Putin Plan for Second China Gas Pipe Will Depend on Price

By Elena Mazneva 

Russia’s plan to build a second gas pipeline to China would cement President Vladimir Putin’s policy of tilting energy exports toward Asia. Fulfilling his goal will probably come at a price.
The pipeline from western Siberia to China has long been a Russian aim for two reasons -- it’s a relatively short distance from the fields to China’s border and the same deposits also serve European customers, allowing state gas company OAO Gazprom (GAZP) to switch supplies between the two markets.
China’s been less keen. The western route delivers gas to the country’s arid west, thousands of miles from industrial heartlands on the coast. That’s why the two countries agreed to a pipeline from eastern Siberia earlier this year with less ground to cover on the Chinese side of the border.
To get a final deal for the second route, Russia will have to
offer a very attractive price compared with existing exports contracts, said Alexander Kornilov, an Alfa Bank energy analyst in Moscow.
“The new deal is less attractive to China, Gazprom might need to agree on a serious discount to get the contract,” Kornilov said yesterday in an interview, adding he was skeptical of Gazprom’s statement that a binding contract could be reached within a year.

Photographer: Andrey Rudakov/Bloomberg

Alexey Miller, Chief Executive Officer of OAO Gazprom.

The preliminary agreement to build the second Russia-China link was announced by Putin and President Xi Jinping at an economic summit in Beijing two days ago. The pipeline would deliver as much as 30 billion cubic meters of gas a year for 30 years, adding to the 38 billion agreed in the first supply contract. That would see China overtake Germany as Russia’s largest gas customer.

Difficult Element

The framework deal between Gazprom and China National Petroleum Corp., one of 17 struck during Putin’s summit with Xi, didn’t include any price agreement. As negotiators who spent a decade trying to agree on the first contract can testify that’s the most difficult element of any deal.
The base price in the contract signed earlier this year is about $360 per 1,000 cubic meters (about $10 a million British thermal units), two Russian officials said in July. While precise payments will vary to reflect changes in global oil prices, that’s near the average $366 per 1,000 cubic meters that Gazprom charged Germany last year, which pays one of the lowest prices in Europe.
Gazprom Chief Executive Officer Alexey Miller told reporters after the signing that a binding contract would be completed next year. Deliveries would start four to six years after a final deal.

Optimistic Timetable

For the second contract, China would be interested in getting a 20 percent discount to the current European price, or about $8 per million Btu, said Gordon Kwan, a Hong Kong-based analyst at Nomura Holdings Inc. Chances for the new deal by the middle of the next year are high, Kwan said today by e-mail.
“Of course much remains to be decided, but if the Chinese have signed up to at least the logic of a potential pipeline from Western Siberia, that’s a major step forward for the Russian side,” Jonathan Stern, a senior research fellow at the Oxford Institute for Energy Studies, said by e-mail.
Still, that timetable is optimistic given the history of the first pipeline project, said Valery Nesterov, an analyst at Sberbank Investment Research in Moscow. This week’s announcement should be seen in the context of Russia’s difficult relationship with Europe because of the Ukraine crisis, he said.
“It’s more a PR action now, more a war of nerves” with Europe and the U.S., Nesterov said.

Price Competition

Another complication is an existing pipeline linking China with Turkmenistan. Under agreements to expand that link, by 2020 China will import 65 billion cubic meters from the former Soviet republic, which has become a competitor for Russia in Asian energy markets.
It’s not clear that China needs all that Turkmen gas as well as a second pipeline from Russia and liquefied natural gas imports contracted from Australia and elsewhere.
“There is a general view out there that China is going to underwrite all these projects, that Chinese demand is insatiable,” Adrian Wood, a Sydney-based analyst at Macquarie Group Ltd., said yesterday. “We’ve never shared that view.”
A new 2,600-kilometer (1,615-mile) gas link from West Siberia to the Chinese border could cost about $14 billion, Miller said in 2010 after Gazprom and CNPC signed a similar agreement on gas supplies, also planning to close the deal in a year.

Stretch Gazprom

Even if the second Russia-China route goes ahead now, building two major pipelines to the Asian neighbor while trying to complete the South Stream link from Russia to Europe could stretch Gazprom’s financial and technical capabilities.
All three projects would cost Gazprom about $90 billion, Alpha’s Kornilov estimates. That’s one reason Russia had sought a $25 billion pre-payment from CNPC to help pay for the first pipeline. Because China tried to link that to a gas-price discount it’s no longer on the table, Miller said.
By giving up upfront payments from China to protect its pricing power, Gazprom will be forced to prioritize projects with the quickest return, Russia’s Otkritie Bank (NMOS) wrote in an e-mailed note.
Gazprom press service declined to comment on the issue.