The Fuse

Long Distance Pipeline Connects Russian Gas to China

by Nick Cunningham | December 03, 2019

Operations of a long-distance natural gas pipeline connecting Russia and China were inaugurated on December 2, connecting one of the world’s largest gas producers to one of its largest consumers.

The new pipeline is not just an important issue for the Russian-China trade relationship, although it is. The pipeline also carries global implications. A substantial increase in gas via pipeline into China could force coal plants offline while also displacing expected growth in LNG imports, which may potentially weaken an already oversupplied worldwide gas surplus.

Power of Siberia
The pipeline has been years in the making, with the initial agreement announced five years ago. The deal consisted of a 30-year contract worth $400 billion in gas. The pipeline itself cost $55 billion, and the Wall Street Journal called it “a feat of engineering,” and Russia’s “most significant energy project since the collapse of the Soviet Union.”

The world has changed a lot in just the last few years, with chronic surpluses for both oil and gas, and prices far below the peak reached in 2014. Reuters reports that Russian industry sources suggested some flexibility on trimming prices for China, but the details remain a secret.

The project is a notable milestone that could alter markets and geopolitical arrangements. Russia has fiercely guarded its market share in Europe, peeling off various European governments over the years and locking them into bilateral contracts. That leverage has since weakened, both due to growing global supplies of gas, and because of an antitrust crackdown by the European Commission. Russia still has a strong grip on the European gas market, and the completion of the Nord Stream 2 pipeline will lend it another advantage.

Yet, even as much of Europe feels anxious about too much reliance on Russia for gas supply, Moscow also recognizes the risks of being overly dependent on sales to the European market. Its annexation of Crimea, which led to a raft of sanctions, has brought on economic pressure, as well as greater scrutiny on Russian influence in the region.

Against that backdrop, the Power of Siberia Pipeline is a momentous shift. There is an obvious logic in a massive buyer of gas and a major seller expanding their trade relationship. “This is an absolutely natural partnership, and it will continue,” Russian President Vladimir Putin said in October.

The pipeline is “a landmark project of bilateral energy cooperation” Chinese President Xi Jinping told Putin in a live video link on Monday, and added that it is an “example of deep integration and mutually beneficial cooperation.”

Coal and LNG hit
Even as the pipeline begins operations, it will take time to absorb the gas. The pipeline connects to a rusty part of northeastern China, which has relatively little gas-fired power generation or growing industry in which the gas can be consumed. The project will initially send about 5 billion cubic meters (bcm) of gas per year, with shipments slated to rise to as much as 38 bcm by 2025. At around that time, the Power of Siberia pipeline could alone meet about 10 percent of China’s gas demand.

In addition to scrambling the geopolitical map, the effects of the Power of Siberia project will be felt across several global markets. China has reduced coal consumption in an effort to cut down on horrific smog, and Beijing has leaned hard on rising gas consumption. The new pipeline could edge out even more coal.

A surge of pipeline gas will also carve out market share from imported LNG. China imported about 43 percent of its gas needs in 2018, with about two-fifths coming from a pipeline in Central Asia, while the rest was delivered via LNG, according to Bloomberg. But demand continues to rise, and China is widely expected to be the largest source of LNG demand growth going forward, by a large margin.

It is on this premise that dozens of LNG projects have been planned or built around the world – in the U.S. Gulf Coast, East Africa, Australia, Qatar, among others. China’s insatiable appetite for gas is at the core of all of these projects.

The problem is, however, that the market for LNG has already become oversupplied. Prices have collapsed around the world, including in the United States, wrecking balance sheets and forcing shale gas companies to pull back on drilling. Morgan Stanley said last month that around 2.7 billion cubic feet per day of American LNG might need to be shut in for a period of time next year due to the surplus, which is equivalent to about half of U.S. export volumes. In an ominous sign for the industry, Singapore-based Pavilion Energy recently cancelled the purchase of an LNG cargo from the U.S., even as it agreed to pay for it. The unusual move suggests the market is dealing with a worsening supply overhang.

The surplus could continue for several years. BP’s CFO Brian Gilvary said in October that the glut may not rebound before 2022. “The UK is full on LNG right now. Europe is full on LNG imports. We do not anticipate that all of the gas that was planned to be exported from the US will be able to hit a demand market any time soon,” Gilvary told analysts on an earnings call. “You will see some exports out of the US but not anywhere near the capacity that has been built.”

U.S. LNG exporters have already lost most of their market share in China due to the trade war, which resulted in retaliatory tariffs from Beijing on U.S. LNG at a rate of 25 percent. The levies meant that China essentially stopped buying American gas, at a time when exports had been on the rise.

But the new Power of Siberia pipeline could lock out U.S. LNG, even after the trade war comes to an end. Meanwhile, Russia and China are negotiating a second long-distance pipeline that could traverse Mongolia, which looms as another market threat to all of LNG exporters around the world who have made big bets on China.