China’s Gas Prices From Russia Fall As Market Risks Rise – Analysis

By Michael Lelyveld

A little over a year after Russia opened its giant Power of Siberia pipeline to China, natural gas prices for the Chinese market have fallen below European rates.

In October and November, the prices charged by Russian monopoly Gazprom dropped to U.S. $126 (810 yuan) per thousand cubic meters from $144 per thousand cubic meters (tcm) in the third quarter, Interfax reported, citing Chinese customs data.

The decrease marked the first time that China’s costs dropped below those for Europe since the 3,000-kilometer (1,864-mile) pipeline began deliveries in December 2019.

Gazprom was charging China more than twice as much as its prices for Europe in January and February 2020, according to earlier Interfax reports and rates cited by Belarus President Alexander Lukashenko last April when demand slumped due to the COVID-19 crisis.

At the time, Russia was selling gas in Europe for “no more than $90 per thousand cubic meters,” Lukashenko told the BelTA state news agency.

But by October, Russia’s spot market prices in Europe had risen to $168 per tcm, while China’s prices from the Power of Siberia line fell by some 38 percent, Interfax said.

The unexpected price break for China was the result of contract provisions that were negotiated over a decade and which Gazprom still regards as a “commercial secret.”

The provisions of the 30-year deal include quarterly adjustments based on price changes for petroleum products with a nine-month delay, according to Interfax. The starting price for the changes has remained undisclosed.

In its first year of operation, the $55-billion pipeline and gas development project delivered about 4 billion cubic meters (bcm) of gas to China, exceeding daily contractual supply obligations in December to meet China’s cold weather demand.

The extra deliveries appear to have made up for China’s attempt to suspend gas imports last February during the COVID lockdown by declaring force majeure, a legal exemption from contract commitments due to circumstances beyond a party’s control.

The rocky start to the project’s first year of operation has been followed by huge swings in gas prices that are likely to affect costs and benefits on both sides as Russia presses ahead with its plans for expansion.

Last year’s supplies from the project accounted for less than 3 percent of China’s combined imports of pipeline and liquefied natural gas (LNG). But plans call for volumes to reach 10 bcm in 2021, rising to 38 bcm per year with a possible increase to 44 bcm by 2025, Gazprom has said.

Pricy pipeline

As Russia’s first gas pipeline to China, the Power of Siberia project has proved to be a costly investment with uncertain returns.

This year, Gazprom will more than triple its financing for the project from 55 billion rubles (U.S. $722 million) to 192 billion rubles this year with spending on pipeline connections between its Chayanda and Kovykta gas fields in Siberia.

Last year, China started construction of a 1,509-kilometer pipeline section from Yongqing in northern Hebei province to Shanghai as part of its 5,111-kilometer route from the Russian border to be completed in 2025, Reuters reported.

China has not disclosed its costs for the project, but Gazprom officials have said that the supply contract includes a “take-or-pay” provision covering 85 percent of the scheduled deliveries.

The complexities of the contract and the price changes make it hard to tell whether state-owned China National Petroleum Corp. (CNPC) or Gazprom is getting the better of the Power of Siberia deal.

The outcome is particularly uncertain in an unsettled energy market where Asian spot prices for LNG have swung from record lows to record highs in a matter of weeks.

In a commentary on Sino-Russian energy relations for the Carnegie Moscow Center, energy expert Edward Chow said the profitability and relative benefits of the Power of Siberia project have yet to be determined.

“It is too early to judge the commercial attractiveness of this 30-year gas deal. However, the Power of Siberia story does reveal the inherent risks in such deals,” said Chow, a senior associate for energy and climate change at the Center for Strategic and International Studies in Washington.

“They take a long time to negotiate, finance and complete; project costs and financial risks are high, market conditions will change in a notoriously cyclical industry; and political guidance may make deals easier to conclude, but does not guarantee commercial success,” Chow said.

The Power of Siberia project followed the relative success of Russia’s first oil pipeline to China — the Eastern Siberia-Pacific Ocean (ESPO) project, which opened direct deliveries in 2011, paving the way for massive investments.

But unlike the investment in ESPO, Russia failed to secure any Chinese financing for the Power of Siberia project, leaving Gazprom to bear the risks on its own.

Moscow has been partially drawn to the opportunity of China’s growing gas demand by the need to develop Eastern Siberia and the Russian Far East. But political pressures from the West have also played a part.

“The need for diversification became more urgent for Moscow in 2014, when Western economic sanctions were imposed over the conflict in Ukraine,” Chow said in his commentary.

In an analysis last July, Interfax noted the timing of Russia’s investment decision after years of trying to persuade China to accept a “western” pipeline route through Xinjiang instead.

“Russia needed a breakthrough in the East, and exactly two months passed from the signing of the decree on Crimea becoming part of Russia on March 21, 2014 and the signing of the contract to supply gas along the ‘eastern route’ on May 21,” the news agency said.

Strange bedfellows

In his commentary, Chow compared Russia’s energy relations with China to a less-than-perfect marriage.

“Sino-Russian relations may be a marriage of convenience arranged by oil and gas, but arranged marriages have a way of lasting,” Chow said.

“Over time, the spouses get used to each other’s annoying habits and understand the other person better,” said Chow.

“It is particularly helpful if there is a common enemy, such as an overbearing West,” he said.

Moscow now seems determined to double-down on its policy of increasing gas exports to China with a “Power of Siberia 2” pipeline crossing Mongolia to deliver another 50 bcm per year.

The plans appear to be forging ahead despite the risk that the pipeline could become a “stranded asset,” unable to generate a return on investment, if China makes good on President Xi Jinping’s pledge to peak carbon emissions before 2030 and achieve “net zero” emissions before 2060.

In a meeting with President Vladimir Putin on Jan. 19, Gazprom CEO Alexei Miller said the company would submit a feasibility study for the Power of Siberia 2 project before the end of the first quarter.

“But already, according to the pre-feasibility study, it can be said for sure that this is a technically feasible and a cost-effective project,” Miller said.

Miller seems to have made up his mind before determining whether the first Power of Siberia project will be cost- effective or not.

In an email message, Chow said it is difficult to draw conclusions by comparing the delivered gas prices for China and Europe because of the higher pipeline tariff costs of using new infrastructure over a longer distance through Siberia. The Interfax comparisons do not use “netback” figures that take transportation costs into account.

Even so, Russia has shown a predilection for mega-projects that would be more difficult to approve in a modern market economy with commercial considerations.

“National champion companies can make different choices for strategic considerations,” Chow said.

“Nevertheless, even national champion companies have financial limits on how many strategic projects they can pre- invest in while anticipating improvement in market conditions,” he said.