Wednesday 21 May 2014

30% discount? The Russia/China gas deal

I have it on good authority that when President Putin first approached China in March the Chinese were quite cool on the idea of a huge deal with Gazprom. They did though agree to a timetable to negotiate and set May as a timet o meet to sign a deal

After all, the Ukraine from whence problems came, is a big customer of Gazprom so the fact that Russia is so willing to use it as a tool of state power when it needs to is not lost on the Chinese.

Russia is only in China because it is so dependent on Germany and the West as customers which is now at odds with Putin's foreign policy.

So, the Chinese, being ever keen on a negotiation suggested that a long-term discount of half of the market price should be in order.

Moscow was shocked, I note, has not yet invaded Ukraine despite all the activity that would suggest it was strongly considered - or still maybe.

Then yesterday Putin was finally in China to conclude the deal. A mega deal it is too However, it was signed quite quickly which suggests to me the Chinese were able to get the deal they were looking for. My guesstimate is that the price to benchmarks will be around the 30% mark. It will be hard to ever know as Chian will make up front payments using its huge cash reserves, which clearly has a big impact on the overall long-term real price calculation.

This is much worse than Russia could do in Western Europe, even if the deal is better, Russian gas is sold for not too far off market price in Europe ( ND, can you enlighten further here in the comments?).

So politics has triumphed over business for Putin, a rare occurrence indeed. This deal won't do too much for Russia's long-term budget that currently needs hydrocarbons at above world prices to balance.


Nick Drew said...

Gas isn't as fungible as oil (long-range transportation difficulties) and so it doesn't arbitrage as smoothly

there are three very distinct pricing bands (& some sub-categories in each) with clear daylight between them

lowest is the USA @ just under 5$ (/mmbtu)

in the middle is Europe, around $7.5 (but with a notable divergence, see below) having dropped a lot this spring

highest is Japan/Korea/Far East, a much less liquid spot market so 'prices' refer to info on individual spot cargos of LNG to J/K, currently running @ just under $15, having recently dropped even more than Eu

(until the advent of US shale on large-scale, Eu and US had effectively converged, arbitraged by the Atlantic LNG trade which went both east and west, but is now one-way only (to Eu), so arb is suspended until something changes - maybe US LNG export)

the stand-out oddity in the global 3-band pricing set-up is average Russian long-term contract delivery prices at Eu borders: it is once again significantly above Eu spot prices

the last time this happened (2009) it triggered a rash of acrimonious re-negotiations followed by arbitration (not at all the same thing as arbitrage) with Gazprom losing comprehensively - click on the Gazprom tag for C@W coverage

if it persists (very likely), we are in for another round of beatings for Gazprom ...

CU, that's interesting intelligence: I am guessing the 'discount' is vs the Far East market, such as it is

50% or more against other 'world prices' would be suicidal for Putin

BTW this all makes HMG's huge bet that gas prices will rise for ever - because that's what our energy policy is based on - look even more stupid

Anonymous said...

So all that cheap gas will find it's way into Chinese production costs. Interesting for energy intensive industries like steel.

Wonder what Mittal thinks.

The Ruminator said...

In addition to Nick's fungability comments above the fields which are initially being targeted to deliver 38BCM include Kovytka, which was NPV10 negative at what I assume to be considerably higher prices.

So not only a discount, but negative NPV for GAZP in delivering.

I don't believe its such a good deal as is being made out.