Gazprom close to agreeing pricing deal on China gas supplies

Investors in Gazprom seemed unconcerned about it missing another deadline to sign a massive deal for gas supplies to China by the end of 2013.

In fact, Russia’s state gas company has been discussing the planned deal with China’s CNPC for so many years that many started doubting it would ever happen.

But now an agreement is within reach. Negotiations have picked up steam in recent months, paving the way to a deal that could not only help satisfy China’s energy demand for many years to come but also transform Gazprom.

Both Chinese and Russian sources say the two sides are getting close to a pricing arrangement that would allow the gas to arrive in eastern Chinese markets at about $13 per million British thermal units.

That would translate into $10-$11 per mBtu at the Chinese border – a price that suits both Chinese and Russian calculations.

China has long insisted that it will not pay Gazprom much more than the $9 per mBtu it pays for gas from Turkmenistan, and that the piped gas must be cheaper than liquefied natural gas.

“Price talks have become less difficult for Gazprom now that LNG prices are high,” says Julia Pribytkova, a gas analyst at Moody’s in Moscow.

For Gazprom, the key is that the huge investments necessary in a new pipeline system linking new gasfields in eastern Siberia to a planned liquefaction terminal in Vladivostok for shipments to several Asian customers, must pay off.

It therefore calculates its China price by deducting from the benchmark price for LNG in Asia – currently between $16 and $17 per mBtu – the cost for transportation to a regasification terminal at the importing country, the liquefaction cost and the transport to the Chinese border. “With that calculation, you arrive exactly at $10-$11 per mBtu,” says Maxim Nechaev, head of consulting at IHS in Moscow.

The formula for the deal is expected to be based on a reference to oil price products in Asia, possibly Singapore crude.

The Chinese side is quick to point out it no longer needs the Gazprom gas as much as it did when negotiations began a decade ago. China has now constructed alternate gas pipeline links with central Asia and Myanmar. LNG terminals already import shipped gas and more are in the works, to take gas from Qatar, Australia and even Russia itself.

“Russia is already 10 years too late in entering China’s gas market,” says China-Russia energy expert Feng Yujun of the China Institutes of Contemporary International Relations. “Time is on China’s side,” he adds.

But China cannot be too dismissive of Gazprom either. The country faces a large future gas deficit, thanks to plans to cut coal-fuelled pollution in the more prosperous eastern cities. An important part of those plans simply call for moving coal-burning power and industrial projects further out to the poor and arid west, but eastern cities’ manufacturing, heating and power will still require a lot more gas.

The breakthrough came when Gazprom finally agreed in May to prioritise the so-called Eastern Route. From the very beginning of gas talks with China in the early 1990s, the Russian state company had planned to supply the eastern neighbour from existing gasfields in western Siberia.

But growing pressures both domestically and abroad convinced Gazprom to give up on this idea.

The rapid take-off of shale gas production has altered the global demand picture. In Europe, traditionally Gazprom’s largest market, the company has run into problems with an antitrust probe and, more recently, a challenge from the European Commission to the South Stream pipeline project.

The Russian government, keen to increase the country’s global gas market share and to crank up development of thinly-populated eastern Siberia, has started breaking Gazprom’s monopoly. This month, legislation took effect that allows both Rosneft, the state oil firm, and Novatek, Russia’s largest privately owned gas company, to compete with Gazprom in gas exports.

Other Russian-Chinese energy projects have moved ahead while the Gazprom pipeline stalled.

Notably, CNPC is an investor in other overseas gas projects – for instance gasfields in Turkmenistan and in Novatek’s LNG joint-venture with France’s Total on the Yamal peninsula, which received the final go-ahead this month following the gas export liberalisation law. That means the company gets some benefit from gas sales even though the domestic Chinese gas price cap is lower than imported prices, sweetening the pill for CNPC.

These big changes drove Gazprom to agree to supply China via a new pipeline system, called the Power of Siberia. It will connect Kovyktinskoye and Chikanskoye, new gasfields west not far from Irkutsk, and Chayandinskoye, a field north of Lake Baikal, run southeast and then follow the Chinese border all the way to Vladivostok. It has a link to Sakhalin, the huge island north of Japan where both Gazprom and Rosneft are producing gas, and several entry points into China are planned.

Christopher Granville, managing director at Trusted Sources, says a failure to seal a deal would make Gazprom a west-facing company exposed to the risks from growing competition at home and a potential collapse in European demand.

“This is Gazprom’s chance to enter the fastest-growing gas market in the world,” he said. “It’s now or never.”