Russia-China Gas Deal - Why It Matters and What it Means for Canada

May 30 2014

After more than a decade of negotiations, China and Russia have agreed to a natural gas deal worth about $400 billion that represents a major step not only in global energy markets but also in geopolitics.

The deal will spark development of massive gas fields in Eastern Siberia and the construction of some 4,000 kilometres of pipelines, efforts that together are expected to cost $55-billion (US).

 

Despite the size and scope of the deal—it will last for 30 years and require Russia to eventually deliver 38 billion cubic meters of natural gas per year, according to a post China National Petroleum's website—it may not have a significant short-term financial effect.

Still, the deal signals changes for several key global issues, not just energy. 

Although the exact pricing of the deal has not been disclosed, most analysts have been anticipating its details for some time. Some of those analysts have pegged the value of the deal at around $400 billion. Renaissance Capital analyst Ildar Davletshin wrote in a Wednesday note that he estimates "a limited financial impact" on the valuation of Russia's Gazprom. In fact, he writes that if total exports to China remain at 38 billion cubic meters, then construction on a natural gas pipeline to China may actually decrease the company's overall value.

Keith Crane, director of RAND Environment, Energy, and Economic Development Program, said he agrees that the deal doesn't change anything for either party in the short term, especially as the price remains undisclosed.

 

Some much needed investment capital

Still, Crane said that the ultimate legacy of the deal may be that it will give Gazprom a badly needed source of investment capital. While this will largely finance the pipeline to China—the company is responsible for all infrastructure on its side, and the Chinese will handle construction in their own country—Gazprom is also involved in other projects. Among them is the planned "South Stream" pipeline through the Black Sea, which he said could see some benefit from added liquidity.

 

Impact on natural gas markets

Once the natural gas pipeline to China is completed, Crane said, the global gas markets will become more integrated. According to economic theory, greater integration brings greater price efficiency, so the direct connection of East and West markets should theoretically herald better market conditions. Integration has been a trend in the market for some time through liquefied natural gas, he explained, but there is no better way than a direct pipeline to make this change.

 

Boost for Putin at "Russia's Davos," and a June meeting with Obama

Although Gazprom may not see short-term benefit from the deal, at least one man in Russia will reap immediate gains. At the St. Petersburg International Economic Forum, which began Thursday, Putin will be able to boast to his country's economic elite at "Russia's Davos" that their nation remains enticing for foreign investment, said Lauren Goodrich, senior Eurasia analyst at geopolitical intelligence firm Stratfor.

"It will be [Putin] riding high, not only this deal, but a string of very large deals with China," Goodrich said. "[He'll say] 'The West keeps on saying that we're bad for investment, but we have a lot of investment coming in.'"

When Putin meets with President Barack Obama and German Chancellor Angela Merkel at a World War II commemorative event on June 6, he'll also be able to flaunt this $400 billion deal as a sign that his country is not at the mercy of Western sanctions, Goodrich said. The ability to demonstrate financial security in the face of continued threat of sanctions was essential for the Russian leader, she said.

"Putin had to get this deal done today, period," Goodrich said.

 

Russian-European trade dynamic

In addition to allowing Putin to take a stronger stance against Merkel and Obama, the deal will also affect the nature of Russia and Europe's energy trade, experts say. In essence, Crane said, Gazprom was facing a monopsony, or a single buyer, in the European Union: It sent over 80 percent of its natural gas exports westward, according to Stratfor, while European consumers benefit from an increasing variety of gas options.

"It is important for Gazprom to get outlets for its gas, if it alienates Europe much more. Plus, it has a need for a bigger market," Malcolm Graham-Wood, founding partner at energy consultancy HydroCarbon Capital, told CNBC.

Goodrich said the deal will not only give Russia more options, but force its European customers to "at least keep decent relations with Russia on the energy front," lest Gazprom divert more of its supply to the East.

The deal is a message from Mr. Putin to Europe to “do your worst. We are not reliant on your friendship. If you want to apply sanctions and behave unreasonably to us, we will turn to our good buddy the Chinese,” said Bobo Lo, a British academic who has spent decades studying Russia’s foreign policies and geopolitics.

Or, as Russian parliamentarian Alexei Pushkov put it in a tweet, U.S. President Barack “Obama should abandon the policy of isolating Russia: it will not work.”

 

Russia's new approach to China

While "Russia has historically shunned China," this deal represents a turning point in Sino-Russian relations, Goodrich said—not necessarily making them political allies, but at least making them significant economic partners. She said that Russia has had a "historical nervousness of having China inside the country," but sanctions from the West have forced that to change in a "big, big way."

Now China will not only have an energy partnership with Russia, but Beijing is also in talks to acquire a stake in Gazprom's Vladivostok liquefied natural gas terminal and a 19 percent stake in Russian oil company Rosneft, according to Stratfor.

 

China's important stake in Russia

As Russia sees a new economic partner in China, Beijing has found an investment in the future of its neighbor. It is tough to make any firm predictions, but this new stake may give China some leverage inside of Russia, Goodrich said. Still, this will mostly be relegated to economic sway, not direct political clout, she added.

 

'So much more secure'

Perhaps more important for Beijing than a stake in Russia is the promise of greater energy security gained by the deal. The Chinese energy market is "incredibly vulnerable" to the situation at sea, Goodrich said. Recent tensions in the South China Sea, in which China unilaterally began drilling near islands claimed by Vietnam, only underscore how important it is for Beijing to secure more land import options, she said. China, she added, becomes "so much more secure" with the added diversification of its energy supply. But beyond the source of the gas, the Gazprom deal helps China address its rising energy consumption.

"It makes sense for China to sign up for as much reasonably priced gas it can," Graham-Wood said.

 

China's battle with pollution

China faces a significant uphill battle in terms of pollution, but an increase in natural gas can only help, Crane said. As Beijing seeks to close more coal power plants it hopes to meet the population's consumption needs with natural gas, he added, explaining that this switch "could have a pretty significant impact" on air quality.

 

Russia's entrance into East Asia

While modern Russia has long made overtures to East Asia, the construction of a Gazprom-connected pipeline into China will give Moscow a physical stake in the region, Goodrich said. And once the project is completed, Russia can begin to look to other countries for partners—or rivals.

"Russia can start playing these countries off each other," Goodrich said. "And this will create a fun new dynamic because this will be the first time we'll be able to see Russia play around again in East Asia."

 

Impact on Canada

Under the deal, China agrees with a single stroke to buy from Russia’s OAO Gazprom nearly half the volume of natural gas consumed by all of Canada.

And for Canada, that new source of natural gas is another sign that its own ambition to become a major exporter of the commodity faces intensifying global competition. Energy companies are planning several liquefied natural gas export projects on the British Columbia coast, but Canada is well behind other international players.

B.C. Premier Christy Clark insisted the province is still well-positioned to become an LNG exporter. She said Asian buyers, including China, still want their suppliers to include countries that offer reliability over the long term.

“We’ve certainly seen the way that Russia likes to do business these days, and we certainly know that the Chinese want a dependability of supply. We can supply that,” Ms. Clark said at a Vancouver news conference on Wednesday. “Being honourable, being trustworthy, providing the assurance that we are not going to play politics with energy. I think that’s worth a lot to our potential customers out there, especially for China.”

Shamsul Azhar Abbas, the chief executive officer of Malaysia’s state-owned Petronas, also played down the impact of the Russia-China natural gas deal on Canada’s fledgling LNG industry, and specifically the Petronas-led Pacific NorthWest project.

“What I am interested in is whether it will compete directly with our Canadian project, and the answer is no. The beautiful part of our project is that we have a buyers’ consortium,” Mr. Shamsul said during an interview at an international LNG conference in Vancouver.

The Pacific NorthWest LNG joint venture is being planned for Lelu Island, near Prince Rupert in northwestern British Columbia. “As far as China is concerned, they have a very huge need for energy,” Mr. Shamsul said.

Russia and China expect the first gas to flow in four to six years. Although financial terms were not disclosed, China is expected to pay about $20-billion up front toward the enormous cost of building pipelines that will deliver gas to Beijing, and further south to the Yangtze River area.

Gazprom expects to sell the gas for about $350 per thousand tons, or $9.91 per thousand cubic feet. While that is far above prices in North America, where gas has lately traded for around $4.50, it’s well below the pricing for Pacific liquefied natural gas.

The more important question for global energy markets involves the deal’s influence on the way gas is moved on ships. For Australia, Mozambique, the United States and Canada, China has held promise as a lucrative new market for sea-borne liquefied natural gas. The pipeline from Russia is the “least-cost trade pathway,” meaning it is cheaper than any other potential source of imports for China, said Kenneth B. Medlock III, senior director at the Center for Energy Studies at Rice University in Houston, which has developed a global model of the natural gas trade.

(That gas will be worth $10.50 to $11 by the time it reaches Shanghai, Mr. Medlock said, which slightly reduces its pricing advantage.)

Meanwhile, Russia is looking to quickly seize LNG market share as well. The development of the Eastern Siberian gas fields will allow Russia to tap additional supplies that can be exported onto tankers through the Pacific port at Vladivostok. And China, in a separate deal, agreed to buy a smaller volume of LNG from the Yamal project, which will help support construction of that undertaking in Russia’s Arctic.

The combined effect stands to disrupt LNG markets as Russia elbows in with large new supplies. That places new pressure on countries like Canada, whose bid to be early to market has been eclipsed by Russia.

The earliest discussions of LNG shipments from Canada’s West Coast pointed to a potential bonanza, with Asian prices far higher than those in North America. And although rising natural gas demand means the Asian market remains for the taking, the Russian deal underlines the need for Canada to think differently about exporting to the Pacific, said Peter Tertzakian, chief energy economist at ARC Financial Corp. in Calgary.

“The trick for Canada is to make sure we get to market with a good, low-cost product,” he said. “Because there’s no point in getting to market only to find out you’re the high-cost producer.”

 

 

Adapted from:

Rosenfeld, Everett. "Why the Russia-China Gas Deal Matters." CNBC.com., 22 May 2014. Web. 30 May 2014. <http://www.cnbc.com/id/101693525>

Vanderklippe, Nathan, and Brent Jang. "Massive Russia-China Gas Deal to Shake up LNG Markets." The Globe and Mail., 22 May 2014. Web. 30 May 2014. <http://www.theglobeandmail.com/report-on-business/international-business/asian-pacific-business/massive-russia-china-gas-deal-to-shake-up-lng-markets/article18783872/>

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