BMI View : We believe Russia has made significant concessions to China in order to secure the geopolitical and diplomatic dividends of a Sino-Russian gas supply agreement. The gas agreement not only cements Russia's strategic pivot towards Asian energy markets, but also acts as a potent political symbol as Western powers increasingly seek to economically isolate Russia.
The USD400bn Sino-Russian gas deal agreed on May 21 is a symbolic diplomatic victory for Russia. In the midst of European threats to reduce Russian share in the continent's gas market, Russia has secured a new market that will be the second largest after Germany with China's agreement to take 38bcm of Russian gas for 30 years. It also reflects Russia's success in securing an energy ally in China as Europe threatens to use the energy card to weaken Russia's position in Ukraine.
It is also a commercially important deal for Russia's Gazprom, a major source of revenue for the Russian state budget. The long-term supply agreement with China will provide Gazprom with a steady stream of revenue as European contracts approach expiry.
Russian Energy Minister Alexander Novak also stated that China could pay USD25bn in advance for this gas supply - one of Russia's reported conditions in the final moments to close the deal. As with China's advance oil payment to Russia's Rosneft that facilitated the construction of the ESPO pipeline to bring Russian oil into China, this advance to Gazprom could also help finance the Altai pipeline to bring gas from Siberia to China. This is particularly significantly as western banks are increasingly cautious of large loans to Russian firms, given growing risks that the West could tighten sanctions on Russia if the situation in Ukraine deteriorates.
However, we believe that this deal - eight years in the making - was achieved with greater concessions from Russia than China: on pricing and possible allowance for greater Chinese participation in Russia's upstream gas projects.
Breaking The Pricing Conundrum
Neither side has revealed the final price formula agreed on in concluding the agreement. However, according to an anonymous source quoted by Interfax, the final price is likely between USD350.00 per thousand cubic metres (Mcm) - or about USD9.92/mnBTU - and USD380.50/Mcm (USD10.78/mnBTU). The latter is the average price that Europe currently pays.
This is significantly higher than the USD260.00/mcm (USD7.37/mnBTU) that China was allegedly pressing for when negotiations began nearly eight years ago. While Russia appears to have succeeded in pushing for prices near European levels, we note that China also gains from the USD9.91-10.78/mnBTU range that the two countries most likely agreed on: China is currently paying an average of USD11.85/mnBTU for its gas imports. Given Russia's longstanding reluctance to lower its gas selling price - which translates into higher state revenues, this can be seen as a commercial victory for China.
| A Good Bargain For China |
|China's Current Gas Import Prices And Russia Gas Price Possibility (USD/mnBTU)|
It highlights the strengthening of China's negotiating power in the eight years since negotiations began in earnest with Russia:
Beginning of gas flows from Central Asia, buttressed by pipeline expansions;
Expansion of its LNG import capacity;
Expected growth in domestic gas production, led by tight gas and other unconventional sources.
In contrast, Russia's political standoff with Europe over Ukraine and its possible commercial ramifications have increased the geopolitical importance of a Sino-Russian gas deal than when negotiations began.
| Better Supply Picture Boosts Chinese Position |
|China - Total Possible Gas Supply Given Existing And Planned Gas Transportation Capacity (bcm)|
Chinese Stakes In Gas Fields
We believe that Russia has most likely conceded to Chinese request for equity stakes in Russian gas field developments to secure the deal. While the exact terms of the agreement are not disclosed, China's oil agreement via state-owned China National Petroleum Corporation (CNPC) and Rosneft sets a precedent for what may follow from the Sino-Russia gas deal. After closing a USD270mn oil deal in 2013, CNPC was offered a 30% stake in Rosneft's fully-owned subsidiary Taas-Yuryakh, which operates the Srednebotuobinskoye field, with reserves of up to 1bn bbl, in East Siberia.
CNPC has targeted greater involvement in Russia's upstream. It had reportedly considered spending up to USD10bn on minority shares in Siberian fields operated by Gazprom and Rosneft. Unlike Rosneft, however, Gazprom had been reluctant to allow Chinese participation.
We believe that Gazprom has weakened its stance on Chinese equity involvement to close the deal. China's stronger bargaining position would have allowed it to push this agenda - diversifying its oil companies' production portfolio - in exchange for price concession. Prior to the announcement of the gas deal, Gazprom had offered Chinese companies a share in its planned Vladivostok LNG project, though the offer appears to exclude equity stakes in the fields that would supply the plant's feedstock. We expect Chinese firms to take up direct stakes in gas fields, which would allow them to book reserves and boost their financial value.
Allowing greater Chinese involvement would reduce Gazprom's net commercial gains from the gas deal. Additionally, it also traverses Russia's longstanding policy of reserving its hydrocarbon riches for itself. Nonetheless, we note that entry into the Chinese market and Chinese finance would be worth this compromise, given the high risks of western finance drying up. Moreover, the accessibility of Chinese finance, which we expect the deal to facilitated, will help speed up the rate of project development. China has specifically requested for gas to be supplied from East Siberia instead of established production centres in West Siberia. Field developments in the underdeveloped region will have to accelerate to meet Russia's goal of supplying China by 2018-2020.
A Greater Far East
The Chinese deal provides the guarantee for Gazprom to proceed with its Far Eastern Gas Programme. The Vladivostok LNG project had provided the impetus for East Siberian projects, flanked by expansion of gas infrastructure in the Irkutsk region and development of the 1.3tcm Chayanda field that has targeted 2018 for completion. Having initially approached Japanese investors, the Vladivostok LNG project hit a roadblock after Gazprom failed to secure commitment from Japan. Reports that Mitsubishi and Mitsui have pulled out of financing Yamal LNG - which already has off take agreements - increased the downside risk to Vladivostok's progress.
Chinese involvement in Vladivostok, likely offered as a carrot to complete the deal, will help advance the project. In total, the USD55bn investment that will be generated directly as a result of the Sino-Russian deal, and the USD38bn Gazprom had previously factored in for East Siberia's gas development, will support growth in the Russian Far East between 2014 to 2020, when gas projects are expected begin commercial production.