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Gas to be key Russia-China outcome in St.Petersburg

Gas to be key Russia-China outcome in St.Petersburg
A long term gas supply deal between Russia and China is expected to be completed in time for signing by Presidents Dmitry Medvedev and Hu Jintao at the St Petersburg International Economic Forum.

­Negotiations over a gas supply agreement have been underway for some time and proven protracted, with China looking to ensure diversity of supply and Russia looking to maximise price.  The differences in approach to price largely reflect a Russian desire to approximate European based price for gas going to China, against a Chinese view that the gas planned for supply to China would be unlikely to be sold to Europe, meaning it should get a discount.

Chief investment strategist at Verno Capital, Roland Nash, says the lengthy nature of the talks reflects

“Both countries believe they hold the better bargaining position.” But he adds that an agreement is inevitable.

Deputy Prime Minister, and Energy Minister, Igor Sechin affirmed to journalists that he was expecting an imminent deal.

"Before June 10 Gazprom and China's CNPC will complete negotiations and prepare to sign a commercial contract. Under the agreement, Russia will supply China 68 billion cubic meters per year for at least 30 years. In this case we consider two routes of gas supply: the east route is planned to deliver 38 billion cubic meters per year, and the west route – 30 billion.”

68 billion cubic metres would account for an estimated 60% of China’s 2010 consumption, and come on top of a long term oil supply deal signed in 2009.  At European prices a 30 year deal could be worth as much as $700 billion. 

Unicredit oil & gas analyst Artem Konchin says he thinks that price will continue to be a major issue even if agreement is reached in time for signing this week, with Gazprom likely to face pressure on European contracts if it agrees to a significant discount for China. Konchin says the Chinese have the upper hand in negotiations.

“I don’t think this deal is very promising for Russian side, more for China which has already ensured itself with diversity of energy sources and developed the infrastructure to ensure domestic demand coverage. In this case, I think China will not afford any price issues and rather will probably accept an offer for undeveloped Russian gas assets. However, I doubt that Gazprom and Russian Government will let talks to turn this way around. The assets are impossible to valuate and Russia will not rely on approximate estimations. The gas prices China has agreed with were around $230-250 per 1000 cubic meters which is almost 40% less of Gazprom contracts in Europe. That means that even if Gazprom accepts the offer and cash out to build infrastructure, the European contractors of Gazprom will ask to review their price agreements for gas supply. “

Konchin added that another key fact to be priced in will be the investment in pipelines.

“Gazprom, in case of positive outcome of the negotiations, will probably agree to finance the project which includes construction of 6700 km of Altai gas pipe which will deliver first 30 billion cubic meters of gas in 2011. The cost of the construction could be around 30 billion roubles according to approximate calculations of the cost of Gazprom pipe construction for other projects multiplied by the distance of the Altai pipe."

InvestCafe analyst Grigory Brig believes that despite the cost, the infrastructure to supply China is vital to ensure a foot in the market, providing a long term strategic position in a market tipped for exponential demand increases.

“Although it is unlikely that pipelines will be initially fully loaded, they give Gazprom access to important Chinese market. The gas market in China is very promising, because the country's energy needs are growing at a high rate, often outstripping production growth rates of other countries – producers of hydrocarbon resources. It is expected that gas consumption in 2011 will grow by more than 20% to 130 billion cubic meters, and by 2020 will reach 230 billion cubic meters. In this regard, China needs not only to diversify sources of gas consumption in the country, but also to ensure long-term contracts. I think the position of Russian side is fair, but I think that in order to conclude a contract with China, Gazprom will have to make some concessions.”

Finam Oil & Gas fund manager Roman Bessedovsky says the additional risk likely to be taken on by Gazprom to fund infrastructure construction means that Russia will be looking to stand firm on pricing.
“We expect the long-term upwards trend in world prices for hydrocarbons to continue. Given the long-term investments that are required from the Russian side for the start of deliveries to China, its position is more vulnerable to risks, so it is logical to rely on Russian estimates. If in the future world prices fall and China will find other sources of supply, it will always be able to push the Russian side for lower prices. Russia has a large experience in such negotiations and it will hedge the project risks with guaranteed prices.”