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    Delivering the Power of Siberia


The pipeline locks China and Russia into a firmer economic relationship.

by: Joseph Murphy

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Delivering the Power of Siberia

Russia’s Power of Siberia pipeline to China opened on December 2, connecting the world’s largest gas exporter with its largest importer.

The 3,000-km pipeline is expected to pump 38bn m3/yr of gas from Eastern Siberian fields to China’s eastern seaboard at full capacity, under a $400bn gas deal signed in 2014.

The project’s launch was marked by a teleconference hosted by Russian and Chinese leaders Vladimir Putin and Xi Jinping. Putin, speaking from Sochi, said the event was “historic not only for the global energy market but first of all for us, for Russia and China…. It brings us closer to the goal set together with Xi Jinping to raise mutual trade turnover to $200bn by 2024,” according to the Kremlin's website.

Xi, speaking from Beijing, said the pipeline launch was an “important transitional result” and “the start of a new era in co-operation”, one that meant an “all-encompassing partnership entering a new epoch.” He said he and Putin agreed that Russia-China relations are and will be a priority in our foreign policy.”

The line will have sweeping implications for the energy markets of both countries. China has secured a new import source, at a time when it is preparing for a rapid expansion in gas consumption. State-owned CNPC’s latest 2050 outlook report predicts that demand will soar from 283bn m3 last year to 610bn m3 in 2035 and 690bn m3 by 2050. Even based on CNPC’s projections for domestic output, which have proved overly optimistic in the past, China’s import needs will expand from 119.3bn m3 in 2018 to 310bn m3 in 2035 and 340bn m3 in 2050.

Without Power of Siberia and other new pipeline projects, this extra demand would have to be covered with LNG shipments, which already account for over half of imports.

Russia has meanwhile gained a new channel for eastbound gas exports, for now confined to LNG sales from its liquefaction terminals on Sakhalin Island and in the Arctic. This will help it overcome dependence Europe for its valued gas export revenues – the only gas market which the IEA expects to shrink between now and 2040. Gazprom’s business is already under assault on the continent from rising global LNG supply. Gas prices to Europe, even at today’s depressed prices, are almost three times the price at home where it sells the most.

Equally important is what Power of Siberia’s completion means for Russia’s vast and largely untapped Eastern Siberian gas resources – assessed by Russian authorities at above 9 trillion m3. Unlike more established oil and gas basins in Western Siberia and the Volga-Urals area, serious exploration in Eastern Siberia did not get underway until after the collapse of the Soviet Union. First oil production began a decade ago, following the start-up of the Eastern Siberia – Pacific Ocean (Espo) pipeline, which provided local producers with means of supplying oil to Asia-Pacific markets on a large scale for the first time.

It is hoped that Power of Siberia’s launch will similarly galvanise development of Eastern Siberia’s gas resources. Gazprom has no other means of commercialising the region’s gas, owing to limited local demand and scarce infrastructure. Feeding the pipeline with gas is the Chayandinskoye field in Yakutia, which at peak capacity will yield 25bn m3/yr of gas each year. A second field, Kovyktinskoye, will start up in the 2020s and provide a similar output. That field was once licensed to BP, whose CEO at the time, John Browne, said was earmarked for China.

Questionable economics

Power of Siberia is far from a strictly commercial enterprise. The gas supply contract between Gazprom and China’s CNPC underpinning its construction was signed at a time when Moscow’s relations with the West were at a post-Soviet low. The US and EU had just begun imposing sanctions against Russia, primarily directed at its oil and gas industry, in response to its annexation of Crimea of March 2014. These measures and the collapse in oil prices later that year sparked an economic crisis in Russia and a plunge in the value of the ruble. Russia used Power of Siberia’s unveiling to add legitimacy to its so-called Asia pivot – Moscow’s plan to expand trade with Asia as a counterbalance to economic reliance on Europe.

There are also questions about how quickly Gazprom will be able to recoup its investments in Power of Siberia, estimated at over $55bn and fully funded by Russia without Chinese support. Costs were originally projected half this sum but later inflated, reportedly because of Gazprom’s award of major contracts to companies owned by associates of Putin, with little oversight.

Power of Siberia will also take until 2025 to ramp up to full capacity, flowing just 4.6bn m3 in its first year and 19bn m3 in 2022.

Exact details of the pricing agreement between Gazprom and CNPC were never disclosed, although Beijing is widely considered to have exploited Russia’s precarious economic position in 2014 to secure lucrative terms.

Russian officials have said before that the pricing has a straight link to oil prices. Sberbank CIB estimated in a research note last year that the deal’s initial value implied a simple slope to oil prices of 10-11%, noting that Gazprom had not put in place any downside protection. This means a price of $6.5-$7.15/mmbtu or $189/1,000 m3 at current oil prices, which is less than European consumers pay for Russian gas.

Sberbank CIB estimates Power of Siberia’s break-even price at $12/mn Btu. As such, Gazprom will have to revise contract terms as gas flows increase, if it has not already done so, to avoid running Power of Siberia at a loss.

Russia earlier pushed for a pipeline link to China via Altai, but China rejected this plan because of the longer distance supplies would have to be transported through Chinese territory to reach Beijing. According to Sberbank CIB, this option would have been far more profitable for Russia, with a break-even price of $7/mn Btu and costing only $10bn to build in half the time as Power of Siberia. 

The next steps

China will need to advance additional pipeline projects if it wants to avoid rising dependency on LNG. While the Altai option appears to have been dropped, China and Russia have recently discussed routing a second pipeline through Mongolia. Beijing appears more receptive to this idea, which would require less domestic pipeline construction than the Altai project. An alternative is the flow of gas from the South-Kirinskoye field off Sakhalin Island to China using the existing Sakhalin-Khabarovsk-Vladivostok pipeline. But the field have been blacklisted under the US sanctions regime, putting development on hold.

In any case, it could take some time for China and Russia to finalise new supply contracts to support either of these projects. It took the pair more than a decade to agree on terms for Power of Siberia’s gas, and future negotiations are likely to be subject to the same wrangling over price. Furthermore, Russia will probably insist on including take-or-pay clauses in new contracts, ensuring stable revenues, while China will look to secure more flexible arrangements, allowing it to cut down on Russian shipments whenever alternative supplies are cheaper.

There are also signs that China is finally committing in earnest to construction of the long-delayed Line D of the Central Asia-China gas pipeline network. The line would provide China with an extra 30bn m3 of gas from Turkmenistan, Uzbekistan and Kazakhstan, competing with Russian volumes. With new pipeline deals between China and Russia unlikely for a few years, Russia’s more immediate means of expanding supply beyond Power of Siberia will be an expansion in its LNG export capacity in the Arctic, where China has taken an active role as a partner.