An active discussion of the construction of a new gas pipeline to China with a capacity of 50 billion cubic meters should begin in the near future. This project was announced earlier, and now it is of particular relevance. Ob-viously, one of the most pressing issues will be the price of future deliveries. Moreover, the issue is raised from time to time even now, in the context of the work of the Power of Siberia, the existing gas pipeline in the PRC.
Indeed, the cost of selling gas to China is now two to three times lower than the price of natural gas for many EU countries. The reasons are known: for the contract with China, “oil” pricing is used (more precisely, prices are tied to a basket of petroleum products), moreover, with a time lag, so even current prices reflect the cost of oil a few months ago. And in Europe, settlements under contracts are linked to exchange prices for gas within the EU itself, which have now grown many times over from the “norm”.
But while the current ultra-high exchange prices in the EU may persist for a long time, perhaps even years, they are unsustainable in the long run for a variety of reasons. For example, at such a price, it is profitable to extract the most difficult reserves, which will increase the supply. And just heating with oil products now turns out to be two or more times cheaper than gas. By the way, this process occurs, of course, on a limited scale, since such a switch is far from being possible everywhere. In addition, if hypothetically “to exchange all gas for oil”, then the latter simply will not suffice.
Qatar also demonstrates its attitude to the future of gas prices. The country traditionally tries to sell its LNG at a high price, Qatar, for obvious reasons, has maximum flexibility in ch-oosing a buyer, and Europe is ready to conclude contracts pegged to very high exchange prices at the moment. It would seem that all the cards are in hand. But against this background, Qatar is negotiating the sale of LNG under new long-term contracts with China and with an “oil” price peg. We will not go into details of pricing formulas. But at an oil price of, say, $80 per barrel, one can estimate that LNG on the Chinese coast will cost about $330 per thousand cubic meters. That is, in the long term, Qatar still expects a drop in spot gas prices and wants to gain or gain stability from the price pegging to oil.
Can we expect a similar price for a future Russian contract for new pipeline gas deliveries to China? It is possible that it will be slightly lower, and there is an objective reason for this.
The fact is that the main economic activity and, accordingly, the demand for gas in China (as in ma-ny other countries) is obs-erved in coastal provinces. Accordingly, LNG is the most convenient solution, as it is purchased onshore. And gas, for example, from the countries of Central Asia enters the sparsely populated Xinjiang Uygur Autonomous Region. Therefore, further gas pipelines have to be pulled by China itself to the coast, which affects the final cost of gas.
This is also why the existing Power of Siberia gas pipeline is designed in such a way that it enters to the east and brings gas to the Beijing region, where it is really needed. And China’s costs for the construction of its part of the gas pipeline turn out to be less compared to Central Asian gas. Nevertheless, even a simple glance at the map will immediately show that the route from Beijing to the Russian-Chinese border is several times longer than to the Chinese coast. And as the volume under the current supply contract increases, Russian gas will go further south along the coast, this is also China’s expenses. Therefore, Russian pipeline gas is of interest to China at prices below the cost of LNG in order to compensate for its costs of transportation within the country.
But let’s get back to the new Power of Siberia-2 gas pipeline, which is currently being designed, which will no longer bring gas to China from new fields in Eastern Siberia, but will redirect the reserves of Western Siberia that are now going to Europe. Initially, it was planned to make the narrow section of the border between Kazakhstan and Mongolia the point of entry into C-hina. But then we would be faced with the problems al-ready described – China do-es not need gas in this re-gion, which means that it is ready to take it very cheaply. Therefore, a couple of y-ears ago, the project was c-hanged, now Mongolia is supposed to be a transit co-untry and access to the sa-me region, close to Beijing.
Nevertheless, it must be admitted that now Russian gas on the border with China is cheaper than Central Asian supplies, although gas from Central Asia has a longer transport arm through China. This is often explained by the special conditions on loans and investments by the PRC itself in the production and transportation of gas in Turkmenistan.
One way or another, now it is important for us what the cost of gas will be for new supplies from Russia. It is too early to talk about specific formulas and prices, perhaps, by the way, that pricing will be mixed and will take into account new trends in the market.
But it is important to note here: the oil-linking ratio in the new LNG supply contracts has become 20-30 percent lower than at the time the Power of Sib-eria-1 contract was signed. That is, based on the desc-ribed logic, China could offer an even lower price in a new contract for the supply of our gas. And, of co-urse, we should not forget that China would like to ta-ke advantage of its status as the only buyer of pipeline gas in the East so far.
Nevertheless, there is every reason to hope that the price will be worthy. The situation has changed a lot compared to 2014, when the first contract was concluded with China, on the Power of Siberia. Recent events show that in the event of any international tension, LNG supplies, including American ones, and maritime transport in general, turn out to be risky. This gives our side certain advantages in the negotiating position. After all, the pipeline provides almost one hundred percent guarantee of supply, so valuable in a changing world. All th-is, of course, is understood both in Beijing and in Mos-cow. Which does not negate the fact that the negotiatio-ns will be difficult: China is traditionally a difficult neg-otiator, in addition, the ob-jective reasons described a-bove, related to the costs of China itself for transportation within the country, explain the desire to receive an additional discount.
And last, but perhaps most importantly. Textbooks on financial management teach us that in order to make an investment decision on a project, we need to build a model of cash flows, moreover, discounted ones, that is, taking into account the value of money (the return on expected investments, in the simplest version, this is the interest on the deposit). And if, they say, it is not possible to achieve a given return on investment, then there is no need to participate in such a project. There was a lot of speculation on this topic with regards to the current “Force of Siberia”. And here are two considerations. Firstly, hardly anyone calculated the profitability of Soviet export gas pipelines to Europe using these methods. And if they counted, perhaps it would turn out to be negative. But the Soviet gas infrastructure paid off and for many years provided income for the Russian Federation and Gazprom”as a commercial enterprise.
And secondly. Gazprom now has money and increased income from expensive sales on the European market. Of course, as theory teaches us again, if there is no project with an acceptable rate of return, you can simply keep the income in your accounts or “distribute it to shareholders” (we also note that there is always internal gasification, but right now the process is in full swing there).
But there can be no doubt that Gazprom should continue its export activities as well. This is not only foreign exchange earnings, but also a geopolitical component. This means that in any case it is necessary to build a new pipeline to China, since European exports will gradually decrease. And one more consideration: it is very likely that we are entering a period of high inflation. If this really turns out to be the case, then for the company, the presence of assets that generate revenue is much more important than the money in the accounts or even loans.