IEEJ： June 2014

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Special Bulletin
A Japanese Perspective on the International Energy Landscape (172)

May 22, 2014

Agreement Reached on Russia-China Pipeline Gas Deal
Ken Koyama, PhD
Chief Economist, Managing Director
The Institute of Energy Economics, JapanAt last, final agreement has come on Russia’s pipeline natural gas supply to China. On
May 21, Russia’s Gazprom and China National Petroleum Corp. announced that they reachedagreement on a contract to supply China with 38 billion cubic meters in natural gas (some 28 million
tons in terms of liquefied natural gas) annually over 30 years from 2018. Gazprom President Alexey
Miller indicated gas sales under the contract would total $400 billion. It may be called a grand inscale and historic agreement.
The reason I used the word “at last” at the outset of this report is that China and Russia had
10-year-long marathon negotiations on the gas contract. Russia has attempted to secure gas sales
channels in Asia and diversify gas sales destinations in a bid to ease its heavy dependence on theEuropean market, while China has tried to acquire gas supply to meet growing domestic energy
demand. The large-scale gas deal is complementary and of strategic significance to the two countries.
Nevertheless, they had remained wide apart particularly over the gas sales price, leading thenegotiations to be so prolonged. They had reached agreement on the terms and conditions other thanpricing last September. The latest agreement indicates that the two countries have finally overcome
the last difficult pending problem.
Both parties fell short of specifying details on a solution to the last difficult pending
problem. Based on the contract value of $400 billion and the supply volume (38 billion cubic metersx 30 years), however, the average gas supply price turns out to be some $350 per 1,000 cubic meters(about $9.8 per million British thermal units). This price is almost equal to the price for Gazprom's
gas sales to the European market (Western Europe). But the above estimated price is a simply
calculated average. Gas supply volume changes from the project launch may have to be taken into
account. In this respect, market players estimate a price range of $370-380 per 1,000 cubic meters($10.4-10.6/MBtu). Russia pursuing a higher price and China seeking lower-price procurement
might have compromised at the European sales price level that can be a reference for both countries.
To implement the contract, Russia will have to fully develop the Chayanda and Kovykta
gas fields as supply sources and construct pipelines. Given that there are only four years left before
the supply launch, Russia is required to implement the gas field development and pipeline
construction at high speed. The Russian side has estimated that a large-scale investment worth $551

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billion would be required in the gas field development and the pipeline construction within Russia.
Relevant financing would be a key point. Media reports said China has agreed to pay $25 billion inadvance. This Chinese concession might have been a key step inducing the final agreement. CNPC
is set to undertake relevant pipeline construction in China.
Given the large-scale initial investment required for future gas supply, the net profit that
Russia’s Gazprom would gain at the just agreed price under the contract with China is dominantly
seen as lower than that on sales to Europe (at almost the same price). Therefore, Gazprom might
have had desperate negotiations with the Chinese side that had strongly sought to procure Russiangas at a price lower than that for Russian sales to Europe. It might have been very difficult for themto reach the pricing agreement. Nevertheless, it is significant for Gazprom to have secured themassive gas sales revenue through a non-European sales channel, even though the revenue will notcome before 2018.
The China-Russia gas supply agreement may be described as grand in scale and historic as
noted above. But the energy supply agreement is also of great significance for enhancing theirstrategic cooperation. We must pay attention to the fact that the agreement was timed to coincidewith the May 20-21 Summit Conference on Interaction and Confidence Building Measures in Asia,
which China hosted in Shanghai. At the CICA summit, the host country’s President Xi Jinping in his
address emphasized that security problems in Asia should eventually be solved by Asians themselves,indicating China’s intention to take the initiative in building a new Asian security order. Among thesummit participants were Russian President Vladimir Putin and Iranian President Hassan Rouhani.
On May 21, they issued the Shanghai Declaration calling for building an Asian security framework
through confidence-building efforts. The CICA summit and the Shanghai Declaration haveundoubtedly been designed to counter the recent U.S. foreign policy that seeks to “rebalance” and“pivot” toward Asia to deepen U.S. engagement in Asia. At a time when Russia is undergoing
Western sanctions and other heavy pressures amid the tense Ukraine situation, it is strategically andgeopolitically important for Russia to demonstrate its enhanced cooperation with China. Under suchsituation, the large-scale gas supply contract came out of international politics surrounding China
and Russia.
The latest China-Russia agreement is a key step toward actual Russian gas supply to China
and enhancing bilateral interdependent relations. However, given that the deal contains gas fielddevelopment, pipeline construction and other challenges to be tackled in the future while the details
are not yet available, we may have to pay attention to relevant future developments. We may also
have to watch how the China-Russia gas deal would influence China’s gas and energy
supply-demand balance, its natural gas/LNG procurement strategy and the Asia-Pacific gas/LNG
market supply-demand balance. How Russia would tackle various natural gas/LNG projects for theAsian market including Japan would also be interesting. For Russia that has chosen to enhancestrategic relations with China, balancing may grow more important as China’s significance increases
more and more. How will Russia implement its strategies for Japan and Asia under such conditions?
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How should Japan deal with Russia? We may be required to accurately analyze trends under theliquid international situation.

Contact: report@tky.ieej.or.jp
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