Wednesday, May 21, 2014

21/5/2014: Russia-China Gas Deal


Russia and China signed bilateral gas deal to supply 38bcm of Russian gas per annum, with an option of expanding shipments to 61bcm. The deal covers 30 years of supply. Full valuations and prices are not yet known, but the deal at 38bcm/annum x 30 years was originally valued at USD440 billion.

Here are the best reports on the deal so far (to be updated):

http://www.businessinsider.com/russia-and-china-sign-billion-gas-pipeline-mega-deal-2014-5

Update: zerohedge covers price details here: http://www.zerohedge.com/news/2014-05-21/russia-and-china-finally-sign-400-billion-holy-grail-gas-deal

WSJ on the deal: http://blogs.wsj.com/moneybeat/2014/05/21/russia-strikes-gas-gold-in-china/ pointing to heating up competition in Asia-Pacific energy markets and Russia's play coming ahead of Canadian exports flows. This, in part, explains why Russia agreed on a deal pricing gas at just above USD350 bcm whereas Russia previously looked for a price closer to USD400 bcm. As you can see from the second chart below, over the years while the deal with China was in negotiations stages, gas price inflation fell significantly, reducing room for price upside in the deal.

The deal is of huge importance to Russia.

Russian economy is only weakly-dependent on gas prices, Government deficits are somewhat more closely linked to these. See more here: http://trueeconomics.blogspot.ie/2014/03/2232014-russian-capital-flight-and.html and in the slide below:


The reason for this is that Russian economy is not as dependent on exports (gas accounts for ca 60% of these on goods side):

And in the long run, there is spending and income channel feed through from gas prices (and exports) to domestic demand:

It is worth noting that China-delivery price of Russian gas can be lower than European delivery for two reasons:

  1. Internally contained transit costs
  2. Lower risk of disruptions (remember that Ukraine routinely pushed Russian gas shipments to the brink by either threatening to or actually syphoning gas designated for Western European deliveries for domestic use) and non-payment (settlements are likely to be in Chinese yuan, rather than in the USD and with this, there is no risk of non-payment, as in the case of Ukraine). See: http://trueeconomics.blogspot.ie/2014/04/1042014-game-of-chicken-ukraine-debts.html for more.
Also, gas for China will be coming from newer fields, which are located closer to the Chinese border and, although more expensive in production, are not competing with Western Europe-focused Western Siberian fields.

Finally, new pipeline holds promise bringing exploration and production further East from existent centres of production.

All across - this should be a very good deal for Russia and China. The core threat here is to the US exports of LNG to Asia-Pacific, where US producers are collecting huge margins, compared to European markets. But this threat is still some years (if not decades) off from becoming a significant pressure point.
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