Dr Keun-Wook Paik
Associate Fellow, Energy, Environment and Resources
On 21 May, Russia’s Gazprom and the China National Petroleum Corp (CNPC) finally agreed to a deal for the supply of gas to China, following years of negotiations. The deal represents a major breakthrough, and will have serious impacts on both regional and global patterns of gas trade and energy security.
Gazprom CEO Alexei Miller, Russian President Vladimir Putin, Chinese President Xi Jingping and CNPC General manager Zhou Jiping pose for the media during a signing ceremony on 21 May 2014 in Shanghai, China. Photo by Sasha Mordovets/Getty Images.Gazprom CEO Alexei Miller, Russian President Vladimir Putin, Chinese President Xi Jingping and CNPC General manager Zhou Jiping pose for the media during a signing ceremony on 21 May 2014 in Shanghai, China. Photo by Sasha Mordovets/Getty Images.

According to Gazprom CEO Alexi Miller, the contract with China is worth $400 billion, and is supported by preferential tax regimes on both sides. Russia’s president Vladimir Putin has promised investment of $55 billion for exploration, production and pipeline construction, and $20 billion of investment is expected from China. More broadly, however, the deal is the first step towards very large scale gas exports from Russia to Asia. 

The deal initially provides for a 38 billion cubic metres per year (bcm/y) pipeline gas supply to China, but it is not just the size of the deal itself that is important. It will also help justify the economics of Vladivostok LNG developing the pipeline gas supply from east Siberia. Once the 22 bcm/y pipeline gas − using the much-touted Power of Siberia line − is supplied to Vladivostok LNG, the solid ground for a larger 60 bcm/y pipeline gas export to China and the Asian market will be laid. Separately from the gas supply from east Siberia, a total of 40 bcm/y of gas supply from the Sakhalin Islands (including 15-16 bcm/y from Sakhalin 2 LNG) will be ready by the first half of the 2020s. If the Altai gas export to western China (30 bcm/y) is added, the total volume Russia can export to Asia via China ultimately will be as much as 130 bcm/y. This is a massive volume considering that Gazprom’s export to the European market in 2013 totalled 162 billion cubic metres. 

The 38 bcm/y pipeline gas supply option could change the terms of liquefied natural gas (LNG) pricing for Asia. CNPC’s success in diversifying its gas will undermine the high LNG premium currently charged to Asian consumers. CNOOC (China National Offshore Oil Corp) together with SINOPEC (China Petrochemical Corp), which have struggled to secure less expensive LNG supply sources, will be indirect beneficiaries. It would signal to potential LNG developers that they would have to lower their price expectations – at least for China-bound cargoes. While the estimated price of $350 per 1,000 cubic metres is not as good as CNPC had expected, it is significantly lower than the $380 per 1,000 cubic metres which Gazprom originally demanded.

What drove Putin to make a compromise? Due to the Ukraine crisis, Russia was in a delicate situation, needing to show that Russia’s strategic partnership with China is solid enough to ease the pressure of isolation from the US and EU. It was a priority for Putin, and the compromise was the minimum price he had to pay. 

In the long term, however, Putin aimed at carving out a bigger market share from the Asian market, which is currently being targeted by LNG supply from the US and Canada. The importance of the Asian market was highlighted when Putin was reminded of the difficulty of sustaining the level of export to Europe, and this was why he allowed Rosneft CEO Igor Sechin’s initiative to break up Gazprom’s LNG export monopoly. Rosneft is now aiming at breaking Gazprom’s pipeline export monopoly as well by indicating its serious interest in taking advantage of the Power of Siberia pipeline development. 

Regardless of the competition between the two state corporations for Asian gas market, Russia needs to find a way to become a ‘swing supplier’, able to supply either Europe or Asia at will, to cope with the situation of drastic demand contraction from the European market. The safest way is to revive the momentum of the Altai route export. This was the reason why Putin and Miller highlighted its importance to China. 

It is not an exaggeration to say that Russia’s natural gas export business is standing at the centre of the geopolitics of energy, and Russia is very shrewdly and skilfully pursuing the aim of becoming a swing gas supplier between Europe and Asia. Russia’s determination of reviving the Altai route export to China is a strong reflection of Putin’s interest in repeating the ESPO performance for natural gas trading as well. Being a swing supplier would be a dream come true for Russia, but a nightmare for Europe.

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