Report

From Russia With Love (and a Discount)

After years of talks, Moscow and Beijing finally inked a $400 billion deal that will change the face of the global natural gas market.

After a marathon negotiating session that lasted until almost four in the morning, Russia and China inked one of the world's biggest energy deals Wednesday, a 30-year, $400 billion pact that will send natural gas from Siberia to energy-hungry China.

The successful conclusion of talks that began in the late 1990s, and which were nearly derailed Tuesday on the first day of Russian President Vladimir Putin's trip to China, presages a new era in global energy trade. The implications are potentially huge for Russia, for China and much of Asia, and also for Europe, still Russia's biggest energy consumer.

For Russia, the deal is a way to finally start selling more of its energy to Asia after decades spent supplying Europe with oil and natural gas. For China, the pact offers a way to meet part of its fast-growing demand for energy, especially energy that's cleaner than the dirty coal that has fueled three decades of growth. Europe, meanwhile, is watching the Sino-Russian bear hug with a mixture of relief and apprehension: While the deal potentially gives Russia a way to sidestep European and American pressure on Russia's energy exports in the wake of the Ukraine crisis, it also offers Europe hope of landing its own favorably-priced energy contracts in years to come.

The agreement reached Wednesday calls for Moscow to provide 38 billion cubic meters of natural gas per year to Beijing for three decades. Exact details of the landmark pact are still scanty; Russia's state-owned energy giant Gazprom has not revealed the price at which the contract was signed. But people close to the talks and in the industry said that China had secured a long-term supply of gas at about $350 per thousand cubic meters -- less than what Russia wanted to charge, and less than the $380 that it has traditionally charged European customers.

"Our Chinese friends drive a hard bargain as negotiators," Putin told reporters after the deal was clinched. "But we managed to settle on contract terms that are not just acceptable conditions but actually satisfy both sides."

The deal -- which Putin called a "historic event for Russia's gas sector" -- will lead to the massive development of gas fields in Russia's far east, requiring at least $50 billion in investment by Russian firms and, Putin said, perhaps $20 billion in Chinese investment.

Most importantly, the deal is the first major shift to Asia in terms of Russia's gas exports. It has sold modest amounts of oil to China for years, and is trying to ramp up its exports of liquefied natural gas to thirsty markets in Asia. But the China deal is a big step toward the eastern diversification of energy markets that the Kremlin laid out in 2010, and could pave the way to additional big future deals with South Korea, Japan, and India.

While the new Siberian gas fields will require heavy investment and years of development before they come online, the deal also offers Russia an alternative to its heavy reliance on Europe for gas exports. That means that, by the end of the decade, Russia will have more ability than ever to sidestep any U.S. or European efforts to use Moscow's reliance on revenue from its energy sales to Europe as a weapon. To date, at any rate, neither Washington nor Berlin has quite had the stomach to use Moscow's $100 million-a-day of European gas sales as a point of leverage in the standoff over Ukraine.

"Russia is the big psychological winner in my view," said Tim Boersma, a natural gas expert at the Brookings Institution.

Russia and Putin have perhaps more reason to celebrate than Gazprom does. The deal was delayed for years in large part because Gazprom wanted to replicate in Asia the kinds of profitable gas contracts it had in Europe; China simply refused. The reported price agreed upon in Shanghai would be about break even, or just under, for Gazprom. The China contract will diversify revenues, in other words, but not fatten profits. Gazprom shares briefly jumped Wednesday before giving up most of their gains.

"It's a political deal. Whether it's good for Gazprom and for cash flow is always a secondary priority" for the Kremlin, said one European diplomat who works on energy issues with Russia.

The pact seems to be a clearer victory for China, which locks up future supplies of natural gas at a reasonable price. That's important for several reasons. China's demand for natural gas is expected to skyrocket in coming years, in large part because the government wants to reduce the role that dirty coal has played in powering the economic miracle since 1978; coal-related pollution has become a political liability for Beijing.

Estimates of Chinese gas demand range widely, but analysts agree that gas consumption will double or triple in the next decade. Conservative estimates by the U.S. Energy Information Administration suggest developing countries in Asia will lead the world in gas demand growth between 2010 and 2040, and that China will account for more than 60 percent of that increase. Some companies with a dog in the fight, such as General Electric, which makes gas-fired turbines for the power sector, are even more bullish.

Importantly for China, the deal with Russia won't require a Faustian bargain. Unlike many small European countries who are nearly 100 percent dependent on Russia for their gas supplies, and thus vulnerable to blackmail and supply outages, China will likely only rely on Russia for 10 percent or so of its gas when the project is completed. Other possible supplies include piped gas from Central Asia and liquefied natural gas, or LNG, from Australia, Qatar, Canada, and perhaps even the United States.

If the Siberian fields are developed, and all the pipeline infrastructure is built, that should also offer some relief for other Asian countries, even those who are not directly buying gas from Russia. The availability for the first time of piped gas into northeast Asia will likely put downward pressure on the currently high prices for LNG in Asia, which are about 50 percent higher than in Europe. That's one reason Seoul and Tokyo were closely watching the progress of the Russia-China talks: As the world's biggest buyers of LNG, they could end up benefitting from the deal as well.

But what does Russia's pivot to Asia mean for Europe? In the short term, very little. Gas supplies for China in the first phase will come from new fields in Siberia, rather than from existing fields that pump gas for the European market. In other words, the China deal is a complement, rather than a substitute, for Gazprom's European business.

To be sure, Putin said after the signing that talks are beginning on a second deal with China to supply gas from western Siberian fields, and that Russia's ultimate goal is to link the mature gas fields in the west with the virgin fields in the east, "making it possible if need be to diversify supplies from west to east and east to west." But that will require years of work and billions of dollars of investment to make it a reality.

Until the initial Siberian fields and pipelines are built, Russia will still rely on the European market for the bulk of its gas revenues. That will start to change after 2020, but given the lower prices conditions that China appears to have secured, the Asian market will be less profitable for Gazprom than the European market has been.

Alexey Druzhinin - AFP - Getty

Report

Russia, China Finally Ink Landmark Energy Deal

Moscow and Beijing concluded an energy pact that has been in the works for years. That's better news for China than for Russia.

Russia and China finally inked a huge energy deal Wednesday that will see Russia provide natural gas to the fast-growing market in China for the next 30 years. The agreement, coming just one day after a surprising and disappointing impasse cast a shadow on a much-touted visit by Russian president Vladimir Putin to Shanghai, caps a nearly two-decade odyssey in which both countries have sought to diversify their energy business.

The exact terms of the deal have not been made public, so it is hard to say exactly how much of a bargain China extracted from Russia, which is looking east for new export markets.

People close to the negotiations said that China had agreed to pay about $350 per thousand cubic meters, which is less than the roughly $380 per thousand cubic meters that Russia's Gazprom charges most customers in Europe. That would equate to around $10 per million British thermal units, roughly in line with the prices that Beijing sought during tough and protacted negotiations.

Gazprom, however, did not make public the pricing terms of the deal, which had been the sticking point since the two sides first began talking in the late 1990s and which as late as Tuesday remained contentious.

The deal calls for Russia to develop gas fields in eastern Siberia and ship 38 billion cubic meters of gas per year to the populous northeastern corner of China. Both sides could still apparently expand the deal to as much as 60 billion cubic meters of gas a year. The initial deal would supply about one-quarter of China's natural-gas demand today, but will only meet about 10 percent of China's gas demand in 2020, when the fields and pipelines are expected to be operational.

The Russia-China gas deal will give Moscow an alternative market for one of its main exports, and will help China meet part of its rapidly-growing demand for cleaner sources of energy. But it won't come at the expense of Russia's gas business with Europe. That's because the gas to supply China will come from different fields in Russia's Far East.

Still, in the next decade, it will give Russia a way to lessen its dependence on the slow-growing European gas market--and a way to take the sting out of future efforts by the West to use the energy weapon against Moscow.

As the Chinese market develops, it will offer Russia an alternative source of export revenues to complement its European business, which will make it more difficult for European countries to strike back at Moscow by reducing the amount of energy they buy. In the wake of Russia's annexation of the Crimean peninsula, the United States and the EU have sought to take advantage of Moscow's dependence on energy exports, which account for about half of Russia's federal revenue.

Alexey Druzhinin - AFP - Getty