The crisis in Ukraine may have offered China a crucial window of opportunity to cash in on its blockbuster gas deal with neighboring Russia. On Wednesday, Beijing and Moscow formally signed off on a $400 billion contract between state-sponsored energy companies, China National Petroleum Corp. and OAO Gazprom. While most of the deal’s finer details have not been disclosed publicly, the thirty-year contract seems to favor China and its ever-increasing demand for energy.
While Russia would be reluctant to admit it, the crisis in Ukraine has taken a definite toll on its political reputation in recent months. As sanctions have soured its ties with the United States and Europe, Russia has ventured eastward in hopes of forging new diplomatic relations. In this particular instance,it is the finalization of a contract ten years in the making with the world’s second largest economy. The deal offers Russia some clout in exhibiting to the European Union that Gazaprom has other buyers.
The basics of the deal consist of Russia’s promise to supply China with roughly 38 billion cubic meters of liquefied natural gas per year starting in 2018. By the time the project is in full swing the target amount is closer to 60 billion cubic meters. According to Citigroup (NYSE: C), the implied price of the liquefied natural gas is somewhere between $350 and $380 per thousand cubic meters.
Shortcomings for Gazaprom
Despite what is a seemingly substantial political win for Russia, there are some question marks from the financial end. For starters, Gazaprom will need to make a considerable capital expenditure layout in the short term to build oil fields in Siberia and a pipeline to China. The $55 billion dollar estimated future expenditure would give the project a negative free cash flow in the medium term.
Beyond the cost of building the infrastructure, the slated price for the gas is itself rather low. Whether it’s $350 or $380 per thousand cubic meters, it is still slightly less than the amount paid by the European Union.
China Gets a Great Deal
Though it’s hard to pinpoint exactly where the countries win or lose without concrete numbers being provided, all signs point to a steal for China. At 38 billion cubic meters a year, China would be receiving a gas supply equal to more than one-fifth of Chinese gas consumption last year.
In addition to the heavy volume it will receive; China also wins out on the price it is paying. At $350 to $380 per thousand cubic feet, it is right around the price it pays to its biggest gas import, Turkmen gas, but appreciably lower than the average of $625 is pays to import gas from overseas.
China may even gain indirectly from the deal as it will put pressure on other foreign firms to lower their prices in an attempt to compete with the new planned influx of Russian gas. Royal Dutch Shell PLC (NYSE: RDS.B), Chevron Corp. (NYSE: CVX) and Eni SpA (NYSE: E) are just some of the major energy companies poised to export liquefied natural gas to China in the near future. However, as these companies have yet to sign any long term contracts, the prospect for locking in higher prices may be somewhat diminished by the Sino-Russian deal.