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China's gas prices from Russia fall as market risks rise

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.

China's gas prices from Russia fall as market risks rise

TIn October and November, the prices charged by Russian Gazprom dropped to $126 per 1000 m3 from $144 per 1000 m3 in the 3rd quarter, RFA analysed.
The decrease marked the 1st time that China's costs dropped below those for Europe since the 3,000-km 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 A.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 1000 m3," 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 %.

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 9-month delay.
The starting price for the changes has remained undisclosed.

In its 1st year of operation, the pipeline and gas development project delivered about 4 billion m3 (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% of China's combined imports of pipeline and 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 1st 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 RUB 55 billion ($722 million) to RUB 192 billion 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-km pipeline section from Yongqing in northern Hebei province to Shanghai as part of its 5,111-km route from the Russian border to be completed in 2025.

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 % of the scheduled deliveries.

The complexities of the contract and the price changes make it hard to tell whether state-owned 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
  • 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
The Power of Siberia project followed the relative success of Russia's 1st 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.

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.

Strange bedfellows

In his commentary, Edward 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
  • Over time, the spouses get used to each other's annoying habits and understand the other person better
  • It is particularly helpful if there is a common enemy, such as an overbearing West
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 V.Putin on Jan. 19, Gazprom CEO Alexey Miller said the company would submit a feasibility study for the Power of Siberia 2 project before the end of the 1st quarter.
A.Miller said:
  • 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 seems to have made up his mind before determining whether the 1st Power of Siberia project will be cost- effective or not.

Energy expert E.Chow noted:
  • 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
  • Nevertheless, even national champion companies have financial limits on how many strategic projects they can pre- invest in while anticipating improvement in market conditions

Author: Michael Lelyveld