CONTRACT AGAINST SANCTIONS

Struggle for energy resources is gathering momentum. Russian President Vladimir Putin's visit to China set the trend for all the media last week. There were no political discussions on the world order between the two big powers and permanent members of the UN Security Council. The talk was about gas supplies to China. 

After 10 years' negotiations, Gazprom has at long last reached consensus with China's CNPC on gas supplies. 

In accordance with the 30-year contract, China is going to import 38bn cu m of gas per year. The gas price being still behind the veil of commercial secrecy, Gazprom head Aleksey Miller has made public the total value of the contract: 400bn dollars spread over 30 years. 

According to A.Miller, this is the "biggest gas supply contract throughout the history of the Soviet Union and Gazprom: more than one trillion cubic metres during the contract period. This gave a clue for a number of media and experts to roughly figure out the price within 350 dollars per 1,000 cu m or a little higher. The price formula in the contract is pegged to the oil basket. It also has a take-or-pay provision, Gazprom said. 

Laid down as the resource base for the gas supplies to China are the Kovyktinskoye (in Irkutsk Region) and Chayandinskoye (in Yakutia) fields with reserves totalling three trillion cu m of gas. Supplies will be launched towards 2020 as it is necessary to invest both in developing those fields in Eastern Siberia and in building the Power of Siberia pipeline to China. That work will take quite a lot of effort and investments: 55bn dollars from the Russian side and 20bn dollars from the Chinese side. As V.Putin said, that will be "the biggest construction site in the world for the next four years, without exaggeration". According to him, both sides are satisfied with the contract terms. 

It is exactly China's non-compliance on matters of price and supply routes that protracted the negotiations for as long as 10 years. The first agreement on cooperation between Gazprom and CNPC was signed in 2004. As early as March 2006, during Putin's visit to China, the companies signed a protocol on natural gas supplies from Russia to the People's Republic of China. Then in 2009, the sides signed a framework agreement on major terms of natural gas supplies from Russia to China that envisaged exporting up to 68bn cu m of gas annually (up to 38bn cu m using the eastern route and up to 30bn cu m using the western route). Initially, Gazprom wanted to start export by the western route using the existing Altay pipeline. But the Chinese were not much interested in that direction as they were in the eastern one and they got their way in the end. The thing is that Turkmen gas is being supplied to the western part of China and its import volumes will keep growing given the fact that Chinese companies that are playing the leading part in developing Ashgabat's gas fields and in building and operating the gas pipelines from Central Asia. As for the eastern part of the country where major industrial centres are concentrated, there is a shortage of gas. 

As for the gas price, Gazprom calculated it on the basis of the average European value of 400 to 450 dollars per 1,000 cu m China was ready to pay between 300-350 dollars and even suggested during one period to peg the price to that of the US Henry Hub exchange. According to experts' data, that hub's gas price is three times lower than in Europe and it is in general the world's lowest price. In order to reach a level of prices acceptable for both sides, the Russian Federation had to offer tax preferences in developing the Kovyktinskoye and Chayandinskoye fields which will naturally reduce budget revenues from this deal. 

Even V.Putin confirmed that the talks had a hard going admitting that the "Chinese friends are hard negotiators". 

In order to understand why Beijing in so uncompliant on matters of gas purchase from Russia, we need a little excursus to China's energy sector. Natural gas accounts for as little as 4 to 5 per cent of the country's overall energy consumption with coal (70 per cent) playing the first fiddle as its reserves are huge in China. 

In addition, the country also produces quite a lot of gas by global standards, within 100bn to 120bn cu m, while consuming 170bn cu m. As a result, import does not exceed 50bn with only half of it being piped from Central Asia, specifically, Turkmenistan, and from Myanmar. The rest is liquefied gas supplied from Australia, Qatar, Indonesia, Malaysia and other countries. 

Naturally enough, China has set the task to reduce the consumption of coal as the most environmentally-unfriendly energy resource. At the same time, rapid growth in gas consumption makes the country seek new sources. 

According to expert data, the demand for gas will almost double by 2020 reaching 300-350bn cu m and 700-750bn cu m within another 20 years. Gas production will certainly be growing, too, but definitely not at such an impressive pace. China has the world's largest shale gas reserves (31.5 trillion cubic metres) but current technologies cannot provide for its large-scale extraction. In any event, China expects to produce 60-100bn cu m of shale gas annually by 2020. 

However, taking into account consumption growth rates which may increase even more upon the Chinese government's decision to limit the use of "dirty" coal, the country will need new sources of gas. 

In such conditions, the contract with Gazprom enables Beijing in the long term to diversify its sources of natural gas import. More than that, by importing gas from Russia, China can reduce its expensive purchases of liquefied gas currently imported at almost 700 dollars per 1,000 cu m. 

According to Yelena Yushkova, chief analyst of AVG Capital Partners (Russia), the agreement on Russian gas supplies to China strikes a blow against the liquefied gas market. "Beijing may gradually lose interest in liquefied gas projects. In addition, China now has more leverage in its negotiations on liquefied gas contracts," Ye.Yushkova told R+. 

This contract also promises quite a lot of advantages for Russia in general and Gazprom in particular. Although the amount of gas supplies to China (38bn cu m) equals only a quarter of gas export to Europe (150bn cu m), this opens the door for Gazprom to the rapidly growing market of South East Asia and makes it possible to get rid of Europe's monopoly as the biggest market. "This points to the fact that Russia has found a way to diversify its gas export and reduce dependence on European markets getting at the same time more freedom in negotiating gas supply prices with Western partners," Ye.Yushkova said. 

It is all the more so that, according to the analyst, one can hardly expect any significant growth in supply volumes as current recession in the European economy does not imply any increase in consumption of energy resources in the next few years. 

In addition, gas supplies to China may give an impetus for exports to South Korea and Japan. By the way, Takao Kasumi, deputy general manager of the Tokyo Gas office in Paris, announced recently that Japan, the world's biggest consumer of liquefied natural gas, was continuing negotiations on building a gas pipeline from Russia but this may be a matter of more distant future. According to him, a gas pipeline is an option for providing Japan with gas supply especially against the background of the high price of liquefied natural gas. 

It is no coincidence that the contract with China was concluded just during an aggravation in relations between Russia and the West over Ukraine. Most probably, the threat of sectoral sanctions from the West including against the energy sector made a contribution to compromise from Gazprom. Although there is some four to six years to go before the start of physical supplies, the presence of the contract unties to a certain extent the Russian gas monopoly's hands in its talks with its European partners who have got more than one gas reduction over the past few years. "However, it will now be easier for Gazprom to agree on gas prices with its European partners as the West is no longer the only export destination outside the CIS countries," said Ye.Yushkova. 

It is all the more so that the news of signing the long-awaited contract may play a role in the Russian-Ukrainian gas crisis gathering momentum. Gazprom promised to make Ukraine pay for gas supplies in advance as from 1 June. This means that if Ukraine, already owing a debt totalling, according to the Russian and Ukrainian sides, 3.5bn and 2.2bn dollars respectively, fails to transfer a certain amount to the Russian Federation on 2 June, gas supplies to Kiev will stop on the very next day. At the same time, the gas monopoly guarantees fulfilment of its commitments to its European consumers provided that Ukraine remains responsible for the transit. 

"This also includes our Ukrainian partners' responsibility for so-called unauthorized tapping of gas. Yet Gazprom for its part is going to do its best for European consumers to have no problems," A.Miller said. 

Taking account of the threat of stopping supplies, European Commission President Jose Manuel Barroso sent a letter to Russian President Vladimir Putin. "As long as the trilateral talks are on-going, gas flows should not be interrupted. I count on the Russian Federation to maintain this commitment. It therefore continues to be Gazprom's responsibility to ensure the deliveries of the required volumes as agreed in the supply contracts with European companies," J.M.Barroso's letter reads. He also expects Russia to activate the early warning system well in advance if ever the need arises. 

By the way, despite pressure from the USA, the EU is against imposing sanctions on Russia's energy sector. "Our Russian partners for over 40 years are the most important gas suppliers 

"Our Russian partners for over 40 years are the most important gas suppliers to the EU market. Now due to the crisis in the EU, we consider possible sanctions against Russia. But in regard to the energy sector and particularly gas supplies, sanctions do not seem appropriate," said EU Commissioner for Energy Gunther Oettinger. 

We believe the misuse of gas supplies as a weapon by their termination ... We expect that there will be also provided with gas supplies to Ukraine, Moldova and the Balkan countries. Energy security concerns of these countries. These are our partners, and we accept responsibility for them. We are preparing to hold a trilateral meeting on gas with the intention to ensure security of supply gas from June 1," the EU commissioner said. By the end of June, the Council of the EU is preparing a special resolution on the security of gas supplies on the basis of different development scenarios, he added. 

In any event, it can be said that the Ukrainian crisis has played its role on the energy map of the world and Russia's 10 year long negotiations with China have been crowned with success not only thanks to the sides' skilfully built strategy but also due to worsened relations with the Old World. 

In this situation, Europe can also play its own game of gas, in particular, using China's reduced demand for liquefied natural gas and sending those excessive amounts to its own market and increase purchases of such gas. 

Yet nonetheless, whatever the economic premises of Russia's gas deal with China, the hidden motive behind the contract is rather political. By demonstrating enviable unanimity in approaches to a number of international problems including the Syrian crisis, Iran's nuclear programme, settling the Palestine-Israel conflict and a number of others, Moscow and Beijing have pointed to their intention to expand their integration even more. This is especially important for the Russian Federation during this period when its relations with the USA and Europe are deteriorating and a new round of sanctions is starting. Therefore, even if there is a long time to go before the sides get their financial gains from the deal, they can harvest their political dividends straight away.