May 22nd, 2014
By now, I’m sure you’ve heard of the Russia-China gas deal that is estimated at $400 billion over the course of 30 years, starting in 2018. There are also a lot of speculations and confusion over the term of the deal, who has got the upper hand, etc. I’d like to chime in on a few points here:
1. Yes, it’s a big deal, but China’s energy appetite is even bigger.
Russia will provide 38 bcm (billion cubic meters) of natural gas per year to China, but it’ll take some time after 2018 to ramp up to that level. Alexei Miller, chief executive of Gazprom, estimated the deal at $400 million. Putin said that ““This is the largest contract in the history of the gas industry of the former USSR and the Russian Federation.” (Washington Post)
This is, however, not the biggest gas deal for China. China began importing gas from Turkmenistan at the end of 2009, under a 30-year contract signed in July 2007 at the level of 30 bcm/year. In late 2011, China and Turkmenistan signed another agreement that added another 34 Bcm/year, which brings the total of Turkmen gas to China to nearly 65 Bcm/ year. 65 billion cubic meters – that’s a big deal!
Yet when you compare it to China’s energy appetite, it’s almost a drop in the bucket. Natural gas on the whole makes up about 4% of China’s total primary energy consumption. China is trying to raise the natural gas percentage in the energy mix to 7.5%, and reduce the coal percentage from 70% to 65% by the end of 2015 — a goal many experts think they will not achieve. The government expects the natural gas use to rise to 420 bcm by 2020. If China can get 38 bcm from Russia by 2020, it’ll be 9% of the natural gas use, of the 7-8% of the total energy consumption — that is, 0.0068.
2. What’s the price? Who got a better deal?
We do not know the specific terms of the contract. Putin mentioned that the two sides negotiated till 3 AM (as in the morning), then start all over again. The fact that they reached an agreement the next day suggests that it is a rushed deal, even though the deal is 10 years in the making.
There are still some facts that came out in the reports.
A. The price is likely to be around $12/mmBtu.
ITAR-TASS, a major Russia news agency reported the following:
Gazprom expected to get $400 as a starting price for 1 thousand cu. m. of gas for China. The Chinese side wanted to buy gas for $350-360.
The price of Russian gas for China would be no less than $400 for 1,000 cubic meters, an expert of the Eurasian Development Research Center of the Chinese State Council said in April. Inclusive of infrastructure costs, supplies to China would cost no less than $400 for 1,000 cubic meters, given Russia’s export price of $380 for 1,000 cubic meters, he said.
Deputy Director of the Institute of Energy Strategy Alexei Belogoryev then estimated the contract price at $350-400 for 1,000 cubic meters. Director of the Energy Development Fund Sergei Pikin predicted a price of about $380.
Any of the scenario above would convert to a price of around $12/mmBtu.
Just to put this number in context for you: in 2013, the gas from Myanmar to China has a delivered price of $11.81/mmBtu; Turkmen gas averaged $9.55/mmBtu; Uzbek gas averaged $8.83/mmBtu, according to customs data. So the Russian gas is not as cheap as the Chinese expected.
B. The price is pegged to oil and oil products.
As BBC and a number of other news agencies reported, Putin said specifically that the price is pegged to oil, which is something China does not want.
President Putin said in a statement to the Russian news channel Rossiya: “The price is satisfactory for both sides.
“It is tied, like it is envisaged in all our international contracts with Western partners, specifically our partners in Western Europe, to the market price on oil and oil products. It is an absolutely calibrated, general formula for pricing.”
C. This sets the benchmark price for LNG imports.
We have seen a convergence of price expectation for gas in China: $10-11/ mmBtu, or $12/mmBtu when it reaches eastern China. This is going to be the benchmark price against which future LNG imports would be measured against, and has great significance for U.S. companies planning to export to China.
3. Who needs whom more in this case? And why didn’t China get a better deal?
Europe has roughly 30% dependency on Russia for natural gas, but as much as 76% of Russia’s natural gas goes to Western Europe, which means Russia in fact has a greater need for diversification of their export. With the Ukraine crisis putting Russia sharply at odds with U.S. and Western Europe, Russia desperately needs to find an alternative market for its natural gas, which is why this deal, stalled for a decade, is all of sudden at the forefront of Putin’s agenda now.
On the other hand, China has a massive population with increasing energy demand — not just any energy, they want something cleaner burning than coal, so they’ve been propelled to go on huge energy quests all over the world, and Russia has the largest natural gas reserve.
From the analysis above, it seems like Russia has got a better deal: they’ve got the price pegged to oil and at a pretty high price; they are able to diversify the export and relieve some of the pressure since Crimea crisis; they manage to conclude the deal during Putin’s visit — just imagine what a failed deal would do to Putin’s image domestically.
This leads some to speculate whether or not China essentially helped Russia out of a difficult situation in exchange for other kinds of favors: What leverage does Russia have vis-a-vis China? Energy and military. Is it possible that towards the end of the negotiation, China lets Russia take the better side of the gas deal in order to reach a separate agreement regarding military technology? It is plausible.
It is also possible that CNPC just has less bargaining experience and power than Gazprom. Even though from an objective perspective, Russia and Gazprom need this deal more than China does, Putin and Gazprom leadership seem to be in their own reality bubble, unaware of the exact magnitude of the difficulties they are in.
Gazprom leadership reportedly were reluctant to turn to the east. And Putin himself, as seen from his speech to the Federal Assembly on the annexation of Crimea, almost lives in an alternative universe. He emotionally talked about “the graves of Russian soldiers”, and “Millions of people went to bed in one country and awoke in different ones [after the USSR’s collapse]…, while the Russian nation became one of the biggest, if not the biggest ethnic group in the world to be divided by borders.” as if Putin is preparing to annex whichever land where ethnically Russia people live. It is possible that Gazprom walked into the negotiation room convinced that they have the upper hand, that they possess all the power, and that panache in the end helped them emerge victorious.