Gazprom pens biggest contract in its history

Alexey Miller, Chairman of the Company’s Management Committee and Zhou Jiping, Chairman of China National Petroleum Corporation (CNPC) yesterday signed a contract to supply pipeline gas from Russia to China via the eastern route.

The parties signed the document in the presence of Russian President Vladimir Putin and Chinese President Xi Jinping in Shanghai.

The 30-year contract stipulates that 38 billion cubic meters of Russian gas will be annually supplied to China. The mutually beneficial contract contains such major provisions as the price formula linked to oil prices and the ‘take-or-pay’ clause.

“Russia and China have signed the biggest contract in the entire history of the USSR and Gazprom – over 1 trillion cubic meters of gas will be supplied during a whole contractual period. Russian gas will be sold at a brand new market with a huge potential.

The arrangement of Russian pipeline gas supplies is the biggest investment project on a global scale. USD 55 billion will be invested in the construction of production and transmission facilities in Russia. An extensive gas infrastructure network will be set up in Russia’s East, which will drive the local economy forward. Great impetus will be given to entire economic sectors, namely metallurgy, pipe and machine building.

Today we started the first page of a big book, a fascinating story of the Russian-Chinese cooperation in the gas industry, and many more essential chapters are yet to be written in it,” said Alexey Miller, Gazprom CEO.

The eastern route stipulates the delivery of 38 billion cubic meters of natural gas from Russia to China via the Power of Siberia gas trunkline (unified gas transmission system encompassing the Yakutia and Irkutsk gas production centers designed for supplying natural gas to Russia’s Far East and China). The bulk of pipes used in the construction will be domestically manufactured. Some 11,700 experts will be engaged within Phase 1 of the Power of Siberia project and some 3,000 employees will ensure the pipeline’s operation.
CNPC is China’s largest petroleum company wholly-owned by the state and is one of the world’s leading integrated oil and gas production companies.
In 2009 Gazprom and CNPC inked the Framework Agreement on the major terms and conditions of natural gas supply from Russia to China. The Agreement stipulates annual exports of up to 68 billion cubic meters of gas to the Chinese market. In 2010 the Extended Major Terms of natural gas supply from Russia to China were signed.
In September 2013 Gazprom and CNPC inked the Agreement on the major terms and conditions of pipeline gas supply from Russia to China via the eastern route.

WoodMackenzie comment

Stephen O’Rourke, Global Gas Research Analyst for Wood Mackenzie says; “The agreement not only establishes a new gas production centre in East Siberia for Gazprom but provides the company with pipe export growth and market diversity away from its legacy European customers. With European gas demand growth uncertain and the Ukraine crisis leading to calls for Europe to reduce its reliance on Russian gas, Gazprom now needs a ‘new Europe’- enter China.” 

“The comparisons with the development of Gazprom’s export business into Europe are clear, with almost identical population sizes between North East China and Western Europe. Gazprom’s exports to Western Europe first reached 38 bcm by the mid-1980s and have since increased to over 150 bcm into the whole of Europe. We anticipate overall gas demand from China over the next two decades will grow more rapidly than that witnessed in Europe from the mid-1980s,” Gavin Thompson, Head of Asia Gas Research for Wood Mackenzie adds.

Wood Mackenzie’s analysis highlights the following implications of the deal for all parties involved:
China’s gas market requires Russian supply
• North East China is gas-short and needs Russian supply to balance long-term demand and supply.
• Eight provinces in North East China will receive East Siberian gas. This area has a population of around 360 million (roughly equal to that of Western Europe); experiences extremely cold winters; and suffers from a shortage of indigenous gas supply options.
• By 2025 Wood Mackenzie estimates total gas demand from these eight provinces will reach 125 bcm. Power of Siberia gas will meet over a quarter of regional gas demand by this time.
• Without East Siberian gas, alternative supplies would have to be sourced requiring significant additional infrastructure and cost. It would also deprive eastern coastal markets of supply, forcing an increased reliance on imported LNG.
Russia and China’s energy trade
• The Russia-China pipeline agreement proves that Gazprom can grow piped gas exports significantly without relying on its traditional European markets.
• From the perspective of international relations level, this deal also signals a deepening of energy ties between Russia and China. They now cooperate across a range of different commodities and have established a broad base for further increases in trade in oil, gas, LNG, coal and electricity.
Opportunities for Gazprom
• The Power of Siberia pipeline will enable Gazprom to pursue additional export projects, also aimed at Asian buyers: volumes from the Kovyktinskoye field could also supply gas to the proposed Vladivostok LNG project.
• The possibility of third-party indirect access to the Power of Siberia could provide Gazprom with additional volumes from independent Russian producers while Gazprom’s giant gas fields are ramping-up.
• This could signal further gas sales of Russian gas to China, from Gazprom and other Russian companies.
Challenges remain in upstream development
• The Chayandinskoye field development will be difficult with complex geology (relative to West Siberia) and helium-rich gas.
• The overall cost for the Chayandinskoye upstream development, Power of Siberia pipeline and processing costs could exceed US$40 billion. This makes it one of the largest oil and gas investment decisions of the year globally.