Issue Number: 109   June 2014

From Russia with Gas: Impact of Russia-China Gas Deal on European and International LNG Markets



A gas deal between Russia and China has been in the pipeline for over a decade. And now, after a marathon of discussion and negotiation that lasted until almost four in the morning, the two countries have signed one of the world's largest energy deals. The contract, worth $400bn, will last 30-years and will supply 38 billion cubic metres of natural gas annually to China.

There is little doubt that with sanctions coming from the West, a deal with the East has come at the right time for Russia. Gas supply is set to start in 2018 and in the meanwhile, the two sides are to share the estimated $77bn cost of constructing the new 'Power of Siberia' pipeline which will stretch across Eastern Siberia to the north-east of China.

There has been speculation that Russia's gas deal with China could spell bad news for global gas markets. Erica Downs of the Brookings Institution, an American think tank, has said that the deal has 'upped the ante for Europeans to diversity their gas imports away from Russia [1].' And in Foreign Policy, Keith Johnson has said that 'the implications are potentially huge for Russia, for China and much of Asia, and also for Europe [2]'. But what are the implications of the Sino-Russian bear hug? And does the deal pose an actual threat?

What is the Impact on European energy security?

Gazprom has been very clear about what it thinks the implications of the gas deal will mean for Europe. Alexey Miller, chairman of Gazprom, has said: 'The global competition for Russian gas resources started yesterday. Let there be no mistake about that. We have untapped the Asian market and this is going to have an impact on European gas prices.' Miller sees that the deal has created competition for Russia's gas, since China will now be vying with Europe for the country's gas. In his comments, Miller also targets Europe's lack of energy security, describing its energy shortage as 'scary', because the EU's focus on wind and solar is a shambles, and the liquefied natural gas (LNG) import terminals are only operating at 22% of their full capacity [3].

Whilst it is true that Europe's energy security is not in a good way (not least because of its overreliance on Russia's gas), it is less clear whether the Sino-Russian gas deal will have an immediate impact - if any - on gas prices in Europe. First of all, it must be realised that gas supplies going to China will come from new fields in Siberia, rather than from existing fields that Europe gets its gas from. Secondly, a broader view needs to be taken: in 2013, Russia exported 161.5 billion cubic metres of gas to Europe, which is more than four times the amount of gas that will be exported to China. The teeth of the threat of the Sino-Russian gas deal to European gas markets seem blunt.

Yet it should not be understated that the deal with China will mean that Russia now has an alternative gas partner. Russia will have a card up its sleeve in pricing negotiations because the possibility is there to divert some of the earmarked gas for Europe to China. However, in reality the maximum capacity of the Power of Siberia pipeline will be 60 billion cubic metres; about a third of what Europe currently imports from Russia. Whilst Russia may now have more leverage in negotiations, Europe will remain its biggest and most important customer.

Impact on Global LNG market?

The Russia-China gas deal may have greater implications for the international LNG market. China is currently a large importer of LNG and imported 20 million tonnes of LNG in 2012, with Australia being the second largest seller (4.8 mtpa) after Qatar (6.8mtpa). Although it is unclear what price China paid for its gas from Russia, it will certainly be lower than the price it pays for LNG. Discussion that Russia could sign another deal with China in the future may mean that pipeline gas, rather than LNG, will meet more of the country's growing gas demand. Given that there will be greater competition between LNG producers in around 2019/2020 when various new trains and projects come onstream, the risk factor is being increased for fledgling LNG projects: will there be sufficient demand, or will greater supply push prices down?

LNG projects in Australia are perhaps the most exposed, although this also includes other future LNG exporters, such as the United States [4]. Australia has a fragile LNG market position, where liquefaction projects are some of the most expensive in the world due to the high labour costs. The greater costs involved in the production of LNG is reflected in the sale price of the gas, which is around $15/MMBtu (it has been reported that China may be paying only $10/MMBtu for future gas from Russia [5]). Although Australia has well-established LNG projects, and is the second largest LNG producer in the world, there is a great deal of uncertainty over the second wave of investment, which consists of some 65.8 million tonnes of planned expansion, and worth about $180bn of future development [6].

The uncertainties and challenges Australia faces has been summarized by Jock O'Callaghan, head of energy and mining at PwC. He has said that the next wave of Australian gas projects may not happen: 'As things stand at the moment, unless we can improve we don't have an economic case for commanding that capital [7].' In a twitter post, he also said: 'Australia's LNG industry needs to embrace a culture of change'. If Australia is to embrace a culture of change [8], this transition will not be helped if one of its important markets cuts LNG imports in favour of pipeline gas.

Luckily for Australia, and other LNG exporters, China is not a static market. It is one of the BRIC economies (Brazil, Russia, India and China), and one of the fastest growing countries in the world and the International Energy Agency estimates that China's energy consumption will double by 2035 [9]. Gas is likely to play an important role in this. According to the 12th Five-Year Plan for Natural Gas Development, China's natural gas demand should reach 230 billion cubic metres by 2015 (8% of primary energy consumption), up from 145 billion cubic metres in 2012 (5% of total primary energy consumption) [10]. China's central government is attempting to encourage gas consumption to reduce oil dependence and cut urban pollution. Premier Li Keqiang has recently declared a 'war on pollution' during the National People's Congress in March [11]. Natural gas is a cleaner-burning option compared to coal. And if gas replaces coal in electricity generation, gas demand can only increase in the future. In this light, natural gas, in the form of both pipeline gas and LNG, will increasingly play an important role in meeting China's growing energy demand.

Conclusion

On first glance, it may appear that Russia is threatening Europe's energy security with its new gas deal. Russia's new gas partner will open up more trading opportunities, perhaps sometimes putting Europe's gas needs second. However, the deal is unlikely to have an impact on European gas markets as a different gas field will be developed to supply China. It may create leverage opportunities for Russia but it is yet to be seen how this would affect gas supply and pricing for Europe. A more possible impact of the Russia-China gas deal is that it may reduce China's LNG imports - particularly from expensive sellers like Australia. The Russia-China gas deal will add a layer of uncertainty to some fledgling LNG projects that are already struggling.

Researched and written by MJMEnergy Analyst, Nico Cottrell,


[1] http://www.brookings.edu/research/articles/2014/05/28-russia-china-gas-grand-bargain-downs

[2] http://www.foreignpolicy.com/articles/2014/05/21/from_russia_with_love_and_a_discount

[3] http://www.telegraph.co.uk/finance/newsbysector/energy/oilandgas/10852419/Russias-gas-king-taunts-crumbling-Europe-over-China-pipeline-coup.html

[4] http://www.forbes.com/sites/pikeresearch/2014/05/30/russia-china-gas-deal-narrows-window-for-u-s-exports/

[5] http://www.theaustralian.com.au/business/latest/china-russia-gas-deal-to-undercut-aust-lng/story-e6frg90f-1226923620452

[6] http://uk.reuters.com/article/2014/04/08/column-russell-australia-lng-idUKL3N0N00UF20140408

[7] http://www.abc.net.au/news/2014-05-28/russian-gas-threat-for-australian-producers/5484124

[8] https://twitter.com/JockOCallaghan

[9] http://www.eia.gov/todayinenergy/detail.cfm?id=3130

[10] https://ir.citi.com/ROzgbJktqIDIbvbbj8Kae%2BI%2F1te4V9Hh91ex5wFyG1wuStLT5EL8L%2BP7DiZLBZC%2FZIYJ%2BHi13iU%3D

[11] http://www.reuters.com/article/2014/03/05/us-china-parliament-pollution-idUSBREA2405W20140305


June 2014 MZINE