Russia Presses China for New Gas Deal

An analysis by Michael Lelyveld
2015-08-31
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Russia's President Vladimir Putin (L) applauds during an agreement-signing ceremony with Gazprom chief executive officer Alexei Miller (C) and CNPC chairman Zhou Jiping (R) in Shanghai, May 21, 2014.
Russia's President Vladimir Putin (L) applauds during an agreement-signing ceremony with Gazprom chief executive officer Alexei Miller (C) and CNPC chairman Zhou Jiping (R) in Shanghai, May 21, 2014.
AFP

Russia appears to be putting a brave face on its chances for a new gas deal with China as President Vladimir Putin prepares to visit Beijing this week.

Despite indications to the contrary, Russian officials have cited active engagement in talks with China on a western gas route to Xinjiang, as well as progress in building its first pipeline to the east under a contract valued at U.S. $400 billion (2.5 trillion yuan) last year.

Together, the two lines would eventually deliver 68 billion cubic meters (bcm) (2.4 trillion cubic feet) of gas annually to China, or 38 percent of the country's consumption of the cleaner-burning fuel in 2014.

But work on the eastern route had barely begun this year before it ran into financial trouble, pushing Russia's hopes for a second line further into the future.

Despite the challenges, Russia has continued to promote its prospects for another China gas deal.

Last month, Russian Energy Minister Alexander Novak said agreements on a second gas route from the west could be ready for signing in time for Putin's trip on Sept. 3 to mark the 70th anniversary of the end of World War II.

"If it's ready, the visit will certainly be a good opportunity for concluding this transaction," Putin spokesman Dmitry Peskov told reporters on July 29, according to Interfax.

In May, Russia's Gazprom and China National Petroleum Corp. (CNPC) signed a memorandum of understanding on basic conditions for the western line, but negotiations on prices started only in the past month.

Last week, Gazprom CEO Alexei Miller continued his push for a new contract at meetings with CNPC's chairman Wang Yilin and Vice Premier Zhang Gaoli.

In a statement, Gazprom said negotiations "are steadily moving forward," but the daily Kommersant cited industry sources calling it "part of the information campaign."

Another preliminary accord

Analysts say Putin's meeting with President Xi Jinping is unlikely to produce anything more than another preliminary accord, in part because of troubles with the contract for the eastern line to supply China's industrialized northeast.

On Aug. 21, a Chinese official dampened hopes for a contract on the western line at the Xi-Putin meeting. A signing in September "is not obligatory, if one takes into account the regularity of the two leaders' meetings," said Ling Ji, Ministry of Commerce director for Eurasian affairs.

Ling instead stressed the importance of implementing the contract for the eastern route, noting that the plunge in oil prices had complicated negotiations "to a considerable degree," Interfax reported.

At a press conference in Beijing last week, Russian Ambassador Andrei Denisov voiced confidence that a new gas deal would be signed "at the last minute" along with some 20 other agreements.

The western line through Russia's mountainous Altai region would add 30 bcm of supplies annually to the 38 bcm already promised from the east.

While the Altai route has been a priority for Russia because of its ready resources in West Siberia, China has no need for more gas in remote Xinjiang.

Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington, said preliminary agreements mean little to the Chinese side despite their apparent importance to Russia, as long as problems with the eastern route persist.

"They're mainly being polite when the Russians bring up the western route," Chow said. "It doesn't mean that they're sincerely and earnestly interested in the western route. Those are two different things."

Analysts say conditions affecting Russia and the gas market have changed dramatically since the eastern pipeline deal was signed in May 2014.

"The world has completely flipped since then," Chow said.

At the time, Russian reports estimated that the starting price for gas under the 30-year contract would be U.S. $350 (2,241 yuan per thousand cubic meters [mcm]), largely in line with Gazprom's export prices for Europe.

Since then, oil-linked gas prices have plunged, putting pressure on Russia to renegotiate the contract.

Earlier this month, Gazprom lowered its forecast for this year's average export price to U.S. $235-242 (1,505-1,550 yuan) per mcm, over 30 percent below China's presumed starting price last year.

On Aug. 10, the London-based Financial Times reported that Gazprom had not negotiated a lower limit for price adjustments in case of a prolonged slump in the oil market, suggesting that gas rates could fall as low as $175 (1,120 yuan) per mcm.

That could leave Gazprom with huge losses on the eastern pipeline, known as the Power of Siberia project, which Putin estimated would cost U.S. $55 billion (352.2 billion yuan) for infrastructure on Russian territory.

An expected prepayment of U.S. $25 billion (160 billion yuan) from China to finance Russia's construction never materialized, leaving Gazprom with few options at a time when Western sanctions over Ukraine have squeezed Russian finances.

Unwilling to bear risks

It is unclear whether China has delayed financing until Gazprom lowers its prices, but analysts believe China's banks have been unwilling to bear Russian risks in any case.

"I think the eastern pipeline's in some trouble," said Mikkal Herberg, energy security research director at the Seattle-based National Bureau of Asian Research. Herberg cited reports that some of the limited work on the project has already stopped.

A second pipeline project may only add to Russia's cost burdens.

"It's hard for me to believe they would sign anything that would be called a contract for the western pipeline," Herberg said.

The launch of the 3,247-kilometer (2,017-mile) Power of Siberia pipeline, initially expected under the contract by end-2018, has been pushed back by six months, the Russian daily Vedomosti reported.

An Interfax report suggested that deliveries might not start until mid-2021, "depending on whether the infrastructure is ready."

Although Gazprom denies it has sought state funding for the Power of Siberia project, Putin has ordered the government to complete a plan by Sept. 1 to finance the costs.

Chow said there is still value in the ambitious project, which would open East Siberia for development, but state resources to cover losses are in short supply.

"Of course, the government can subsidize economically sub-optimal projects, but there's a limit on what they can subsidize," he said. "They can't do everything they want to do."

Western sanctions and Russia's recession have spurred competition among oil companies and major industries for state funds that have been stretched thin.

China's economic slowdown has also weakened the country's gas demand growth, cutting deep into forecasts that underpinned Russia's grand plans.

After years of double-digit growth rates, China's gas consumption rose by only 2.1 percent in the first half of the year, according to official figures.

"Everything suggests slowing down fairly dramatically from what was expected," Herberg said. "They're having trouble marketing gas at the price they need to justify importing gas."

Last week, Miller floated a new option, offering to boost gas supplies in the east with a pipeline from Russia's Sakhalin Island projects in the Far East.

The latest scheme follows the failure of Russian plans to build costly new liquefied natural gas (LNG) plants for the resources, now that world markets are awash with LNG supplies.

The heavy investments that China has already made in resources and pipelines from Central Asia are also likely to make imports from Turkmenistan a priority over Russian gas, but both sources may face demands to cut prices if oil continues to sink.

Despite the many challenges for Russia on the existing contract for the eastern project, it is expected to paper the way for Putin's visit with another preliminary accord for the western line, if only to send a message to the European market that it can sell its gas to China instead.

But without major price concessions or a pickup in demand, Gazprom could be years away from signing a new contract.

“I think it's going to be a meaningless agreement," Chow said.

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