Gazprom designs new gas pipeline to China via the ‘Eastern Route’

Gazprom, a Russian state-owned gas company, has started designing a new gas pipeline to the Peoples Republic of China (PRC), reports Kommersant. The new pipeline will be an extension of the existing Sakhalin – Khabarovsk – Vladivostok pipeline, which was initially designed to supply natural gas to Russia’s Far East from the Sakhalin island. The planned capacity and length of the new pipeline are not announced.

Designing a new pipeline in the Far East reflects Gazprom’s growing interest to diversify its customers and supply natural gas to China via the so-called ‘Eastern Route’. Earlier this year Gazprom’s senior management announced that the new pipeline from the Sakhalin island would become a new priority for the company after the ‘Power of Siberia’ gas pipeline is commissioned in December 2019.

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Power of Siberia pipeline construction. Image credit: Gazprom

At the end of 2017, Gazprom signed a Heads of Agreement with CNPC, a Chinese state-run oil and gas company, in which the companies agreed on the terms of natural gas supply to China. This agreement, however, specified neither price nor the starting date of supply. Under the 30-year Sales and Purchase Agreement signed by Gazprom and CNPC in 2014, the Russian company will supply to China 38 billion cubic meters (bcm) of natural gas per year. For this reason, the company has already started working on the extension of the Sakhalin – Khabarovsk – Vladivostok pipeline in order to increase its capacity from 5.5 to 20 billion cubic meters a year by 2020.

The current macroeconomic environment in the Asia Pacific region is favourable for increasing gas exports to China due to the rapid growth of natural gas consumption in the country. China’s purchases of liquefied natural gas (LNG) increased by 45 per cent since the beginning of 2018 reaching 40.4 billion cubic meters. According to International Energy Agency (IEA), China will become the world’s top importer of natural gas next year, boosted primarily by LNG purchases. Chinese demand for natural gas will rise by almost 60 per cent between 2017 and 2023 to 376 billion cubic metres, including a rise in its LNG imports to 93 bcm by 2023 from 51 bcm in 2017.  At the same time, Gazprom expects that by 2035 China’s annual demand for Russian gas supply via pipelines will rise to 80-110 billion cubic meters.

Prices for natural gas and, first of all, LNG supplies in Asia are also growing. Thus, according to Platts, LNG supplies to Northeast Asia in December 2018 is currently traded at $12.2 per MBTU or about $440 per 1,000 cubic meters. At the same time, Gazprom currently supplies gas to its customers abroad at an average price of $245 per 1,000 cubic meters. For this reason, $440 is a very comfortable and attractive price for Gazprom, and the company could insist on linking the price of its pipeline gas sold to CNPC to LNG prices in Asia since gas from the Sakhalin island can also be exported as LNG via Sakhalin-2 LNG terminal.

Moreover, due to geopolitical and trade confrontation with the U.S., China may try to avoid purchasing LNG from American gas producers, both in short- and long-term perspectives. At the beginning of August 2018, China announced it will put a 25% tariff on LNG imports from the U.S. as part of a wider plan to introduce $60 million worth of measures to counterbalance trade tariffs recently imposed by the Trump administration. If the trade wars between China and the U.S. continue, other large gas exporters – such as Qatar, Australia and Russia – will most likely take advantage of the situation.

However, stable supply of natural gas to China via the proposed pipeline will require further development of the Sakhalin island resource base and, first of all, resources of Yuzhno-Kirinskoye gas field. As we reported earlier, Yuzhno-Kirinskoye field is affected by the U.S. sectoral sanctions that would make it difficult for Gazprom to purchase necessary technologies and equipment from any American or European manufacturers. For this reason, Gazprom will either have to purchase the equipment from China or develop a ‘sanctions-avoiding’ purchasing scheme with one of the European suppliers. The latter option is supposed to be more difficult since such equipment is usually produced for specific projects, making it easy for regulators to monitor and control such deals. Gazprom expects to bring Yuzhno-Kirinskoye field online in 2023, reaching its planned output of 21 billion cubic meters per year in 2034.

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