375 to $380 per thousand cubic meters (mcm) or slightly over $10 per million Btu—roughly equivalent to the average Gazprom export price to Europe of $380/mcm.
This latest deal in the making to supply 30 bcm/y (1.06 tcf/y) of West Siberian natural gas to China is an extension of this trend—i.e., a sign of the Russian economy under duress, a desire to deepen market ties east, and a gesture toward Western countries seeking to constrain Russia through economic means. There are, however, several fundamental difference between the May and November agreements. First, the negotiation is far from over. For example, there is no indication that the two sides discussed price in earnest. Second, China has never been in favor of the western route, as its entry point is far from Chinese gas consumers and from a direction already supplied by Central Asian gas. Indeed the argument between Russia and China over western versus eastern routes was one of the reasons the previous gas negotiations stalled for more than 10 years. It may be just as difficult this time around for Russia to find the right combination of factors and incentives to get the Chinese to agree.
Q2: Who is the winner in this deal?
A2: While trade by definition presupposes mutual benefit, China is the clear winner in the recent natural gas deals, as it gains not only further access to the Russian upstream, but also leverage over potentially competing gas markets for Russian gas supplies.
An energy highlight from the Beijing meeting, besides the Altai MoU, was a CNPC agreement with Russia’s Rosneft to gain a 10 percent stake in Vankorneft, a subsidiary of Rosneft that operates the Vankor oil field—a notable Russian concession to China. Located in the Turukhanskiy region, the Vankor oil field has estimated recoverable reserves of 3.6 billion barrels of oil and 6.4 tcf of gas. In recent years, the Russians have agreed to allow several Chinese equity investments in the normally closed-off Russian upstream, including a 20 percent stake by CNPC in Novatek’s Yamal liquefied natural gas (LNG) project and a 49 percent stake by CNPC in one of Rosneft’s oil development projects in East Siberia. The Vankor stake in particular is significant in that it is a developed oil field in West Siberia where the Russians have no need for Chinese investment but may be able to raise as much as $1 billion, indicating their desperate need for cash.
Moreover, China appears to be steadily securing East Siberian gas supplies. While it still remains to be seen whether the May gas deal will include future CNPC investment in the two East Siberia fields of Chayanda and Kovykta, which the Chinese demanded to be the source of the pipeline gas, Gazprom announced in October that supplies from these fields would no longer go immediately to Vladivostok as potential supplies for LNG to broader regional markets as initially planned, but to China via the proposed pipeline.
Another sign that China is in a position of strength in the current bilateral energy relationship is the absence of a Chinese loan or prepayment in the May deal. Contrary to Western media reports, which relied initially on Russian sources, CNPC is not providing—so far—a $25 billion loan or prepayment to help Russia finance field development and pipeline construction to the Chinese border. Instead, Russia is seeking new loans from Chinese banks whose terms will likely take into account the higher credit risk Russia now represents.
Q3: How significant is this deal to China and Russia from an energy market perspective?
A3: The volume mentioned in the November MoU is 30 bcm/y. The May agreement left on the table the possibility of future supply expansion from 38 bcm/y to 60 bcm/y (or 2.12 tcf/y). Moreover, following the November MoU, Gazprom noted that its capacity might even be expanded up to 100 bcm/y. Together, the two Russia-China gas deals could translate into over 60 bcm/y (2.12 tcf/y)—and as much as 160 bcm/y (5.65 tcf/y)—of Russian gas supplies to China in the future. Russia is acutely aware of how robust shale gas production in the United States and future U.S. LNG supplies, along with other LNG supplies coming online in the next decade, will compete directly with Russia for market share in Asia. Given stagnant energy demand in Europe, Russia aims to increase its gas supply to Asia from 6 percent of its exports today to 31 percent by 2035. Russia’s pipeline gas supplies to China will likely begin in four to six years when global gas markets may see substantial levels of new supply added from Australia, Canada, and East Africa, in addition to the United States.
Additionally, the highly publicized Russia-China gas talks this year underscore the evolving and pluralistic nature of the “Asian gas market,” as such. The growing competition among various pipeline gas supplies into China contrasts starkly with the LNG-import-dependent reality of other major Asian gas importers like Japan and South Korea. On one hand, China’s apparent leaning toward pipeline supplies should serve to moderate the regional demand for LNG. On the other hand, while the dip in global oil prices has likely provided breathing space, LNG-import-dependent Asian economies are under growing political pressure to seek oil de-linkage in LNG contacts so as not to be left behind in the evolving gas trade landscape in Asia, especially in light of the advent of U.S. LNG shipments next year. Incidentally, as part of its ongoing effort to access cheaper natural gas, Tokyo is eager to keep gas supply discussions alive with Moscow despite ongoing Western sanctions against Russia. Japan, which recognizes that Russia is its only potential source of pipeline gas supplies, is probing the viability of a pipeline extension to Japan, as well as keeping a watchful eye on the Vladivostok LNG idea, which has been complicated by the May agreement.
Q4: Does the series of Russia-China natural gas deals endanger future Russian gas supplies to its European customers?
A4: The Altai deal—combined with the May deal—would not only make China the largest single customer for Russian natural gas, but would also put this new market in direct competition with European markets for supplies from West Siberia, whose super-giant fields have been the main source of Russian gas supplies to Europe. Europe has been the destination for about 80 percent of Russian oil and gas exports (160 bcm of gas supplies in 2013), but the prolonged economic crisis and attendant sluggish energy demand in Europe has Russia hastening to seek new opportunities in Asian markets. Meanwhile, developing East Siberia remains important for Russia. The May deal would require Gazprom to invest $55–$70 billion to develop two large gas fields in East Siberia and to build necessary pipeline infrastructure to the Chinese border. The region has become critical for the future viability of the Russian energy sector as production declines in West Siberia.
Following the Altai MoU, Gazprom CEO Alexi Miller said that the “[s]upplies will go from fields in West Siberia, the resource base we are using for supplies to Europe.” As the geopolitical stakes are rising for Russia and energy has become highly politicized, such a comment may be seen as a warning to Europe that Russia would be happy to become much less dependent on European customers, just as the Europeans say they seek to become much less dependent on Russian gas supplies. Yet, gas supplies to China from West Siberia would likely lead to a lower netback price to the wellhead for Russia than the gas it sells to Europe. Notably absent in the ongoing western route discussion is any information on price. Russia is more dependent on its European markets than Europe is on Russian gas supplies for the foreseeable future. The cost of diversification for both sides is not free.
It remains to be seen whether and when the Altai project itself will be realized. If the May deal were to serve as any reference, the November MoU may only mean the beginning of a long negotiation. One should thus be cautious against ascribing the maxim, “a friend in need is a friend indeed,” to the current status of Russia-China relations. Needs change as do friendships, as reflected in the history of Russia-China relations.
Jane Nakano and Edward C. Chow are both senior fellows with the Energy and National Security Program at the Center for Strategic and International Studies in Washington, D.C.
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