After a lengthy silence, Russia and China have indeed signed a legally binding memorandum for the construction of the "Power of Siberia – 2" pipeline to China and the transit pipeline through Mongolia called "Union-East." This was announced by Gazprom Chairman Alexey Miller.
The project plans for annual deliveries of 50 billion cubic meters of gas from Russia to China via Mongolia, with the agreement set to last for 30 years.
Discussions about this supply route began even earlier than those for "Power of Siberia – 1," commercial agreements for which were signed in 2014. This was a historic milestone, as for over fifty years Russia had only supplied gas to Europe and, for the first time, reached an agreement for delivering blue fuel eastward—to China.
Since then, the situation has drastically changed. Russian gas supplies to Europe have sharply decreased, with three routes—the one through Ukraine, the one through Poland, and the "Nord Streams"—suspended. Gas is currently being delivered to a number of European countries only via the "Turkish Stream," while China has become the largest buyer of Russian gas.
However, the discussions regarding the "Power of Siberia – 2" project have significantly dragged on. Finally, after a long silence, the parties have made a step forward toward their goal.
"A binding memorandum is not a guarantee of the project's realization, but it is a significant step forward. I think there would be no sense in signing an agreement and making a public announcement if there wasn't confidence that we would also sign a commercial contract for gas supplies through this pipeline. Therefore, I would wait for the Eastern Economic Forum. There is a chance that the contract will be signed there. The Shanghai Cooperation Organization (SCO) is already famous, but if we sign this contract at the EEF, then our forum will enter history along with this event," says Igor Yushkov, an expert at the Financial University under the Government of the Russian Federation and the National Energy Security Fund (NESF).
The main issue that has delayed this historic event for several years now is the price of supplies.
"Objectively, as was the case with Gazprom's first Chinese contract in 2014, the price of gas will be lower compared to that charged for gas supplies to Europe."
"The final price of supplies will largely be determined by the consumer, i.e., China, whose gas balance is, to date, highly diversified," says Stanislav Roginskiy, an associate professor and visiting lecturer at HSE University.
Miller stated that the price of gas supplies to China is objectively lower than to Europe due to the shorter transportation distance. Gas is being supplied to China from fields in Eastern Siberia, while supplies to Europe originate from Western Siberia. Consequently, transportation costs for sending gas to China are significantly lower.
However, experts consider distance to be a secondary factor in the gas pricing structure. The pricing model in contracts plays a crucial role. The gas price formula in Europe is formed based on gas prices in spot markets, i.e., exchanges, and this year, spot prices have been high while the European market is currently marginal, according to Yushkov. Conversely, the cost of gas supplies to China is defined by a formula tied to oil basket prices with a lag of nine months, meaning that current prices are calculated based on January's oil quotations.
"It is impossible to sign a contract with China where prices are significantly higher than those on global spot markets. This is because China has a fairly diversified portfolio of blue fuel suppliers," says Yushkov. This means that Beijing can maneuver suppliers and purchase fuel from whoever is cheaper at the moment. He cites 2020 as an example when "Power of Siberia – 1" was initially launched. In the first half of the year, China poorly drew gas from this pipeline because the price of gas due to its oil linkage with a nine-month lag had turned out to be higher than spot prices. At that time, the first reports of COVID-19 emerged, leading to falling prices in exchanges. Beijing took advantage of this and bought gas on the spot market. In the second half of the year, the situation changed: China began to rapidly increase its gas intake from Gazprom because spot gas prices rebounded, while those at Gazprom, conversely, fell.
According to Roginskiy, the price difference between supplies to China and Europe can reach up to 30%. For instance, in the first quarter of 2021, the average price of gas supplies to China stood at $121 per thousand cubic meters, compared to an overall average portfolio price for Gazprom of $171 per thousand cubic meters in the same quarter, the expert notes.
"In today's reality, I believe gas should be priced above $300 per thousand cubic meters for supplies via 'Power of Siberia – 2' to be profitable. However, I believe that even at $200, Gazprom will remain in the black," says Yushkov. In any case, now is the best moment for both parties to sign a contract.
"China's negotiating position is currently at its peak, while sanctions against Russia are still in effect and Gazprom is supplying minimal gas to Europe. However, as soon as relations between Russia and the West improve and hostilities conclude, Russia's negotiating position will strengthen. Therefore, it makes sense for China to negotiate gas supplies with Russia now and secure more favorable conditions," believes Yushkov.
Moreover, China is the monopolistic consumer of Russian pipeline gas, which also strengthens its negotiating position, says Roginskiy.
For Russia, the contract is important from both geopolitical and economic perspectives. Gazprom needs to find a replacement for the lost volumes that were previously sold to Europe. Essentially, it involves increasing supplies to China by 2.5 times solely through the construction of a new pipeline. This is because the capacity of "Power of Siberia – 2" is initially greater than the first pipeline, amounting to 50 billion cubic meters per year (as opposed to 38 billion). For the first pipeline, they also agreed to increase supplies from 38 to 44 billion cubic meters per year, coupled with the "Far Eastern route" project—rising from 10 to 12 billion cubic meters per year.
The main argument from Russia's side for signing the contract is that the greater the confrontation between the US and China, the more need there will be for a reliable supplier from Russia, as ultimately the US will attempt to cut off energy supplies to China by sea.
says Yushkov.
"In the context of possible maritime route blockades, China's economy could face future challenges in obtaining LNG. Meanwhile, Russia guarantees supply stability through the continental pipeline corridor," agrees Roginskiy.
"In the long term, the project is beneficial for both countries: China will be able to mitigate supply risks that have intensified after trade wars, while Russia can increase export revenues, which are vital for macroeconomic stability," says Sergey Tereshkin, CEO of Open Oil Market.
The construction of "Power of Siberia – 2" could take as long as the first pipeline. "Construction of 'Power of Siberia – 2' may take about five years and cost at least 1.5 trillion rubles, based on the experience of implementing the 'Power of Siberia – 1' project: the agreement was signed in 2014, and the first gas began to flow in December 2019. The construction of 'Power of Siberia – 1' cost at least 1.1 trillion rubles," says Sergey Tereshkin.
However, Roginskiy believes they might complete it faster—within three to three and a half years, because the project documentation has been prepared and agreed upon by all parties. Additionally, some gas pipelines and developed fields already exist in Western Siberia. Unlike "Power of Siberia – 1," which required developing new resources, taking more time and money.
Nonetheless, a pipeline will need to be constructed across Mongolia, and it is currently unclear who will shoulder this task. "The new construction may cost between 200 to 280 million rubles per kilometer of the linear section and approximately 1.4–1.6 billion rubles for a compressor station of the necessary capacity," concludes Roginskiy.
Source: VZGLYAD
