In early June, Gazprom and CNPC signed an agreement specifying the start of gas deliveries through the Power of Siberia (PoS) pipeline. Gazprom has committed to launch the pipeline by 20 December 2019, about one year ahead of the deadline stipulated in the 2014 gas supply agreement between the two companies. The commitment was inked during Chinese President Xi Jinping’s visit to Moscow, which featured several other deals. Lavishing Xi with praise for his contribution to building Russia-China relations, Putin awarded him with Russia’s highest state honor.
There can be little doubt, in our view, that the PoS serves as Putin’s sacrifice on the altar of the Russia-China relationship. The agreement means that Gazprom has accepted inevitable multi-billion dollar losses that the PoS project will generate for the monopoly. These losses stem from three factors: the cost of construction and field development; the terms of sale to CNPC; and the outlook for China’s domestic gas market.
After cutting its expenditure on the PoS pipeline last year, allocating about $1.2bn, Gazprom has recently accelerated the pace of construction. So far, the monopoly has built about 800km of the line; its total length from the Chayanda field to the border with China near the Far Eastern town of Blagoveshchensk is 2,156km. Gazprom needs to build – at its own cost – close to 1,000km of the pipeline in the next 12 months to stay on schedule. For 2017, Gazprom has doubled rouble expenditure on constructing the pipeline. Given the appreciation of the rouble, the monopoly’s spending on the PoS this year will reach $2.6bn and grow further in 2018. High as it is, this spending pales in comparison to the cost of developing the fields that will supply the pipeline. Investments in Chayanda alone are conservatively estimated at $7bn. Last summer, Gazprom CEO Aleksei Miller suggested that total investment in the PoS pipeline will amount to $55bn.
The terms of the gas sale agreed in 2014 have never been disclosed. However, Gazprom has acknowledged that the contract is based on an oil-linked price and has become considerably less attractive since oil prices have declined in the last three years. Moreover, Gazprom’s commitment to launch the pipeline in 2019 means that the monopoly will initially supply CNPC with untreated gas. Notably, Chayanda’s gas is rich in ethane and helium. Gazprom is building a gas processing plant near Blagoveshchensk to treat the gas, but the 42 bcma Amur GPP, as the plant is known, will only be completed in 2021. As the price of gas will be unchanged regardless of its composition, CNPC will generate additional revenues from Gazprom’s gas it will then treat.
Finally, the deal makes Gazprom China’s hostage due to the abundant supply of gas from various sources that the monopoly will have to compete with. In addition to domestic supply and pipeline gas from Central Asia and Myanmar, China has 11 LNG receiving terminals in operation with an annual capacity of over 40mn tons. Six new terminals are under construction and three are expanding capacity. According to a recent assessment by CNPC Research Institute of Economics and Technology, supply will outpace demand in the coming years and China may face a gas glut of 50 bcma by 2020.
The only plausible scenario of Gazprom recouping its investments in the PoS project is for the price of oil to skyrocket, in combination with robust demand in China. However, this scenario is highly unlikely. Putin may believe that he has strengthened his alignment with Beijing by tying the two countries through the 30-year gas supply deal. The commercial terms of this deal, however, make it possibly the worst in Gazprom’s history.