Game changer – the Sino-Russian gas supply deal, says East Capital

Jacob Grapengiesser, partner and senior advisor at East Capital comments on the sign off of the gas supply deal between Russia and China.

After ten years of haggling Moscow and Beijing finally signed off on game changing $400bn gas supply deal, under which Russia will at first supply 38bn cubic meters (bcm) of gas to China over 30 years from 2018.

Moscow and Beijing are to share the $77bn cost of building the new “Power of Siberia” pipeline – Russia puts in $55bn and China $22bn — stretching from Eastern Siberia to China’s underdeveloped northern provinces.

A second gas pipeline, to the Western Provinces of the People’s Republic, may also be built, expanding the annual Chinese gas purchase to 61bcm.

The sticking price had been the price China was willing to pay. While the final price remains a commercial secret, analyst say that the headline total suggests Beijing will pay between $350 and $380 per thousand cubic meters, slightly less the European price, but almost twice what Russia’s friends in the Commonwealth of Independent States (CIS) pay.

The bottom line is the deal will make state-owned gas monopolist Gazprom a modest but healthy profit.

But securing energy supplies to China is not the importance of the deal. Rather it represents a fundamental change in the relationship between Russia and China and will have far reaching consequences for both global politics and business.

Change in mentality

Russia’s trade with China has more than doubled in the last decade to $90bn this year and should reach $100bn next year, making China Russia’s biggest trade partner: Russia sells raw materials and imports mainly machines and manufactured goods from China.

However, the gas deal is a break from this mercantile relationship and a step towards a much deeper strategic partnership.

The problem with building extremely expensive gas pipelines is you can’t move them once they are done. While the Russian imports will account for less than a quarter of China’s estimated 180-260bcm of demand in 2015 alone, the co-dependency that comes with the gas – China needs the energy and Russia needs the money – means that the two sides are committing themselves to civil relations for the next 30 years, the life time of the deal.

That is no small change in mentality as Russia and China are not natural allies and have always viewed each other, even in Communist times, with a certain level of mistrust until now.

A bargaining chip in global energy deals

The deal also hands both sides a useful bargaining chip in their deals with other partners. The European Union has been unsettled by the string of so-called “gas wars” between Moscow and Kyiv that lead to the spigots being turned off in 2006, 2008 and 2009 leaving the rest of Europe literally to freeze. So now it is looking for new supplies.

At the same time the EU has been complaining about Gazprom’s ‘divide and charge’ strategy of signing supply contracts on a country-by-country basis that has meant some EU members pay a lot more for their gas than others. Brussels is trying to push through an energy reform package that would allow gas to be freely traded across the entire union that would break Gazprom’s monopolistic power.

Now with the option of simply routing more gas east rather than west, Gazprom goes into these negotiations with a much stronger hand than before.

Similar arguments apply to China. Imports of Liquid Natural Gas (LNG) are expected to rise sharply in the future, but these have to be shipped via mega-tanker through the South China Sea that remains vulnerable to a US navy blockade, amongst other things, so a fixed-line supply of gas across its northern border gives Beijing much more strategic energy security.

And like Gazprom in Europe, the alternative supply improves Beijing’s bargaining position in negotiating the prices for that LNG with suppliers.

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