A tale of two gas deals

JULIAN LEE | NOVEMBER 2009 | SOURCE: FSU Oil & Gas Advisory Service

Over the past month Russia has signed two gas deals with neighbouring countries, one with China and another with Azerbaijan. The agreement with China seems to be another tiny step along a very long road that may, or may not, eventually lead to a multi-billion cubic metre per year gas trade between the two countries, but doesn’t seem to be much of an advance on a similar agreement signed three years ago.

In contrast, the agreement with Azerbaijan, although for a much smaller volume of gas, marks real progress in a gas deal that was first discussed seriously only at the end of 2008.

A tale of two gas deals

During October, Gazprom signed two significant agreements with Russia’s neighbours. On the 13th, Gazprom and China’s CNPC signed a general trade agreement during Prime Minister Putin’s visit to China. The agreement envisages the supply by Gazprom to China of 68 bcm/yr of natural gas, but important details, including agreement on a pricing mechanism, still need to be worked out.

Deputy Prime Minister Igor Sechin said that the two state-owned companies would continue negotiations and suggested that a formal contract might be signed in early 2010, with deliveries commencing in 2014 or 2015.

Although heavily promoted to the press as a ‘strategic partnership’, the latest agreement between Gazprom and China does not seem to be any more substantive than the agreement that the two companies signed more than three and a half years ago, in March 2006, during another visit to Beijing by Vladimir Putin, then in his capacity as Russia’s president.

At that time, Gazprom pledged to build two gas pipelines to China within five years (by 2011), each with a capacity of 30-40 bcm/yr. One gas pipeline was planned to carry gas from Russia’s gas production heartland in the Nadym-Pur-Taz region of West Siberia, crossing the Altai Mountains into western China.The second gas pipeline would deliver gas gathered from the Russian Far East and East Siberia into northeastern China.

Gazprom subsequently shelved the Altai pipeline project in 2008, citing ‘a number of serious problems’, which included unacceptable economic, geological and environmental risks. According to the Russian energy ministry’s draft long-term gas strategy at the time, ‘there is currently no economic basis in China to sell gas on market conditions, which would guarantee efficiency and competitiveness of Russian gas supplies,’ an observation that reflected, among other issues, the inability of the two parties to reach an agreement on a gas pricing mechanism.

According to Prime Minister Putin during his latest visit to Beijing, it has now been agreed that Russian gas exports to China will be priced against an ‘Asian oil basket’, although no further details were forthcoming. Until now, Gazprom has insisted that gas exports to Asia should earn the company the same netback value as exports to Europe.

It has been suggested that linkage to an unspecified ‘Asian oil basket’ might indicate that Gazprom is now willing to consider a lower netback for gas sales to China, something that it might have to accept if it wants to break into the Chinese market in the face of competition from Central Asia and Pacific LNG.

A binding gas sales contract with China still seems to be some way off and China will seek to drive a hard bargain with Russia as competing deliveries from Turkmenistan through the Turkmenistan-Uzbekistan-Kazakhstan-China pipeline begin around the end of the year.

The snail-like progress of the gas deal with China is in stark contrast to Gazprom’s success at reaching a quick deal to buy gas from Azerbaijan. Although much smaller in scale (initial deliveries will be just 0.5 bcm/yr), this agreement has the potential to grow into something much bigger, if Gazprom succeeds in its desire to secure all the supplies from the second phase of the Shah Deniz project.

Under the long-term contract, signed on the 14th of October, Gazprom will buy up to 0.5 bcm of gas from Azerbaijan in 2010 at a price to be determined by an oillinked formula. Volumes in subsequent years have not been defined, but Gazprom clearly hopes to be able to increase them significantly.

A price of $350/1,000 m3 was being suggested in Baku, but Azerbaijan is unlikely to see that realised in 2010, when Gazprom is forecasting a European export price of $330-310/1,000 m3.

Deliveries will be made through an existing gas pipeline linking the two countries, which used to carry Russian gas southwards until 2007, when Azerbaijan became self-sufficient in gas following the start-up of the first phase of the Shah Deniz project. The 228-km, 1,200-mm pipeline from Baku top Novo Filya has the capacity to carry up to 5   bcm/yr of gas to Russia.

The speed with which an initial proposal was turned into a concrete deal, albeit initially a relatively small one, reflects the convergence of interests in Azerbaijan and Russia – at least for now. Russia is keen to secure the future production from the Shah Deniz field, thereby depriving the EU-backed Nabucco pipeline of its most likely start-up supply.

Azerbaijan has become increasingly frustrated by its inability to reach agreement with Turkey over the pricing of current exports of gas and the terms of transit of subsequent volumes. Relations have also been soured by Turkey’s recognition of Armenia, which the government in Baku views with a mixture of anger and fear.

From Azerbaijan’s point of view, the agreement with Gazprom is much more than just a diversification of export routes, it is also a warning to Turkey and the EU that, if Turkey cannot be persuaded to behave in what Baku considers a responsible manner over gas transit, Azerbaijan has other options and those other options may not be entirely to the liking of either the EU or Turkey.

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