The Russia-China Gas Deal: A $400 Billion Mirage?

The Russia-China Gas Deal: A $400 Billion Mirage?

05/29/14

Nikos Tsafos

Energy, Russia, China

The devil just might be in the details.

No business agreement in recent times has generated as much excitement, and as much hyperbole, as the announced deal that Russia would supply China with 38 billion cubic meters (bcm) of gas annually for a thirty-year period. The $400-billion deal has been called a victory for Russia, a victory for China and even evidence of a shift in either energy markets, or geopolitics or both. Sadly, the deal is none of these things.

First, let’s talk about the commercial elements of the deal. The reality is that China has always had the upper hand because East Siberian gas can only be developed with China as a customer. For years, pundits have said that China was not willing to pay “European” prices to Russia. This is hardly true: China is paying “European” prices to Central Asia, and it pays more than that to Qatar and other suppliers of liquefied natural gas (LNG). The difference is that China had to compete for those supplies; absent competition in East Siberia, China had the upper hand.

We do not know the full details of the deal yet, nor do we know whether all the issues have been resolved—after all, the two sides have long stressed progress while downplaying their outstanding points. Even so, the rumored value ($400 billion over thirty years) equates to a gas price of around $10 per million British thermal units. Given the costs announced so far, this project will yield a subpar return for Gazprom under today’s assumptions—maybe high single digits or low double digits. This will not be Gazprom’s most profitable endeavor.

It does, however, score it a major political point. Gazprom’s inability to close this deal has frustrated the Kremlin. Together with Gazprom’s marketing strategy in Europe, which many criticized, the company’s privileged position has come under attack. The most visible crack was the decision last year to allow other Russian companies to export LNG. Still, the Kremlin is keen to avoid competition that could lower gas prices overseas. Until last year, this meant Europe. With this pipeline, Gazprom’s writ is enlarged, as are the complications from a liberalized approach to gas exports.

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