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Sep 12, 2013 | 10:38 GMT

8 mins read

Russia's Competition for Natural Gas Deals with China

Russia's Energy Ambitions in China
Summary

Editor's Note: This is the second installment of a two-part series on Russia's attempts to strike a major natural gas supply deal with China. Click here for Part 1. 

As China diversifies its options for natural gas suppliers, it is leveraging its position to get the best deals it can out of new contracts with Russia. Because Russia is counting on the Chinese natural gas market to help it move away from exporting energy to Europe, Moscow is offering concessions to Beijing, particularly in light of the growing competition it faces. 

China has already struck natural gas deals with Turkmenistan. Under the current agreement between Turkmengaz and China National Petroleum Corp., China was to import 30 billion cubic meters per year from Turkmenistan starting in 2010. However, Ashgabat has only been able to send Beijing 21.4 billion cubic meters per year as of 2012, though this level is expected to reach 30 billion cubic meters in late 2013 or early 2014. Natural gas exports from Turkmenistan to China would increase starting in 2015 to 40 billion cubic meters, with the option of reaching 65 billion cubic meters per year by 2020, though the contract allows for flexibility between 30 billion and 65 billion cubic meters. Currently, the Central Asia-China natural gas pipeline has a capacity of 40 billion cubic meters, but expansions are planned in the next few years. On the Chinese side of the border, the West-East Gas Pipeline II has a capacity of 30 billion cubic meters, and a third leg of the pipeline to be completed by 2015 will double that capacity.

Central Asia-China Energy Infrastructure

Map - Central Asia-China Energy Infrastructure

Chinese President Xi Jinping visited Turkmenistan on Sept. 4 in order to inaugurate the massive Galkynysh natural gas field, which began production in July. The field is one of the largest in the world, holding between 13.1 trillion and 21.2 trillion cubic meters of natural gas reserves, and will feed primarily into the pipeline to China. The Chinese government has already given $8 billion to finance the Galkynysh project and promised even more financing during Xi's recent visit, though the specific amount has not been announced yet.

The Russian Option and Complications

Beijing isn't just counting on Turkmenistan to fill its increasing natural gas needs. China has also turned to Russia for natural gas supplies, but this relationship has been difficult for both sides. Though oil deals historically have been easy for Russia and China to strike, the countries have been struggling to make a major natural gas deal for more than a decade.

First, Russian oil is exported by multiple producers, which has allowed China to negotiate more desirable prices for supplies. Gazprom currently monopolizes Russian natural gas exports, which gives consumers little leverage to bargain for lower prices. Second, while Moscow primarily uses oil to make money, natural gas is more useful as a political tool for the Kremlin; financial gain is its secondary use. Because of this, China has been wary of striking a natural gas deal that would make it politically vulnerable to Russia, as Europe has been in the past. China is extending natural gas negotiations in order to have a more advantageous market and more leverage in dealing with the Russians, and this tactic seems to be working so far.

With changes taking place in the natural gas industry, both in the region and in Russia itself, a deal between Russia and China could be more plausible. Now that Turkmenistan's Galkynysh field is operational, Beijing can force Russia to compete with Turkmenistan for the Chinese market. This has already been seen in the recent negotiations between Gazprom and China National Petroleum Corp.

Russian Energy Infrastructure

Map - Russian Energy Infrastructure

The companies struck a preliminary deal for natural gas exports to China on Sept. 5, but a series of obstacles could keep it from materializing. Under the latest agreement, Russia will export 30 billion cubic meters of natural gas per year to China starting in 2017 and another 30 billion cubic meters per year by 2020 — all under a 20-year contract. The natural gas will be exported through the planned Power of Siberia natural gas pipeline, which will stretch 4,000 kilometers (2,485 miles) from the Yamal Peninsula to the Pacific Ocean with four pipeline spurs to China. The pipeline will also pass by two new natural gas fields under development in East Siberia: Chayandin and Kovykta. These fields are expected to begin production of 25 billion cubic meters each in 2015 and 2017, respectively.

However, with Turkmenistan's new natural gas field now able to export to China, and with the possibility of lower liquefied natural gas prices on the horizon, it seems that Beijing is not in a hurry to strike the final deal with Gazprom over the price of natural gas. In negotiations over the past decade, Gazprom has asked China to pay European-level prices for natural gas, proposing at least $400 per thousand cubic meters. In the past year, Russia has dropped its price to $300 per thousand cubic meters in order to make the price much more attractive in comparison to what China currently pays for liquefied natural gas imports and for imports from Turkmenistan.

Currently, spot-market prices for liquefied natural gas in Asia are approximately $635 per thousand cubic meters, though heavy discounts are given if the liquefied natural gas exports are contracted. Turkmenistan charges China $333 per thousand cubic meters (indexed on oil prices), but including the 13 percent value added tax, tariffs for transit through Kazakhstan and a tariff for the use of China's West-East Gas Pipeline, the price ends up being $494 per thousand cubic meters.

Both prices are well above the figure Gazprom is currently proposing to China. However, Gazprom has not clarified what tariffs and taxes will be tacked on to the price of $300 per thousand cubic meters. Gazprom (along with other Russian energy firms) is currently lobbying the Kremlin to cancel any export tariffs for natural gas going to Asia. This would keep Gazprom's proposed price significantly lower than those of its competitors, even when liquefied natural gas prices begin falling. China appears to be waiting on the Kremlin's decision on the issue before signing the final agreement with Gazprom.

Beijing's wariness of a natural gas contract with Russia and its concern about the end price of Russian natural gas has put Gazprom in a difficult position. The company was supposed to begin constructing the Power of Siberia pipeline in September, but without a final deal with China in place, it is postponing construction of the $32 billion pipeline until early 2014 to ensure that there will be a market for the natural gas the line will carry. Gazprom is courting other customers, such as South Korea and Japan, to sign contracts for natural gas exports via the pipeline, but the volume these countries would import is not nearly as great as the amount China has proposed.

Later in September, the Russian Duma is expected to consider revoking Gazprom's monopoly on liquefied natural gas exports — a big step toward weakening Gazprom's hold on the natural gas sector. Although this would not affect Gazprom's hold on piped natural gas, it would make Russian natural gas more commercially friendly, and is meant to sweeten Russia's energy deals with all consumers, not just China. With this shift on the horizon in Moscow, China National Petroleum Corp. signed an agreement Sept. 5 with independent Russian natural gas firm Novatek for a 20 percent stake in its planned liquefied natural gas facility on the Yamal Peninsula, which could give the Chinese firm the option of first exports headed to Asia. China National Petroleum Corp. is also in talks with Rosneft to possibly launch a joint liquefied natural gas facility at Vladivostok.

China's Grand Position

Beijing has been able to diversify its sources of natural gas and its import methods. China has nearly a dozen liquefied natural gas facilities either under construction or in the planning stages, has already secured a high volume of natural gas from Turkmenistan over the long term, and is in the process of making a similar deal with Russia. In addition, China is focusing on domestic natural gas production. All of this allows Beijing to design deals with foreign partners to its advantage, leveraging one player against another.

Should China's natural gas consumption continue to grow at its current rate, each of these methods of natural gas production and imports will be needed to fill its demand. However, there is the critical question of whether China's natural gas needs will indeed continue growing as the country's economy slows down — from growth of more than 10 percent each year for a decade to less than 8 percent this year. China has crafted its natural gas contracts with Russia and Turkmenistan in a way that allows it to receive a wide range of natural gas volumes from each country, should China need to decrease its imports. China can also resell liquefied natural gas imports to other consumers.

While this is wise for Beijing, it puts Moscow and Ashgabat in a tenuous position. The future growth of Turkmenistan's economy depends on natural gas exports to China; energy sales currently comprise 60 percent of the Turkmen gross national product. Russia has made natural gas exports to China and elsewhere in Asia part of its grand diversification project to relieve its dependence on Europe as an energy market. Should China's demand for natural gas not grow as aggressively as forecast, or should its domestic production meet the volume China is aiming for, then Beijing's need for both Turkmen and Russian natural gas might not be as high as expected. This could intensify the competition between Russia and Turkmenistan over the Chinese market — a development Beijing could continue using to its advantage.

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