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The arrival of first gas into this growing gas market
marks Gazprom's significant shift toward pipeline exports to
Asia. The European market will stay a top priority for
Gazprom, but new exports to this rapidly growing gas market is a
growth strategy for the company.
Power of Siberia will be a profitable project for
Gazprom. Despite the sizable amount of capex for upstream
development, the pipeline, and gas processing, IHS Markit estimates
that the project's break-even price including export duty is at the
level of our estimated gas price at the border.
Russian pipeline imports will put a downward pressure
on LNG imports in China's Bohai Bay region. According to
the IHS Markit estimated pricing formula, the Power of Siberia gas
will be among the cheapest supply options in the northeastern
market. It will also be competitive against most term LNG imports
in the Bohai Bay region but not as far south as Shanghai.
The arrival of first gas from the Power of Siberia in
China
Five and a half years after signing the sales and purchase
contract, first gas from the Power of Siberia pipeline project has
finally been delivered to the Chinese gas market. Russia's Gazprom
and Chinese oil giant PetroChina signed a 30-year contract -- which
at plateau calls for supply of 38 billion cubic meters (Bcm)
annually -- in May 2014 and in a supplemental agreement
subsequently to commence on 2 December 2019. Today's inauguration
ceremony at Blagoveshchensk-Heihe at the Russia-China border marked
the beginning of the era of Russian pipeline gas supply to
China.
Gazprom's strategic shift to Asia market
Gazprom started to work on the project very soon after the
contract was signed. Of the 3,000 km of total pipeline length
within Russian territory, the 2,200 km pipeline section connecting
the Chayanda gas field to the Chinese border was essentially
completed in the summer of 2019 (see Figure 1). Chayanda achieved
first commercial gas production in August 2019, allowing the
filling of the pipeline to begin. Pipeline fill to the border was
completed in October. Development at the second field that will
supply gas, Kovykta, has been under way as well, with drilling
beginning in August 2019. Kovykta is slated to produce its first
gas in 2023, allowing total production of raw gas at the two fields
to reach 50 Bcm/y, which is more than sufficient to supply the
contracted export volume.
Figure 1: Power of Siberia gas trunk pipeline.
The European market will remain a top priority for Gazprom, but
new exports to this rapidly growing gas market is a growth strategy
for the company. Gazprom's exports to Europe are expected to be
around 200 Bcm a year (in Russian calorific standard), making the
38 Bcm annual contracted volumes to China a significant addition to
Gazprom's gas export portfolio. Furthermore, the two sides are
still negotiating other supply options for up to 65-67 Bcm a year
in combined delivered volumes. How successful the negotiations will
partially depend on the actual progress of the Power of Siberia
project in China.
Chinese regional demand for Russian piped
gas
On PetroChina's side, pipeline construction within Chinese
territory did not start until December 2017 but progressed on
schedule to receiver first gas. The three regional markets
designated for Power of Siberia gas include the northeastern
region, Beijing-Tianjin-Hebei or Jing-Jin-Ji market, and the
coastal market through Shanghai (see Figure 2). Construction on the
northern section of the pipeline to the northeastern regional
market was completed and started testing in April 2019, extending
to Changling in Jilin province. The middle section of the pipeline,
which will supply Russian gas to the Jing-Jin-Ji region, began
construction in the summer of 2019 and is slated to come online in
late 2020. The southern section of the pipeline, which will go
through Shandong and Jiangsu and end in Shanghai, will follow in
2021.
Figure 2: Russia-China natural gas pipeline within Chinese
border.
The pace of ramp-up in delivery volumes will likely hinge on
developments in China's regional demand for Russian gas. That, in
turn, depends on the target markets' gas demand and Russian gas'
competitiveness in each regional gas supply mix.
From a demand perspective, the northeastern market is the
closest to the border but has low affordability for high-priced
gas. Russian gas will be very competitive in this region on a
delivered-cost basis because of lower transportation costs within
China. The two regional markets farther south (Jing-Jin-Ji and
Shandong-Jiangsu-Shanghai) are well-established gas markets with
growth potential, but already have a diverse supply mix that
Russian gas needs to compete against.
The exact pricing formula for the Russian gas delivered to the
Chinese border, like most gas supply agreements, is confidential.
But IHS Markit understands that it is an oil-linked contract, and,
given the announced package value of $400 billion at the time of
the agreement when Brent oil price was over $100/barrel, IHS Markit
expects the Power of Siberia to have a similar fixed-price
component, $1.25 per metric million British thermal unit (MMBtu),
and a higher slope, around 9%, vis-a-vis oil prices than Central
Asian gas delivered to the Chinese border. When sufficient data on
landed prices at the border become available, regressions can be
run to better estimate the general pricing relationship for the
Power of Siberia gas.
IHS Markit's current economic analysis indicates that the
integrated Power of Siberia project is profitable, despite the high
level of capital expenditure involved (about $29 billion for the
pipeline and upstream development). IHS Markit estimates that the
project break-even price (including applicable tax exemptions and
export duty) is at the level of the estimated contract price in the
Gazprom-PetroChina contract. Upstream tax exemptions are critical
for project profitability.
Transmission tariffs are a significant part of bringing gas to
Chinese consumers, both within Russia and within China. Within
China, the Power of Siberia gas will need to travel thousands of
kilometers from the border to reach the Jing-Jin-Ji region and all
the way to Shanghai. Competing LNG imports, on the other hand,
essentially arrive right at the coastal demand centers.
Northeastern market
Given the short distances from the Russia-China border to
consuming centers in the northeastern market and its limited gas
supply options, Russian gas will be cheaper than most available
supply sources there. But this region will not be able to absorb
all of the contracted volumes, so Russian pipeline gas will have to
go farther south to find sufficient market.
Jing-Jin-Ji market
Transmission tariffs from the border to Beijing will be less
than $2/MMBtu, making the Power of Siberia gas relatively
competitive in the Jing-Jin-Ji. Here, Russian gas will likely be
lower in delivered costs than most term LNG imports. That means
Russian gas will put downward pressure on LNG imports. Nonetheless,
IHS Markit still expects LNG imports to remain a crucial supply
source in this region, especially for winter peak supply.
Shanghai market
The farther south it goes, the higher the transmission cost
Russian gas will incur - IHS Markit estimates $3.3/MMBtu from the
border to Shanghai. That pushes Russian gas to the high end of the
supply cost stack there, making it less competitive than most term
LNG imports.
These assumptions on competitiveness have been built into our
long-term gas supply mix outlook for China. The actual supply mix
in each region will also depend on other factors, such as pipeline
capacity availability, gas demand and supply options in the rest of
the country, and suppliers' strategies in these markets.
Anna Galtsova is Director of the Russia and
Caspian Energy service, and Jenny Yang is Director
of the Greater China Gas, Power, and Energy Future service at IHS
Markit.
