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Sweet-and-Sour Sino-Russian Gas Project

By Anna Tikhonova

The 4000 km-long “Power of Siberia” pipeline stretching from Chayadinskoe and Kovytskoe gas fields in Eastern Siberia to Vladivostok prior to entering China emerged as a $400 bln deal resulting from two decades of deliberations between Russia and China.

 

While the strategic partnership on cooperation was signed by Yeltsin and Jiang back in 1996, it was only after Putin’s visit to Beijing in 2006 that Russia started considering the importance of neighboring Asian markets. Thus, in 2007 the Kremlin-run Eastern Gas Program was conceived as a framework for greenfield developments in Eastern Siberia, the area that had witnessed little action despite being a target of political dithyrambs sang since the Soviet time. Lack of infrastructure and remote location from the European market (which was of strategic importance following the collapse of the USSR due to remaining infrastructure in the FSU space) historically predetermined low level of involvement: even today regional gas potential is only explored at about 7%. Thus, Eastern Gas Program not only introduced preferential tax regimes whose absence used to serve as a barrier for entry for exploration and development companies but created an incentive for further gasification of the region which, following the commercial logic, would improve regional living standards helping to create new industries, enterprises and competitive products.

 

U-turning to China?

 

Eastern Siberian field did not attract much attention during the bidding round given the severe conditions of permafrost which considerably complicate E&P while making sunk costs skyrocket. For this reason, it was only BP and Gazprom, both backed by significant expertise in similar kind of projects, whose claims for the exploration blocks did not seem farfetched. Knowing about the long-lasting relations of mutual understanding and support between the State elite and Gazprom, who is often referred to as the “Kremlin’s wallet,” one did not need a crystal ball to tell which company would be granted the right to develop the fields possessing about 80bln barrels of oil equivalent in undiscovered reserves.

 

“Power of Siberia” has become Gazprom’s largest project and is expected to deliver 65 bcm to China what accounts for a quarter of its annual gas demand. At the same time, it is difficult to say whether this bold move should be considered to be a true pivot to China rather than a mere attempt to find new markets in the view of falling post-crisis European energy demand. Just about a month ago Gazprom celebrated its 40th anniversary of successful trade relations with France, however, speaking about the multilateral EU level, one can feel a growing fear of unreliability of Russian gas delivery stemming from the disappointment over gas interruptions in 2006 and 2009 caused by the so-called gas war with Ukraine. Since then, the EU made energy an issue of common responsibility for the European member states, using the Lisbon Treaty as a framework for market liberalization and unbundling. However, Gazprom’s monopoly over pipeline till the final port of delivery in Austrian Baumgarten and its refusal of TPA (third party access) agreements still separates European market. In order to ensure its security of supply, Europe is actively looking for alternative markets, hoping that shale revolution in the USA as well as such emerging producers as Mozambique and Tanzania will be able to contribute to its diversification strategy. Also, the recent Crimean crisis entailed the devaluation of rubble compared to the US$ making Gazprom lose 20% of its profit, i.e. $300 bln in August 2015 alone. In this respect, it seems more relevant to view an ‘historic’ deal with China as a product of political competition with the West rather than as an organic project reflecting the state of the Russian gas market. The political benefits of Russia expanding its influence in SCO in order to counter joint effort of NATO and the EU, while also securing the Chinese vote in the UN SC seem more optimistic than Gazprom’s commercial losses stemming from the Chinese failure to finance the pipeline construction by pre-paying $25 bln as was stated in the initial contract.

 

Who benefits the most?

 

Chinese inability to provide timely funding of the project as a pre-payment of the future gas delivery stripped it of the opportunity to demonstrate its economic power. At the same time, by satisfying a quarter of its energy demand through purchases Russian gas makes China seem a reliable party with respect to its COP21 pledges of wagging a “war on pollution”. For Russia, however, the final outcome of the gas deal seems to be less exciting. Even though “Power of Siberia” pipeline is likely to cause problems for petrodollar given the yuan-to-rubble conversion agreed upon by VTB and the Bank of China, however, it does not make the project any less costly for Gazprom. Moreover, the lengthy negotiations that resulted from the conflicting desires of Gazprom to charge China a European price averaging 380$/bcm and the Chinese insistence on the incorporation of Henry Hub pricing mechanism made Gazprom lose its comparative advantage. In other words, IEA predicts that by the time the “Power of Siberia” starts exports, its capacity will comprise only a quarter of Australian and American LNG accompanied by increased gas flows from Turkmen Central Asia-China pipeline. Moreover, the fear of political insinuations in the event of China ‘robbing’ the EU for gas, accounted for Gazprom’s departure from the Altai pipeline which would connect Chinese and European market, giving Russia some leverage vis-а-vis Europe. Thus, coming from the Eastern rather than Western Siberia, the so-called “Sila Sibiri” does not even solve the issue of 170bcm oversupply “gas bubble” which resulted from Gazprom’s increased capacity coinciding with the falling domestic and foreign demand following the post-2008 economic stagnation and increased energy-efficiency.

 

“Gazprom: the dreams come true”?

 

Today, when the oil price has plummeted below 30$/barrel and when most of long-term contracts are still linked to oil rather than being traded on gas-for-gas market, the majority of gas producers faces a dilemma: to maximize price or volume. Without thinking twice, Gazprom decided to find a ‘middle ground’ and maximize both. However, this strategy had an adverse impact on its competitiveness. By trying to get the most out of the Sino-Russian project, Gazprom for some time ignored the situation on the domestic market and is currently being elbowed out from its ‘place in the sun’ by Novatek and Rosneft with their increasingly aggressive aspirations for expansion in the Arctic and LNG sectors. At the same time, limited commercial success of the “Power of Siberia” coupled with low oil price can create the window of opportunity for Gazprom to re-examine its contractual structure and to use its managerial talent in order to depart from the internal attitude of the “national heritage” sustaining social contract and to engage into more commercially viable business initiatives responsive to the global market environment.

 

 

RIAC

 

 

07.03.2016

 

 

 

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