Putin backs trans-Mongolian pipeline

Russian leader challenges Gazprom reluctance to accept China’s preferred route for proposed new gas pipeline

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President Vladimir Putin summoned Alexei Miller, CEO of Russian state-controlled gas firm Gazprom, to the Kremlin in September to consider options to construct a new gas supply pipeline to China through Mongolia, in an effort to cut through internal Gazprom resistance to the route.

Putin stressed that the route had Chinese governmental support. Gazprom had earlier in the month met with representatives of CNPC, one of China’s ‘big three’ oil and gas firms, in Beijing to discuss developing a second gas pipeline to link its vast Eastern Siberian gas resources with the world’s biggest gas import market.

A pipeline through Mongolia is not Gazprom’s first choice. Since finalising plans for the first Russia-China gas pipeline, the Power of Siberia, five years ago, the firm has promoted a pipeline route across China and Russia’s 100km shared border, in a corridor between Kazakhstan and Mongolia. The so-called Altai, or eastern, route would enable Gazprom to leverage some of its spare production capacity in western Siberia, reducing upstream investments.

China does not share its enthusiasm for this option. The Altai pipeline would enter China in its restive northwestern Xinjiang province. As well as posing possible security risks, gas would have to be pumped across most of China before arriving at Beijing and other eastern demand centres in the east, increasing transit costs. A Mongolian route would be shorter and more cost effective, at least for China.

The fact that the route via Mongolia is now openly in discussion is likely indicative that both countries are advancing in their negotiations, according to Vienna-based consultancy JBC Energy.

Logical choice

The logic of a second Russia-China pipeline is impeccable. Beijing is on an aggressive push to replace more coal with gas in the power sector, to bring down pollution levels. In its latest 2050 outlook, published in August, CNPC forecasts that Chinese gas demand will surge from 283bn m³ last year to 610bn m³ by 2035 and then 690bn m³ by 2050. Domestic supply will lag behind substantially, rising from 161bn m³ in 2018 to 300bn m³ in 2035 and 350bn m³ in 2050.

“China is unlikely to commit to long-term projects with expensive infrastructure unless it ensures the conditions it wants” Marinchenko, Fitch

China currently gets its imports from Central Asia and LNG suppliers, as well as minor volumes from Myanmar. It has tentative plans to expand its Central Asian gas import capacity by a further 25-30bn m3/yr. But beyond this, China’s only options for filling its growing supply gap are extra LNG and Russian gas.

The Power of Siberia, scheduled to deliver first gas in December, will pump 38bn m³/yr of Siberian gas to China’s eastern seaboard once at full capacity. Construction was underpinned by a $400bn, 30-year supply deal CNPC and Gazprom reached in 2014. Negotiations on a second link started almost immediately, but, as well as routing, price has been a sticking point.

It took China and Russia more than a decade to agree tariff terms for the Power of Siberia supply deal. “China is known to be a tough negotiator and is unlikely to commit to long-term projects with expensive infrastructure unless it ensures the conditions it wants, including a favourable price,” says Dmitry Marinchenko, a Moscow-based analyst at ratings agency Fitch.

Beijing may have a trump card, as it can tap LNG instead of extra Russian gas. Russia, on the other hand, has few other options for monetising its Eastern Siberian resources.

Gas-on-gas pricing

One issue will be whether to link a supply contract to oil or to gas hub prices. While enthusiasm for oil indexation has waned in recent years, there is no Asian gas price reference that would have the liquidity in financial instruments to hedge the sort of volumes involved in a substantial long-term contract.

“Something similar to European importers of Russian gas trying to move away from oil-linked pricing and towards hub-based deals is probably taking place in the Russia-China negotiations,” says JBC, suggesting that a minimum of 30pc of the contract volumes could be gas-linked.

The counterparties could look at tying some of the contract to European prices. Europe is the alternative market for Asian LNG—and possibly, in the future, for Russian gas production that, like oil now, could go either east or west—and the liquidity of TTF futures would be adequate to support hedging. While Europe can be driven by different short-term fundamentals to Asia, the increasingly liquid global LNG market is getting better at smoothing out these regional variations. In any case, the contract vintage and risk management instruments around a long-term contract would be largely unruffled by any temporary divergences in European and Asian spot markets.

TTF linkage would certainly seem less risky for either side than the JKM Asian LNG price, which China—with ambitions of its own to host an Asian gas benchmark—is unlikely to favour, or any Chinese domestic index, of which Russia may be wary and which has nowhere near the required liquidity to support hedging of physical volumes.

Another key consideration is whether a potential new deal will include a take-or-pay clause, committing China to at least paying for a minimum annual volume. This would provide Russia with revenue stability, supporting a new pipeline’s investment case. But China will want as much freedom as it can negotiate to limit Russian supplies and import more LNG at times when the latter is cheaper.

“We expect a supply contract, if signed, to have a take-or-pay clause, but it will most likely be limited compared to what is historically typical for Gazprom,” says JBC.

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