MOSCOW - The announcement on Tuesday of Russia's agreement in principle to
supply up to 70 billion cubic meters per annum of natural gas by pipeline to
China is a bit like pornography - it provides a low-cost alternative to the
real thing, not to mention the chance to fantasize immediately about a future
pleasure that isn't likely to materialize or to be affordable if it does.
Deputy Prime Minister Igor Sechin, in Beijing this week with Prime Minister
Vladimir Putin, needs to show in the present that his command of Russia's
energy concessions is capable of delivering, at some time in the future, cash
into the counting-house.
This week's announcement in Beijing is also a pointer to the state of Sechin's
rivalry over the future of Gazprom, the Russian gas monopoly, with the former
chairman of the Gazprom board, now President Dmitry Medvedev, and those close
to him. If Sechin had
returned to Moscow without the appearance of a deal for Gazprom to sell gas to
China, Medvedev and his allies were bound to have taken advantage.
But appearances can be deceiving, especially on the morning after, so it's
worth asking - what deal has Sechin struck with the Chinese? Or to put the
matter the right way round - if the Chinese haven’t agreed on a price for the
gas, is there a real deal to sell it?
Consider, for example, how long it took for the Russians and Chinese to
consummate their deal to build a pipeline delivering crude oil between Angarsk
and Daqing. The initial proposals came off the drawing-boards and into
negotiations by Transneft, the state pipeline company, and Mikhail
Khodorkovsky's Yukos Oil Company in the late 1990s. Between 2001 and 2003,
talks between Yukos and the Chinese culminated in a memorandum of understanding
between Yukos and the China National Petroleum Corporation (CNPC) in May 2003.
The final deal, including oil volumes, pipeline financing and the crude oil
pricing formula, was not finalized by Sechin until February this year. That
makes six years to a decade of talking without finishing.
On October 13, this is what Gazprom announced officially.
Alexey
Miller, Chairman of the Gazprom Management Committee and Jiang Jiemin,
President of China National Petroleum Corporation, have signed today in Beijing
a Framework Agreement on major terms and conditions for natural gas supply from
Russia to China on the basis of the previously signed agreements. The parties
reiterated that a high pace of the Eastern Gas Program execution by Gazprom
created favorable conditions for further cooperation deepening in the gas
sector and for subsequent signing of a long-term contract for gas supply from
Russia to China.
In Gazprom lingo, the Eastern Gas Program
means the buildup of new gas deposits and new gas pipelines throughout Russia's
far-eastern region, including the offshore island of Sakhalin, and an offshore
zone around the Kamchatka Peninsula.
Without the additional deposits, the company has made clear that it lacks the
volumes required to justify the infrastructure cost and to fill the pipelines
that must be constructed. And without big-enough production volumes, Gazprom
accepts, albeit silently, that it will be struggling to offer natural gas to
China at a cost-plus-profit formula that can compete with alternative Chinese
sources, such as the natural gas pipeline being built across Central Asia, with
30 billion cubic meters (bcm) capacity; or shipments of liquefied natural gas
(LNG) from the new West Australian Gorgon project.
The latest Gazprom release refers to the signing by the same parties of "the
Agreement of Strategic Cooperation on October 14, 2004, in Beijing within the
official visit of the Russian Federation President Vladimir Putin to China. The
Agreement covers a wide spectrum of joint businesses including scrupulous
discussion of the issues related to the organization of Russian natural gas
deliveries to China by Gazprom. The possible ways of implementing joint gas
processing and gas chemical projects in eastern Russia and in third parties are
being studied."
In press statements, Miller said the deal contemplates gas shipments to China
of up to 68 bcm of gas per year, and more in two pipelines that have yet to be
built. Sechin said Gazprom and CNPC might set a price in the course of further
talks and sign a contract in early 2010. In that event, supplies would likely
start in 2014 or 2015, he said. Note the conditional verb.
For this week, all that has been agreed, apparently, is volume and timing.
Still, both fall into the wishful category because the wellhead production
capacity doesn't yet exist.
Industry analysts in Moscow report that pricing is still the sticking point
with CNPC, and that it has been since at least 2006. While Gazprom doesn't
speak on the record, it is generally understood that the Russian proposal is
parity with the price Gazprom sells to Europe. That in turn remains tied, for
the time being at least, to the crude oil marker. The Chinese counter proposal
is for a significantly lower price, based on the currently low spot prices for
gas in the depressed demand circumstances of the European market; the projected
delivery prices for natural gas from Turkmenistan and LNG from Gorgon; and the
huge volume CNPC is offering to take.
Miller indicated that the framework agreement of this week allows for a final
contract that "will include a price formula and principles of setting the price
which will be based on Gazprom's experience in gas exports and principles of
international trade". If that sounds one-sided and wishful, it is - 70 bcm for
China represents roughly half of Gazprom's current export volume to Europe, so
the proposed magnitude committed to China represents a colossal shift in
strategic orientation for Gazprom.
Putin, in a briefing on October 14, claimed that late on the night before, the
two sides had reached an agreement on a concrete pricing formula for the
delivery of Russian gas to China. He didn't say what the formula was, however,
and thus it remains uncertain whether Gazprom has shifted ground towards giving
the CNPC a discount on the European price formula. Some market observers are
optimistic that there is a breakthrough.
It is also hugely speculative to project China's capacity to absorb gas. At
present, gas supplies amount to just 5% of China's energy balance. As a report
by Alfa Bank research head, Ronald Smith, suggests, "Putting a value on Chinese
sales is fraught with difficulty. The reserves, while enormous, are undeveloped
and located in remote parts of East Siberia. When produced, they will be sold
into a country that currently uses little gas (undermining our certainty of its
ability to absorb the volumes) at an undetermined price and demanding uncertain
amounts of capital."
Smith says he believes Putin's latest claim, "while not resolving the question
of the actual level of pricing, indicates that the major stumbling block of the
negotiations [the actual pricing formula] has been surmounted, and the
likelihood of the deal being cemented, and gas flows beginning in 2015, looks
to have just increased materially. That being said, there is some room for
misunderstanding here, and we would like confirmation that the actual formula -
and not just the price link to oil products - has been agreed to."
And what valuation should China putt on the Russian proposal?
The Alfa Bank report suggests "a back-of-the-envelope valuation based on
reserve and production multiples". Skipping the small print, and basing the
calculation on the value of the gas reserves required, the volume on offer is
worth at the moment $5.9 billion, or about 4% of Gazprom's current market
capitalization in the share market. A second calculation, based on the market
value of current production by Gazprom, suggests the proposed contract is worth
$6.2 billion, or roughly the same 4% of market cap.
These numbers, Alfa concedes, look on the cheap - make that the Chinese - side.
According to Smith, "The Chinese will likely prove reluctant to agree to full
European pricing in the near future. Therefore, we see the summer 2010 deadline
[for the final deal] as anything but certain, and we will have to restrain our
optimism, and final analysis, until those pricing details are finally hammered
out and committed to paper."
Artem Konchin of Unicredit Securities, the brokerage arm of the European
banking group, sees commercial value, ahead of politics, in promoting the deal
now, because of the current reluctance of European customers to accept as much
Gazprom gas as they had contracted for last year; or to pay the contract
penalties for not taking the minimum volumes that were committed.
"We see Gazprom's move to the east as a strong potential hedge against European
efforts to move away from the take-or-pay principle. Although we do not see 70
bcm of annual supplies as achievable by 2015, the figure implies a hedge of
over 40% of expected 2015 sales to Europe, which would be a strong argument for
Gazprom when negotiating future European sales contracts."
So, Tuesday's news from Beijing looks "somewhat encouraging for the company's
sales outlook [in Europe]".
John Helmer has been a Moscow-based correspondent since 1989,
specializing in the coverage of Russian business.
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