The Impact Of Gazprom’s China-Russia Gas Pipeline

Gazprom’s Power of Siberia pipeline is more than two-thirds complete.  It will be delivering gas to China by the end of this year.  A second pipeline is still under discussion.

A report yesterday from Alex Mercouris at The Duran noted some frustration from China over the irregular liquefied natural gas (LNG) supplies coming from its contract partners in Uzbekistan and Turkmenistan.

It seems the Turkemi and Uzbek governments are shaking down China for better prices because gas demand in Western China’s autonomous regions is growing rapidly.  Complicating matters is the tough winter in Europe which spiked LNG demand there as well.

Remember, Gazprom recently announced that delivered volumes to Europe rose by 8 percent in 2017 over 2016.  And that number is likely to rise again this year.  Even the U.K. is begrudgingly buying Russian LNG from the Yamal LNG project on the Eastern Baltic coast.

China National Petroleum Corp., CNPC, just signed a deal with Cheniere Energy to supply 1.2 million tons of LNG annually.  China’s demand for natural gas has to rise as its leadership deals with the increasing costs of air pollution from running a major portion of its economy on coal.

This is part of the reason why Russia and China hooked up for the original Power of Siberia pipeline in the first place.  And it’s why I have little doubt that a second pipeline is a slam dunk. This would be the expanded Altai Pipeline or Power of Siberia 2 that was postponed in 2015 but is now back on the table.

Last year China and Russia signed an MOU on Power of Siberia 2.  Though no formal agreement has been reached, it’s obvious both parties want this done.  The question for China is likely price.  And they are not above holding out for better terms and cheaper gas prices.

So, they’ll string Gazprom along on price by talking engineering, etc. for a few more months while they wait to see if the projected glut of gas materializes.

Natural gas prices have severely corrected in the past few weeks, down from nearly $3.50/mmbtu to today’s price at $2.62.  Inventory draws were below expectations and U.S. domestic supply is set to outstrip demand this year as record production numbers necessitate changes.  But, this is the U.S. domestic situation.

Hence, China looks like it got a good deal using Henry Hub pricing for its contract with Cheniere.  And this correction is likely what Chinese leadership was hoping for before committing to Power of Siberia 2.

This is a pipeline China knows it needs but it still doesn’t want to overpay.  I suspect, however, if Gazprom plays true to form that it will tie its gas price to the price of oil.  And with the new Shanghai oil futures contract now trading this provides an opportunity to deepen interest in it.  Any future gas deals between China and Gazprom can be indexed to that contract rather than West Texas Intermediate or Brent Crude.

Russia wants its Urals grade of medium sour oil to be a global benchmark.  And, that’s exactly what the Shanghai contract trades.

With U.S. production spiking it will be hard to maintain these oil and gas prices.  Brent has corrected back to below $63 per barrel and, looking at the chart, I wouldn’t be surprised to see it correct further towards $55-57 per barrel.  In fact, I know oil prices are likely to correct hard because Goldman Sachs is now calling for $80 oil within six months.

Nothing says, “Short oil,” like a Goldman bullish call on it.

This downturn in prices is putting upward pressure on the Russian ruble, now no longer looking at sub RUB56 versus the U.S. dollar but likely pushing back towards RUB60.  Remember, the Russians don’t care about lower oil and gas prices as much as the other major producers.

The ruble floats openly while the Saudi and Qatari Riyal are both pegged to the dollar.

Moreover, the price of LNG has held up much better than was expected.  The market was supposed to be glutted going out to 2020, but as we’ve already seen European LNG demand has been strong, but Asian demand, especially Chinese, has kept the market surprisingly tight.

LNG imports, according to a report from Poten and Partners in November put China’s LNG imports up 42 percent year over year while prices stayed above $9/mmbtu.

So, don’t be surprised if we don’t hear something about Power of Siberia 2 in the next few months.  Between the unreliability of China’s central Asian suppliers, falling gas prices and stubbornly high LNG prices, that pipeline is looking more and more economic for China.

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