Russia-China gas deal: All bets are off
This article originally appeared on the FT. Both Leslie and Tatiana will be speaking at this years Flame Conference.
As the global picture for the natural gas market transforms, Russia and its national champion Gazprom have found their long-term export strategy challenged. No longer able to rely on their core European market, the Russians are looking eastward, where they have long been seeking a strategic gas deal between Gazprom and the China National Petroleum Corp. (CNPC) that would give the Russian producer an easily accessible market for gas from new fields in East Siberia. Gazprom’s urgency to sign such a deal will reach a peak in 2014, and not just because of the desire to develop those fields or the political and economic shifts in Europe. Rather, Russia’s gas giant must reposition itself for a new world in which gas supply is abundant—while at the same time its worries have turned inward, to its growing rivalry with domestic competitors such as Rosneft.
After more than a decade of negotiations over a long-term pipeline and supply deal, Gazprom and CNPC could finally be ready to sign.The soon-approaching Sochi Winter Olympics could have been an attractive venue at which to announce it, but last-minute difficulties have yet again push the deadline back to the second half of the year. The deal will mean a crucial step forward in Gazprom’s Eastern strategy, committing China to buying 38 billion cubic meters (bcm) of gas per year via pipeline from Russia. Although this volume is far below what was initially proposed (up to 68 bcm) and amounts to only a quarter of the annual volume Russia sells to Europe, it is more than it would ever be able to sell via liquefied natural gas (LNG), the chilled and shippable form. The Asian market, the only source of gas export growth, is critical for Russia because nearly 50% of the country’s budget depends on oil and gas taxes and duties, and the Kremlin needs money badly and urgently.
On the Russian side, there are two main reasons to get a deal done as soon as possible. First, there is a strong political push from the Kremlin. President Vladimir Putin wants to send a serious message to the EU, which continues to challenge Gazprom’s business model, and to the US regarding the strength of Russia-China strategic cooperation. Second, Gazprom itself is seeking to protect its territory, not only from global producers, but also from Rosneft and competition inside Russia.
China is well aware of Russia’s predicament and could either use this situation to press for the best deal on prices and upstream equity shares (if it goes this route, the negotiations could again bog down) or decide to go for the strategic alliance immediately, in effect bailing out Russia now to benefit in the future. Beijing is likely to opt for the second choice for three reasons: growing worries about its urban pollution problem, its desire for leverage with Russia, and its hope of keeping Russian gas from instead being sold to Japan. Yet energy-hungry China is hedging its bets—pursuing its own domestic unconventional production, pipeline gas from former Soviet states in Central Asia, and new sources of LNG.
Back-door threats
Recent moves in Moscow have put increasing pressure on Gazprom from two domestic competitors, state-controlled Rosneft and independent producer Novatek. The gas export liberalization bill signed in early December breaks Gazprom’s longstanding monopoly on LNG exports by allowing Novatek and Rosneft to export LNG. Novatek and Rosneft are eager to secure contracts with high-growth Asia-Pacific consumers, especially China. In fact, Novatek recently reached an LNG supply deal with CNPC, among the factors allowing it to go ahead with its Yamal LNG project in the Arctic.
The deeper problem for Gazprom is its rivalry with Rosneft, which not only is actively developing its gas strategy on the domestic market, but also completed a deal with CNPC in October, giving the Chinese company an equity share in the East Siberian oil and gas field—something Gazprom has long refused to do. Rosneft representatives have also hinted at the possibility of exporting gas to China via pipeline. And Rosneft CEO Igor Sechin, influential in the Kremlin, has a successful track record of negotiations with the Chinese on oil deals. A full-court press by Rosneft to take over the role of gas exporter to the East would be a disaster for Gazprom. In short, Gazprom cannot afford any more delays.
Timing is crucial
As it navigates the newly competitive domestic landscape, Gazprom must also contend with mounting international competition. If any of the key Russian players are successful with their respective export projects, their biggest impact will be to reposition Russia as a credible future LNG exporter after 2017–2018, when exports would begin. Russia currently lags in LNG market share in Asia because it only has one liquefaction facility, Gazprom’s Sakhalin-2. Timing, likewise, is crucial. Outside Russia, major new supply is expected over the next decade from Australia, the US (including potentially Alaska), Canada, and offshore East Africa. All these projects target growing Asian demand. But that demand is not infinite, which reinforces Russian urgency to gain a foothold in the market.
The deal will likely be done this year. It will not only be a huge business victory for Gazprom, but will serve to dispel the perception that it has been the main loser in the North American shale gas revolution. With the Chinese deal in its portfolio, Gazprom (and Russia) will look like much more of a winner.
Leslie Palti-Guzman is a global gas analyst at Eurasia Group. Tatiana Mitrova is Head of Oil and Gas Research at the Institute of Energy Studies at the Russian Academy of Sciences. You can hear more from both Leslie and Tatiana at Flame this year.