GIF Inside Story: Russia in talks with China over additional gas supplies via Power of Siberia

LONDON (ICIS)–Russian producer Gazprom and China’s CNPC are in discussions for additional gas deliveries to northeast China through the Power of Siberia pipeline but price remains a sticking point amid rising competition from LNG.

“China has expressed interest in importing additional supplies of Russian gas via the Power of Siberia gas pipeline,” Gazprom told ICIS in early June.

“Negotiations are in progress between Gazprom and CNPC. The exact volume of additional supplies has not been specified yet, and an agreement on the price is expected to be reached shortly.”

Russia has been looking for several years to diversify its export markets away from its core European market to the Asia-Pacific region and specifically China. In May 2014, Gazprom signed a contract worth $400bn (€359bn) with Chinese CNPC to supply 38 billion cubic metres (bcm)/year through the Power of Siberia pipeline (the so-called Eastern Route) over 30 years starting in 2018-2020.

First deliveries are expected to start on 1 December, with an initial flow rate of 10 million cubic metres (mcm)/day, meaning that Gazprom could deliver around 310mcm of gas to China this year.

It will take several years for flows to reach full capacity from Russia to China and the additional gas could be made available during the ramp-up period, although Gazprom said the newly negotiated volumes are beyond the contractual obligations agreed upon in 2014.

Back in 2014, the companies did not publicise the price, other than saying that it was oil-indexed and the contract included a take-or-pay clause.

Russian pipeline gas will sit alongside flows into China from Myanmar and those through the three-line Central Asia-China Gas pipeline from Kazakhstan, Uzbekistan, and – predominantly – Turkmenistan.

The Power of Siberia will be the first major pipeline that supplies northeast China, and connects the region to the major grid. It will cross a range of provinces along the east coast from Heihe to Shanghai.

The price China pays for LNG deliveries and Central Asian pipeline gas are likely to affect the negotiations. Experts think the main competition will come from LNG.

Gazprom also said that deliveries through Power of Siberia would only reach the full contracted capacity of 38 billion cubic metres (bcm)/year in 2025.

From 2024, the ramp-up profile of production at the Chayandinskoye and Kovyktinskoye gas fields, which feed the Power of Siberia, would allow for production of above the 38bcm/year contracted by CNPC from Gazprom.

For China to agree to take on the additional volumes from the Chayadinskoye and Kovyktinskoye fields, the price would have to be considered sufficiently attractive.

Previous price discussions have been lengthy and CNPC may consider that current market conditions justify a lower price for additional volumes compared to when the first contract price was agreed.

The border price should be lower than $7/MMBtu, according to Dr Keun Wood Paik from the Oxford Energy Institute.

It will need to be at an attractive level to be able to compete with LNG coming into the Bohai Bay in northeast China. China pays a wide range of long-term import prices for LNG based on the timing of the agreement. Paik said $8/MMBtu was an important figure for East Asian buyers when looking at future LNG import pricing.

ALTAL PIPELINE

Gazprom has also recently revived the possibility of sending gas to China through the Altai pipeline, also called Power of Siberia 2.

This pipeline would connect west China to the Yamal peninsula, which already supplies the Russian and European markets.

For the Altai pipeline, Russia and China agreed in principal to a 30bcm/year deal over 30 years, but have not yet agreed on the price.

“When we agree on the price with our Chinese partners, we will immediately launch this pipeline into construction,” Gazprom CEO Alexei Miller said on 28 June.

East-West Institute fellow Danila Bochkarev said Russian gas supplied to China through the potential Altai line could not compete with Turkmen gas, due to the abundance of cheap Turkmen gas into Western China priced around $5.28/MMBtu in 2016.

But this price increased to $6.10/MMBtu in 2018 and $7.07/MMBtu so far in 2019, according to Chinese customs data.

It will be crucial for Gazprom to prove in the coming years that it is a reliable supplier – in contrast with supply disruptions from Central Asia experienced through the winter 2017-18, which could indeed facilitate the conclusion of additional supply agreements, International Energy Agency energy analyst Gergely Molnar told ICIS.

CENTRAL ASIAN PIPED GAS

China gets the majority of its pipeline gas from Turkmenistan, Uzbekistan and Kazakhstan via the Central Asia-China pipeline.

The route is composed of three lines, lines A, B and C and a fourth line is planned. However, the completion of the fourth line called Line D has been delayed several times.

On 19 July, Uzbekneftegaz and CNPC agreed to accelerate the Uzbek section of the line. However, there could still be further delays to the completion of the line due to challenging multilateral transit negotiations between all countries involved (Turkmenistan, Uzbekistan, Tajikistan, Kyrgyzstan, China), coupled with difficult terrain, particularly in the mountainous regions of Tajikistan, which will involve the relatively costly construction of tunnels.

Delays in line D may help accelerate negotiations between Gazprom and CNPC or at least increase China’s motivation to reach a compromise with Gazprom.

“The delay of the line D from Turkmenistan to China offers an excellent opportunity for Gazprom to compete against central Asian gas. Turkmenistan has made a big mistake by postponing the D line construction. Turkmenistan’s decision to move away from one gas market and to develop a new market by supporting the TAPI project with Afghanistan, Pakistan and India raises the question mark on Turkmenistan’s money spending wisdom,” Paik told ICIS.

Turkmenistan’s ability and willingness to supply larger relatively cheap volumes to China will also play a role in the Gazprom-CNPC negotiations as in 2018 the bulk of increase of Chinese exports from Central Asia came from Kazakhstan and Uzbekistan, not from Turkmenistan, according to Bochkarev. Gazprom’s new contract with Turkmenistan for the supply of 5.5bcm/year until July 2024 may limit additional Turkmen volumes to China going via the Line D, as Molnar underlined.

“These uncertainties are possibly increasing the interest of China in Russian gas supplies,” he added.

Jack Sharples, Research Fellow at the Oxford Energy Institute, said price competition from Central Asia should not be critical for Gazprom because Central Asian supplies to China are already flowing at virtually full capacity through lines A, B and C of the Central Asia-China pipeline. Therefore, supplies from Russia would be in addition to, rather than in competition with, those Central Asian supplies, he added.

Whether Gazprom can offer a cheaper price than Central Asia depends on border prices negotiated with CNPC, Paik added.

Other factors likely to affect the price negotiations include the state of the Chinese economy and how fast Beijing wants to switch from coal to gas.

LNG COMPETITION

Most of the 38bcm/year of Power of Siberia capacity destined to supply the highest three provinces on the northeast coast of China is quite protected from LNG competition as the provinces are not well connected to the rest of the Chinese gas grid.

But out of the 38bcm, 13bcm would go further south as far as the Shanghai region and so will face more competition from LNG delivered to this area, according to Paik.

As for gas via the Altai pipe, coming into northwest China, it would face competition from both LNG and Central Asian pipe gas. Gazprom will also have to offer a border price low enough to make the final price attractive to CNPC. This is because the Chinese domestic transportation tariff of $3.5-4/MMBtu is high due to the long distance between northwest China and the eastern coast, Paik said.

Sharples agreed, saying that in order for the Altai pipe gas to be competitive, its border price must be substantially lower than the border price for Power of Siberia, because of the additional transportation distance in China itself.

IMPACT ON EUROPE

The threat from Gazprom’s potential status as a swing supplier between EU and Chinese markets is exaggerated, as there is no sign of compromise between Gazprom and CNPC on the Altai pipe, said Paik.

If the Altai pipe is agreed, then Gazprom’s swing supplier position will be a real thing, he added.

Given the substantial investments Gazprom made in new pipes to bring Yamal gas to Europe and with the netback likely to be higher for Yamal gas sent to Europe than to China, it would make more commercial sense for Gazprom to maximise its exports to Europe, Sharples said.

Only if substantial spare capacity at Yamal emerges (due to a lack of European demand for the Yamal gas) will the Altai route become more commercially attractive for Gazprom, he added.

However, Europe may still play a role in the speed of Gazprom-CNPC negotiations, according to Bochkarev.

“The demand for Russian gas in Europe will determine Russia’s urgency to promoting the Altai route. Additional demand in Europe will reduce Russia’s appetite for too many price concessions on the Altai route supplies,” he added.

Gazprom-CNPC negotiations could be difficult and protracted. On the one side sits China seeking lower prices than through the Power of Siberia to compensate for higher transport costs and using Central Asian cheap gas and LNG prices as “benchmarks” for their negotiating position. On the other side is Russia seeking prices as close as possible to their European prices.

Another factor affecting these negotiations will be the resolution of Russia’s transit talks with Ukraine after the end of 2019, according to Bochkarev.

COMPETING FOR CHINA

China’s gas demand has grown rapidly in recent years following the 13th five-year plan running from 2016 to 2020 that pushed for the move from coal to gas.

The most substantial rise was an 18% year-on-year increase to 280bcm in 2018, according to Chinese government data. Going forward, much will depend on economic performance but increases of more than 10% are expected over the coming years.

The International Energy Agency expects China’s natural gas consumption to grow from 280bcm in 2018 to 450bcm in 2024.

“The rapidly growing Chinese gas demand will be met by a combination of rising domestic supply and an increasing reliance on both LNG and pipeline gas imports, with diversification being a key component of China’s gas strategy,” according to Molnar. China will become in the next five years both the world’s largest LNG importer and the world’s largest piped gas importer, according to the Agency’s Gas 2019 market report.

China has a diverse pool of LNG suppliers for spot cargos and its biggest long-term contracts are with Qatar and Australia. It relies on long-term contracts predominantly indexed to oil to ensure security of supply and that will not change in the future. So far in 2019, a spot cargo in East Asia cost an average of $5.61/MMBtu, a 42% drop from 2018, LNG Edge showed. It is fair to assume China currently pays a price in this range for its spot cargos, according to ICIS analysts. The average price for a cargo delivered to Japan as part of a long-term oil-indexed contract is $10.38/MMBtu, roughly the same as in 2018, which offers some indication of an average price China is likely to pay.

LNG is and will be a major source of gas supply to China, with the country being the third-largest importer of LNG in the world – both Russian and Turkmen piped gas will have to compete with LNG.

However, Paik said that the Chinese, having built pipe infrastructure within China and having invested in transit lines and production in Central Asia, will tend to prioritise piped gas imports unless the competitive advantage of LNG is significant.

Piped gas volumes into China from Central Asia in 2018, at 48.3bcm, represented less than 65% of the volume of LNG imports in 2018 according to Chinese GAC customs figures and LNG Edge.