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China Searches for Gas

   As you probably know, Gazprom for few consecutive years has been engaged in negotiations on pipeline gas deliveries to China – up to 38 bcm along the western route (the China gas pipeline) and up 30 bcm along the eastern route.
The gas pipeline is to rely on Western Siberian gas as its resource base, but the problem is that China needs gas of easterly direction, that is, from where it has its main industrial facilities. But the fact is that while being in negotiations with Russia, China has struck deals with Turkmenistan, Uzbekistan and Kazakhstan on buying gas from them and on the construction of a pipeline running from there. Moreover, Turkmenistan has received a loan from China to the amount of $4 billion to be spent on gas reserve development.

   Russia was not particularly against such a step on the part of Turkmenistan, its traditional partner, as far as the purchases of “a blue fuel” was concerned, believing that the eastward run of Turkmen gas would be conducive for Russia to feel safe at its traditional European market.

Europe Goes Ahead to the Past

   The European market, however, had quite a few bad news laid in store for Russia together with “a shale revolution” originated in the United States. Indeed, due to the world financial crunch, the consumption of gas in Europe dropped, while LNG unclaimed in the US came to the European market. These developments acted to lower gas prices.

   In addition, the Europeans have launched “an anti-gas game“ – they have begun proactively promoting the production and use of renewable energy sources, and started to try and replace nuclear power engineering not with environmentally-friendly natural gas, but with coal, the past ages’ fuel.
The good news is that all the above is still the intentions listed in the EC Energy Roadmap 2050, but the reality is the renewable energy industry already is being funded. Angela Merkel, Chancellor of Germany, the country which acts as a European economy locomotive, says that gas will become a fuel which will support the transition of the European economy to renewable energy sources, or a bridge to more advanced technologies”. The European Commission also will try and pursue the Europeans to use energy in a thrifty way, and also will throw its weight behind the introduction of energy-saving technologies.

   Gazprom in turn offers its own arguments against the policy pursued by the European Union. Alexander Medvedev, Gazprom Export CEO, says that the European Commission is only focused on bringing the emission of greenhouse gases down (80-95% by 2050 against 1990), but fails to consider any technological, social and economic risks. Addressing the World Gas Congress held in early June he said that “the EC’s energy saving drive may lower people’s living standards, while the technologies used to capture and store waste are still unable to live up to expectations”.

   The production and use of renewable energy sources are based on substantial state subsidies, a situation which contradicts the very idea of competitive economic growth. Moreover, Medvedev believes that this can lead to substantial unbudgeted expenditures.

   Most companies, however, are yet to decide whether gas or coal should become the main fuel for power engineering. Currently, the share of gas in European power generation is 23%, but according to E.ON Ruhrgas’s Chairman of the Board of Management and Chief Executive Officer Klaus Schäfer, this share can soar to 35% or otherwise drop to zero. Addressing the 7th Conference “EU-Russia Energy Dialogue” held in late April, he said that “over the last few years, Europe has failed to use more gas for power generation but instead it now uses more coal largely because of the prices for these energy products”.
Thus, the Europeans are putting pressure to bear on gas suppliers to make them cut down their prices. Probably, the latter would be glad to do that but the problem is that gas reserves become increasingly less accessible thus pushing the production costs up.

   As far as the diversification of gas supply sources is concerned, the EU has shut itself away from Russia with the Third Energy Package (package of energy-marker liberalization documents) and is doing its best to promote competition even in the wrong places. Thus, Gazprom and its German partners on the construction of the Nord Stream pipeline and its OPAL and NEL branches are unhappy about the European Commission because it makes them apply the third-party access rules retroactively to boot, that is, when the new law entered into force after the construction of the pipeline. Alexey Miller, Gazprom Head, told the late-May session of the European Congress that the EU prevents the investor from using as much as 50% of the capacity of its Nord Stream pipeline.
While an exception from the third-party access rules for Gazprom and its partners on the South Stream is still only a dream, in respect of the Nord Stream pipeline, Gazprom says, it is a violation of the effective agreement between Russian and the EU on remuneration and mutual protection of investments.

LNG Regains Confidence

   Under the circumstances, the decision on the liquefaction of more natural gas than was planned before could provide the solution to the above problems.
Last spring, when the partners involved in the development of the Shtokman field once again failed to make the final investment decision, A. Medvedev said “the partners have decided to consider an option to liquefy almost entire gas produced during Phase 1 rather than half of it, or not 7.5 million tons, but almost 14 million tons (1.7 bcm of gas will be sent to the Murmansk Region).
According to him, the Gazprom partners have regained their once lost confidence in liquefied gas, while Gazprom never lost it. In summer, A. Medvedev said “they are reviewing prospects for the liquefaction of gas which will be lifted from Shtokman during all the three phases of field development: the figure in point is 51 million t/yr (the expected three-phase production volume is put at 71.5 bcm/yr).

   Shtokman’s gas will be more oriented on the Atlantic market, while the demand from the Asia-Pacific countries is to be met at the expense of resources of the Russian Far East and Eastern Siberia, said A. Medvedev.

   According to the head of Gazprom Export, as far as the eastern operations are concerned, Gazprom is planning to boost the capacity of the Sakhalin II project currently standing at 10 million tons of LNG per year by additional 10 to 25 million tons. These extra amounts are connected with the prospects to expand the capacity of Sakhalin II and the Vladivostok-based gas liquefaction plant.
In the past, Gazprom was not so vociferous about the expansion of Sakhalin II, the first LNG plant in Russia built by Shell, Mitsui and Mitsubishi. Furthermore, Gazprom has stated to consider Shell as its potential third foreign partner for Shtokman.

   It is expected that gas to Vladivostok will go from the Sakhalin fields (Sakhalin I, II and III projects), and also from Eastern Siberia, namely, from the Chayandinskoe field (Republic of Yakutia) and possibly from the Kovykta field.

   Notably, the subject of LNG supply surfaced in early June in the wake of negotiations between Russian and China. It may mean that the negotiations on the construction of the Altai gas pipeline failed. This is indirectly supported by the fact that soon after the negotiation with Gazprom, CNPC signed a contract with Turkmengaz on deliveries of up to 65 bcm/yr (previous contract with Turkmenistan was for 40 bcm/yr). In the opinion of Deutsche Bank experts, having in mind that Gazprom continuously failed to strike a deal with China (for pipeline gas) during a few years, the LNG-project has potential to provide the company with more possibilities for entering foreign markets.

LNG Demand Grows in Asia

   Currently, the Asian market shows the highest LNG prices. Thus, in Japan which consumes a third of the LNG world market, the rejection of nuclear power generation following the Fukushima-1 disaster has raised LNG prices to $16-18/Btu. European LNG prices range from $6 to $9/Btu. The North American market is seemingly closed to Russia as well as many other suppliers – just have a look at the Henry Hub prices of $2-3/Btu!

   Wood MacKenzie experts believe that demand for gas will be growing in China which will need more gas imports.

   In accordance with the statements of China’s National Energy Agency, by 2015 China will be producing 6.5 bcm of shale gas and as much as 60 – 100 bcm by 2020. At the same time, both industry analysts, and Chinese companies themselves view these plans as overoptimistic. The problem is that the environment of shale gas occurrence in China is much more complicated than that in the US, a country that has performed a shale revolution. “We see a great potential [of shale gas reserves], but it is accompanied with even greater problems”, said Zhou Juping, CNPC vice-president, at the World Gas Congress.
He says that shale gas reserves in China are found in environmentally sensitive territories with a high population density – in southwest China, and, to add to the problem, the gas is deposited much deeper that in North America. Hence, China is in no position to blindly apply the same technologies which have allowed the US to cause a shale boom, namely, horizontal drilling in combination with multiple hydrofracs. Taking into consideration a high population density, and also a limited character of water resources China will seek technologies which require less or even no water at all.

   Notably, at the beginning of the year, the US downgraded the assessment of its shale gas reserves by a factor of 1.7, but it still nurtures the idea to become a net exporter of LNG in 2016.

   Gazprom is still reticent about the timelines of LNG production by each of the project, but Vitaly Markelov, the company’s Chairman of the Management Committee, says that until the end of the summer Gazprom is to come up with an investment decision on the construction of the Yakutia – Khabarovsk – Vladivostok gas pipeline. The investment feasibility study for Vladivostok’s LNG plant is to be performed in Q1 2013, while the LNG plants will need 3 to 5 year to construct.

   Last February, Andrey Galaev, Sakhalin Energy (Sakhalin II) CEO, told the Vedomosty daily that Gazprom needs to be smart enough to squeeze in a “market window” of 2016 – 2018 before launching new ambitious LNG-projects in Australia.

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