GIF Inside Story: Power of Siberia 2’s new route makes Russian gas supplies to China more feasible

Diane Pallardy


LONDON (ICIS)–The new route for Russia’s Power of Siberia 2 gas pipeline to China via Mongolia may give exporter Gazprom a strong competitive edge in the long run.

The project aimed at supplying natural gas to China from fields in western Siberia is moving to the pre-investment stage after Russian President Vladimir Putin gave the green light to the state-owned gas producer on 27 March.

Instead of entering China from the far west, over 3,200km away from Beijing and where central Asian pipeline gas enters China, Russian gas would arrive just 560km away from the capital, in the most populous region where demand is the highest and expected to grow.

In its investor day presentation, Gazprom showed plans to launch the pipeline in 2030, but experts said price talks with China can take years, even decades. Although price negotiation with China is still likely to be tough the stakes are high for all the three countries involved.

Russia’s largest reserves are located in west Siberia in the Yamal peninsula and already feed the European Union.

Connecting these giant reserves would not strictly speaking put Gazprom in a position of swing supplier. But it would give the gas giant flexibility to send volumes additional to those already committed to long-term contracts in Europe and China.

Securing its position in Asia may also help the Russian state-owned producer compensate for a potential drop in EU demand – Russia’s primary export market – as the EU strives to become carbon neutral by 2050.


Compared to the route crossing the Russian-Chinese western border, the one via Mongolia would be shorter and lead to China’s most populated area.

This reduces construction and transportation costs and so price negotiations can start lower.

“The choice of route makes an agreement with CNPC easier to achieve, due to reduced delivery distance inside China. With reduced transportation costs, CNPC might be willing to agree on a slightly higher price,” according to Jack Sharples, researcher at the Oxford Institute for Energy Studies (OIES).

This new route also allows Russian gas to be more competitive against China’s other pipeline supplies.

China’s largest pipeline imports currently come from Central Asia. Central Asian pipeline gas sourced in Kazakhstan, Uzbekistan and Turkmenistan cost an average $6.28/MMBtu in 2019, Chinese customs data showed.

Upstream production costs on Russia’s Yamal peninsula are around $0.50/MMBtu, and this will have gone down somewhat after the recent devaluation of the rouble, according to James Henderson, director of the natural gas research programme at OIES. There is a further $0.40-50/MMBtu of Mineral Extraction Tax to add.

Russia will also face lower competition from LNG as the vast majority of Chinese import terminals are located over 1,200km south of Beijing. “Chinese buyers have a range of oil-indexed LNG contracts. Slope prices to oil vary, with several in a range of 13-14.5%. Given the falling price of oil these contract prices will fall sharply later in the year. At $60/bbl oil this would mean a price range of above $8-9/MMBtu with a small constant. At $25/bbl these prices could fall below $4/MMBtu,” according to Ed Cox, global LNG editor at ICIS.

Gazprom has been bullish regarding its ambition to increase sales in Asia. CEO Alexei Miller told Putin in a recorded conversation published on Gazprom’s website that supplies to China via Power of Siberia 2 may total up to 50 billion cubic meters (bcm) per year, almost double the volumes preliminary agreed. Gazprom and China’s CNPC agreed in principle on a 30bcm/year contract for this route. A source from CNPC told ICIS in early April that “CNPC will not absorb more gas that is higher than the agreed 30bcm, given the current low market price levels”.

Chinese demand is expected to grow in the long term, as its commitment to environmental policies, including coal-to-gas switch holds firm despite the economic disruption caused by the coronavirus.

Russia may also be counting on creating gas demand in Mongolia, which relies on coal for 90% of its electricity production and where air pollution, particularly in capital Ulaanbaatar, is a significant public health problem.


According to the scenarios in the International Energy Agency’s (IEA) 2019 World Energy Outlook, published before the coronavirus outbreak, China is set to consume between 497 and 655bcm by 2040.

“Gas demand more than doubles over the next two decades, rising by 370bcm, more than the rest of developing Asia combined. There is an ongoing strong drive to use gas to reduce residential and industrial coal demand to improve air quality and reduce CO2 emissions.

“Although gas competes with electricity and the direct use of renewables in displacing coal in these sectors, its market share in industry and heat demand for buildings more than doubles over the period to 2040,” the report says.

Chinese domestic production could reach 306bcm in 2040, the IEA estimates. The Central Asia-China pipeline will have a total capacity of 85bcm per year when the 30bcm fourth line is built. China can receive another 12bcm per year via its pipeline with Myanmar. Russia’s Power of Siberia pipeline will send 38bcm as per contracted. All this represents 135bcm of pipeline import capacity.

When subtracting Chinese domestic production from the expected demand, we see a gap between 191-349bcm to be filled with imports. Given China’s 135bcm pipeline import capacity, there will still be a gap of at least 56bcm and up to 214bcm to be filled. This gap can be met with additional Russian pipeline volumes and LNG.


Mongolian transit became a possibility as China grew more confident in its political power.

“Before, China refused the Mongolian route option for fear of becoming dependent on the transit country. But now China is a very powerful force and so it considers it can withstand any attempt from Mongolia to blackmail it with reliable transit,” according to Igor Yushkov, expert of the National Energy Security Fund and the Financial University under the Government of the Russian Federation.

In addition, the trade war between the USA and China reinforced the need for Beijing to diversify supply sources and decrease its reliance on potentially unstable and unreliable routes.

The Malacca Strait carries around half of the world’s trade and is a choke point for energy tankers delivering China and Japan. As such, the shipping route is a regular target for pirates. Three countries share ownership of the strait, which adds to the tensions in the region. Central Asian pipeline gas runs from Turkmenistan to China and the fourth line will cross Tajikistan. Both Turkmenistan and Tajikistan share a border with Afghanistan, which means the risk of regional destabilisation is real, Yushkov said.

China’s current energy reform to reduce the share of coal in its energy mix increases demand for gas, but increasing LNG supplies via the Malacca Strait is an undesirable scenario, he added.

“The more China develops, the worse its relations with the USA, as Washington sees in Beijing a global political rival,” Yushkov added.

In this context, the supply routes to receive Russian pipeline gas and LNG from the Yamal and Gyda peninsulas in the Arctic are harder to block and a preferable option, Yushkov said. The Arctic route is also much shorter.

“It takes 17-19 days for a Yamal vessel to reach China via the northern sea route, whereas it would take at least a month or even longer if it went via Europe and the Suez Canal,” according to Olumide Ajayi, LNG analyst at ICIS.


As the main source fields for the Chinese pipeline have already developed to supply the European market, there is no additional costs for the production part of the project.

There is also already a pipeline network in place between the Yamal peninsula and the Altai region bordering Mongolia, which limits pipeline construction cost.

Russia could also easily build the Mongolian section, since it is more financially capable than Mongolia and has the required engineering expertise. The terrain in the Mongolian regions crossed by the pipeline is relatively flat desert steppes – a less costly than the other routes.

In exchange for building the Mongolian section, Russia would be able to negotiate a lower transit fee, like it did with Poland for the Yamal-Europe pipeline.

Gazprom financed the construction of the Yamal-Europe pipeline and to date Poland has received extremely low payments under a long-term transit contract, Yushkov said. Gazprom also retained a 48% stake in the Yamal-Europe pipeline.

This route creates a connection between Russia’s largest reserves in the Yamal peninsula and east Siberia. This offers more flexibility and enhances the reliability of domestic supplies, an objective that has long been in Gazprom’s plans, as Miller and president Vladimir Putin discussed in late March.

That will also allow Gazprom to more efficiently and timely respond to fluctuating key markets – the EU and China, EastWest Institute fellow Danila Bochkarev told ICIS.

The role of gas and decarbonised gases in the bloc’s energy transition is highly uncertain. Brussels prefers the electrification of the EU network wherever possible. The European Investment Bank will stop financing fossil fuel projects in 2021. The European Central Bank could align its lending policy with regulation which limits the role of gas in the energy transition.

Higher volumes to China would help Russia diversify its export portfolio, which could potentially ease tensions with the USA and EU member states like Poland and Baltic nations keen to block Russia’s attempts to keep or grow its market share.

In 2019, over 95% of Gazprom’s exports went to the west and less than 5% to the east, but as the company turns to the east it plans to adjust that balance to 70% west and 30% east, the company investor day presentation showed.

Potential market in Mongolia

The Mongolian capital Ulan Bator, home to nearly half of the Mongolian population, ranks among the most polluted cities in the world.

Mongolia was the seventh largest coal exporter in the world in 2018, according to the IEA 2019 coal report .

Gas could help reduce coal use but a is likely to be limited by the weak Mongolian economy and the poverty of its people.

Coal remains the most affordable heating fuel for the part of the population that pollutes the most. Poor suburban districts of Ulan Bator can only afford the most polluting raw coal to heat their yurts, and for those who cannot afford coal they burn tyres and other scraps.

High population density in Ulan Bator would limit costs of building gas infrastructure from scratch because the new network would only be in one city. But the construction of a gas network remains unlikely as local authorities have failed to build even the most basic infrastructure, such as water and sewage pipes in yurt districts. These are the poorest districts and sit around the city centre as more and more nomadic families move from the Gobi steppes to the capital city.

The Mongolian economy grew by 5.1% in 2019, according to the Mongolian National Statistics Office. But the growth is very fragile because it is driven by a major copper and gold mining project, Oyu Tolgoi, according to a source. “It is not a healthy growth of the economy. As the whole mining industry is based on ‘boom and bust’ cycles – poor management of a sudden wealth and without any savings for rainy days. Mongolia is not in the best shape to face hard times, let alone switching from coal to gas,” the source added.

Yet, air pollution remains a pressing problem for the Mongolian authorities.

“Coal-to-gas switch in Mongolia shall not be considered only from the direct cost perspective, but also from other effects such as pollution-related health costs, labour losses and other climate change and environmental issues. So coal-to-gas can be a bridge option towards 100% renewables,” according to Enkhbayar Shagdar, senior research fellow at the Economic Research Institute for Northeast Asia (ERINA).

Financing from outside the country may help develop gas infrastructure. Mongolia is one of the partner countries of Japan’s Joint Crediting Mechanism (JCM) for greenhouse gas emissions reductions, which purpose is to facilitate the diffusion of low-carbon technologies and reduce greenhouse gas emissions. Since 2011, 31 projects were initiated via the JCM, nine of them were solar projects, the JCM website shows .


The European market would remain Gazprom’s export basis even after the launch of Power of Siberia 2, according to Yushkov from the Moscow-based National Energy Security Fund.

The project does not put Gazprom in a position to dictate price and supply conditions in China and Europe as it will have to compete against other suppliers, Bochkarev from EastWest Institute corroborated.

Such big projects like Power of Siberia and Power of Siberia 2 are only developed on the basis of long-term contracts in which volumes are committed, Sharples pointed out. Gazprom also has long-term contractual commitments for its European exports.

“Therefore, Gazprom will have flexibility only to the extent that it has any spare production and transportation capacity, and buyers in Europe or China that are willing to take additional volumes on a short-term basis, to maximise the utilisation of those capacities,” Sharples added.


Although Russia and China are more likely to reach an agreement on this new route compared to the previous options, negotiations between the two neighbours for such projects can be lengthy.

“It took four years to move from a major terms and conditions agreement to a legally-binding gas supply contact for Power of Siberia, and just over five years to move from signing that contract to launching the first deliveries. The progress on Power of Siberia 2 could follow a similar pattern,” Sharples said.

According to Yushkov, the project may be launched 3-4 years after Gazprom and CNPC agreed on the price and signed the contract. But as the practice of negotiations with China has shown, price talks can continue not even for years but for decades, he added.

The progress of the project will also depend on the recovery of the global and Chinese economies after the coronavirus, according to Bochkarev. The virus forced many countries to go into quarantine and stop non-essential economic activities, which in turn decreased demand for power and gas and led to mass unemployment. “It will depend on the extent of the global economic crisis in 2020 and the length of the global recovery. Fast economic recovery in China and growing appetite for natural gas might in fact speed up the realization of Power of Siberia 2,” according to Bochkarev.

The discussions for this new route are rather active taking into account the current situation with the coronavirus, a source told ICIS. After the pre-investment stage, the next step is the investment stage with a tender for contractors.


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