Analysis: Last stand for Russia in China gas talks

MOSCOW Thu Oct 13, 2011 9:51am EDT

Chinese President Hu Jintao (R) and Russian Prime Minister Vladimir Putin walk ahead of their talks at the Great Hall of the People in Beijing October 12, 2011. REUTERS/Takuro Yabe/Pool

Chinese President Hu Jintao (R) and Russian Prime Minister Vladimir Putin walk ahead of their talks at the Great Hall of the People in Beijing October 12, 2011.

Credit: Reuters/Takuro Yabe/Pool

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MOSCOW (Reuters) - Risks are rising that Russia could lose a long-term deal to sell gas worth hundreds of billions of dollars to China as Beijing's pursuit of an expanding range of rival sources of supply strengthens its hand in the long-running talks.

Russian negotiators, meanwhile, have shown no willingness to compromise, even though Gazprom, the state-controlled gas export monopoly, needs to sell a lot of gas to finance a push into east Siberia, where vast untapped fields lie waiting and pipelines must be built to carry gas to customers.

Observers never tire of saying that Russia, the world's largest energy producer, and China, the fastest-growing energy market, are a match made in heaven.

But after years of a stalemate in talks between Gazprom and Chinese National Petroleum Corp., China could be ready to move on, said Mikkal Herberg, research director of energy security at the National Bureau of Asian Research in Washington.

"China's hand is getting stronger as it accesses supplies from a widening range of suppliers and becomes more confident about domestic production growth," Herberg said.

"Practically any company other than Gazprom would normally be worrying about losing the market opportunity in China gas long-term and be adjusting their strategy accordingly."

As Prime Minister Vladimir Putin, in Beijing this week, put a brave face on another failure to close a gas deal with China, the Central Asian state of Turkmenistan got an upgrade to the reserves at its South Iolotan field.

South Iolotan, the world's second-largest gas field, will serve as the main resource base for ramping up supplies to China, which are already flowing. It could hold reserves in place of up to 21.2 trillion cubic meters, according to an independent audit.

By comparison, Gazprom, the top world gas company, estimates its entire commercial reserves at 33.6 trillion cubic meters.

South Iolotan is a long way from exploitation and the political risks of dealing with the isolated state of Turkmenistan are significant, but the Chinese have already shown their intent by lending $8.1 billion to finance the project.

CHINA'S OPTIONS

With new supplies from Kazakhstan and Uzbekistan, a pipeline from Myanmar and a spate of new terminals planned to tap Asia's expanding trade in liquefied natural gas (LNG), China has reason to be confident of its supplies to the end of the decade.

Turkmenistan plans to ramp up exports to China to 60 billion cubic meters (bcm) per year, a volume that would rival the outline deal under discussion between China and Russia since 2006, which envisages total deliveries of 68 bcm per year.

Russian exports to China would be split -- 30 bcm per year coming from Gazprom's existing western Siberian fields and, possibly later, a further 38 bcm per year from its far east.

Gazprom has ignored the conventional wisdom on China's rapidly expanding gas options and has insisted that Beijing cannot meet its needs without incremental supply from Russia.

Instead, it has insisted that gas sold to China should be no less profitable than gas sold to Europe, where its long-term supply contracts are indexed to oil prices.

The resulting gap on price is said by sources close to the talks to be as wide as $100 per thousand cubic meters as China has insisted it can pay no more than $250, in line with what consumers pay in its northern regions near the Russian border.

A source close to Gazprom said a compromise is likely to prove elusive, saying: "We've been talking for five years and could talk for another five years."

If Gazprom is serious about getting talks moving again, Herberg said, "they need to send some signals to the Chinese that they are still open to discussion on price."

Instead, Gazprom has responded by floating alternative plans to supply other Asian markets. These range from a plan for Gazprom and its Japanese partners to produce 10 million tonnes a year of LNG from eastern fields and build an LNG plant at Vladivostok -- the subject of a feasibility study due out this year -- to a pipeline through North Korea.

Even Gazprom executives say privately that the latter -- discussed with the Kremlin leadership on a rare visit by North Korean leader Kim Jong-Il to Russia in August -- is on the very fringes of the possible, industry sources say.

"All these moves with Japan, Korea -- they are to stimulate China to buy Russian gas. But obviously this can't be said out loud," a Russian gas industry source said.

TIME RUNNING OUT

These proposed projects have a deeper purpose.

"What Gazprom is looking for is a benchmark price for their large-scale gas exports," said Keun-Wook Paik, a research fellow at the Oxford Institute for Energy Studies who is due to publish a book on Russia-China energy relations.

Alexander Medvedev, chief executive of Gazprom's export arm, said in an interview last month that a Chinese deal was unlikely this year and that the economics of the gas market should be better matched on both sides of the border.

"The country with the biggest hard currency reserves should have subsidized prices? Even Russia doesn't have a subsidized market any more," Medvedev said. "It is inevitable that they (the Chinese) will move to market pricing."

Gazprom may not have time to wait, however. Gas, unlike oil, is an abundant commodity, and its rivals are moving to put pipeline infrastructure in place.

China is under pressure to decide on an expansion of the West-East Pipeline, which carries gas from Central Asia to feed its growing industrial centers.

Unless Gazprom makes price concessions, China may favor increasing Central Asian supplies by extending that link rather than taking Russian gas through the Altai pipeline, planned by Gazprom to connect its Arctic fields to the Chinese border.

Paik said that CNPC would come down in favor of Central Asia when and if it finally loses patience with Gazprom.

Therein lies the risk to Gazprom: It could be forced to pay tens of billions of dollars to develop remote fields in East Siberia and build pipelines thousands of kilometres to a new coastal LNG plant, without the security of a Chinese contract.

"This is the real dilemma of Gazprom," Paik said. "China knows this fact too well."

(Reporting by Melissa Akin,; Additional reporting by Olesya Astakhova, Editing by Douglas Busvine and Jane Baird)

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