The large supply deal that will send natural gas from Russia to China beginning in 2018 is significant in many ways. The deal, reportedly for 38 billion cubic meters (bcm) per year (or about 3.7 billion cubic feet (bcf) per day) at a price of $350 per mcm (or $9.90 per mcf), should put Russia in a very competitive situation to capture market share in a growing Chinese domestic natural gas market. Despite long-standing differences between the two nations, this should come as no surprise. To begin, the current natural gas price in Asia is higher than anywhere else in the world. This has led to increased interest in making large capital investments to export liquefied natural gas (LNG) from the US, Canada and elsewhere. Projections of strong demand growth in China have provided support for a long term expectation for strong prices in Asia. In fact, suppliers around the world are seeking to ink deals to send natural gas to China. Any analysis would indicate that a low cost supplier is in the best position to do so – enter Russia.
Of course, the Chinese, along with every other buyer in Asia, would like to secure supplies at a lower price than what currently prevails in the Asian market. This is something we in the United States should understand very well, since when energy prices rise it hits us all where it hurts – in the pocketbook – and economic activity generally slows. The alignment here is simple. High prices encourage new supplies to enter the market, and buyers are eager to accept them, particularly when they are at a lower cost. Hence the saying, “The best cure for high prices is high prices.” This deal is evidence of it.
Unfortunately, many analysts have long expected Chinese demand will be met primarily by LNG imports, but, it should be obvious that everything is in play, not just LNG. Indeed, the volume of the Russia-China gas deal should be sufficient to give some proposed LNG projects pause. As Russian gas matriculates into the Chinese market it will set the competitive bar for supplies delivered into Asia. This is not to say that price in China will forever be $9.90 per mcf, but it does indicate what the Chinese are willing to pay for a long term supply deal and I would hazard that it is not $15 or more. In fact, in a recent paper I argued that the long term gas price in Asia is likely to fall as new supplies enter the Asian market. This is the first step toward that end.
So, what does it all mean, especially in light of what is going on between Russia and the West? First, do not expect Gazprom to abandon its efforts to hold market share in Europe. In fact, by many respects the infrastructure projects that Russia has recently developed and is actively pursuing (North Stream and South Stream) are endeavors aimed at bypassing transit country risk and maintaining market share in Europe. Moreover, buyers in Europe, particularly in Germany and Italy, have long-standing commercial relationships with Gazprom, and the importance of this cannot be undersold. It will, however, be very difficult for Russia to not lose some market in Europe particularly as central European countries – which depend most heavily on Russian supply – try to diversify away from Russian gas. But just as the US could use free trade status with the European Union as a credible threat to Russian dominance in the European gas market, Russia can tilt its market focus toward Asia to demonstrate that it is not as dependent on the European market for the long term health of its energy sector as many in the West would like to believe. Indeed, the West may have overplayed its hand in thinking it could impose sanctions and deeply harm the Russian energy sector. If anything, Russia has demonstrated that it has a willing customer in China and, moreover, that it is willing to substantially deepen its economic ties with China.
In sum, Russia has strengthened its position in an emerging natural gas market to the east, as it faces threats to its dominant position in natural gas markets to the west. However, the ability of the West to significantly dent Russian market presence in Europe is questionable at the very least. Russian gas will play an important role in balancing global markets for the foreseeable future, despite any effort to the contrary.
The question now is whether or not Russia will use natural gas to gain political leverage in broader negotiations. That may be difficult when it comes to China. Specifically, China is developing a diversified approach to meeting its own gas demands, with supplies coming from domestic sources, Central Asia, South Asia, LNG and now Russia. Indeed, China could arguably be developing a more diversified supply portfolio than even that in the US. So, despite greater pending gas exports to Asia, Russia’s ability to use gas as a political tool may be limited in matters to do with China. Nevertheless, at the very least, Russia has demonstrated that the leverage the West has over it on matters of natural gas is minimal at best.
Post by Kenneth B Medlock III, Senior Director, Center for Energy Studies, Rice University’s Baker Institute
