In late January 2014, the Russian Federation Ministry of Energy published a draft ‘Energy Strategy to 2035’ that reinforces Russia’s drive to develop new oil and gas export markets in Asia. This ambition is fuelled not only by challenges Russia is experiencing in Europe, but also by Asia’s rapidly growing demand for energy resources.
A number of Russian oil and gas companies are seeking to grow their gas businesses through LNG exports to Asia. The Sakhalin-2 LNG facility, which is majority-owned by Russia’s largest state-owned gas enterprise Gazprom, already exports LNG to Asia. There are also four LNG export projects in various stages of development that could ultimately export to the region: Sakhalin-2 Expansion, Sakhalin-1’s Far Eastern LNG, Gazprom’s Vladivostok LNG and Novatek’s Yamal LNG. The first exports from these projects are projected to begin between 2017 and 2020.
Some of these projects have significant Asian investor involvement, reflecting the keen Asian interest in importing Russian LNG. Notably, the Sakhalin-2 expansion, one of the world’s largest integrated oil and gas projects estimated at over US$25 billion, has Japanese companies Mitsui and Mitsubishi among its shareholders, and 20% of Yamal LNG is owned by China National Petroleum Corporation (CNPC).
Russia is also expanding pipeline gas exports to China. In May 2014, Russia and China finally reached agreement on a deal for Gazprom to supply CNPC with 38 billion cubic meters (bcm) of natural gas per year from East Siberia via the Power of Siberia pipeline. This thirty year agreement underwrites Gazprom’s Eastern Programme and makes a significant contribution to realizing the Russian government’s goal of developing a significant new export market in the Asia-Pacific region. Discussions are now underway on a second deal for Russia to sell China an additional 30 bcm of natural gas per year from West Siberia via the proposed Altai pipeline, which would run from Western Siberia to North-Western China. These deals are of global significance as they will impact China’s appetite for increased LNG imports and may set a benchmark price for gas to China.
However, the success of Russia’s LNG business is far from guaranteed. Conflict between the two Russian gas giants Gazprom and Rosneft is significant and adds to uncertainty over whether projects will be completed. Furthermore, in the aftermath of the Ukraine crisis, Western sanctions are reducing the flow of investment and needed technology into gas extraction and export projects.
For further insights into the prospects for Russian LNG exports to the Asia-Pacific region, we spoke with Dr. Michael Bradshaw, Professor of Global Energy at Warwick Business School. Dr. Bradshaw has been studying the development of the Sakhalin oil and gas projects in Russia’s Far East for nearly two decades.
Q: What are Russia’s energy ambitions in the Asia-Pacific region?
A: The notion that Russia should be reorienting its balance of energy trade towards Asia is a fairly long-standing aspiration. It goes back at least a decade if not longer; the fact that the Russian Far East has a lot of resources to sell to Asia is something that was prevalent in political discourse even during the Soviet era. However, the drive to reorient to Asia has gained a lot more steam recently for two reasons. First, Russia has been experiencing challenges in the European market, particularly in gas trade. The challenges predate the Ukrainian crisis and have to do with competition, pricing, and the efforts undertaken by the European Union to liberalize markets. More specifically, the European Commission’s (EC) so-called ‘Third Package’ seeks to create a single European gas market and the EC wishes to move gas trade away from the long-term oil-indexed contracts that dominate Russia’s gas trade with Europe. Second, all the projections indicate that the greatest growth in demand for natural gas will take place in Asia. So you have a combination of problems in Europe and opportunities in Asia. Added to that, Russia has a lot of stranded gas in the areas of East Siberia and the Far East. This is gas that cannot be sold to European markets because the fields are too far away and not adequately connected to pipelines. From the Russian perspective, it makes a lot of sense to marketize this gas and generate a new stream of income and also a new sphere of influence.
Q: Could you tell us more about Gazprom’s Eastern Programme?
A: Gazprom’s Eastern Programme, which started in 2003, can be regarded as a turning point in Russia’s pivot away from Europe to Asia. The Russian government basically required Gazprom to create plans to develop infrastructure, including pipelines and LNG export facilities, in Eastern Russia in order to implement gas exports to Asia.
It took quite a long time to develop the strategy, which was approved in 2007. At the time, Gazprom didn’t control the natural gas fields needed to actualize the export ambitions in the plan. However, due to growing resource nationalism in Russia at the time, there were various campaigns against foreign companies owning Russian natural resources. This allowed Gazprom to put itself in the position to control the resource base. Now it controls the resource base and has plans for infrastructure and for securing markets. In the end, the process took a while. For example, the recent deal for Gazprom to supply CNPC with 38 bcm of gas per year took over a decade to negotiate. But it now appears that “the pieces in Gazprom’s Eastern puzzle” are falling into place.
Q: The terms of the May 2014 US$400 billion deal for Russia to supply China with natural gas have seen by some analysts as more favourable to China. Is this a fair assessment? Was the crisis in the Ukraine a major catalyst for the deal?
A: Russia and China had gotten to the point in negotiations where everything was agreed to except for the price of the gas. And the price has now been agreed upon, but we don’t formally know what it is. People are guessing that it is probably not as high as Russia wanted, but not as low as China wanted. But that price is flexible, because it is an oil-indexed contract. So we must wait to see if it’s a good deal for either side.
Regarding the second question: even before the crisis in Ukraine, Russian President Putin was very frustrated about the lack of an agreement with China. So we will never know whether or not the Ukraine crisis was the deciding factor. But every year at the Sakhalin Oil and Gas Conference, Gazprom promised a deal which didn’t happen. So it was getting to the point that people started thinking “if they don’t do a deal this year, they’ll never do a deal because the Chinese will find other ways of getting gas and the opportunity will be lost.”
We can speculate about the geostrategic reasons--that it was important for Russia to demonstrate to the world that it has a future without Europe, for example. When I say “without Europe”, I do not mean “no gas to Europe”, but the prospect for demand growth for Russian gas in Europe is minimal.
Q: Could Russian LNG projects push other sellers, such as Canada, the US and Australia, out of China and by extension the Northeast Asian market?
A: This could happen depending on how much LNG China wants to buy. Some of the LNG export projects in Canada and Australia have Chinese companies as equity participants, which could guarantee a certain amount of LNG going to China. But the important question is about future Chinese gas demand: how much is satisfied by pipeline deals and how much is satisfied by domestic production, which could include shale gas? What then is the potential new demand?
Concerning demand forecasts, economic growth and population growth do drive up energy demand. At the same time, we need to account for the downward trend in energy intensity in China, as well as in India, and the other factors that influence energy mixes, such as climate change agreements, carbon taxes and whether countries are going to be serious about meeting future demand with less polluting fuels, such as natural gas.
Q: Asian countries have been discussing the idea of an Asian price hub for natural gas. What are the prospects for a hub materializing in the next five to ten years?
A: LNG pricing is still linked to oil pricing, although this is changing in Europe, for example. There was speculation at one point that Russian gas prices in Asia might be linked to the US Henry Hub prices, but that was completely dismissed by Gazprom. Why would you cost Asian gas on the basis of the American domestic price? I think the driver of the debate about LNG pricing in Asia is about price levels, not the process of price formation itself. So what you see, in the post-Fukushima environment, is that Asian buyers are paying upwards of US$17/ MMBtu, but see that the gas price at Henry Hub in the US is below US$4/MMBtu. Asian buyers start to do the maths and think that they can get gas to Tokyo Bay or elsewhere in Asia for a lot less than $17. So maybe what people want is to have a portfolio that has got some Henry Hub and some oil indexation. So we’re moving into a more uncertain future. Whether or not there is sufficient liquidity to develop a hub in Asia is unclear at the moment. But there is a view that if oil prices went down sufficiently, the oil indexed price could end up being cheaper than Henry Hub price. So what you want is probably a mixture – so we may have more of a hybrid pricing system.
I think the distinction between pipeline gas and LNG is important. The big question is how cheap can LNG be, because you have got the cost of liquefaction, transportation, and regasification to take into account. Pipeline gas is usually cheaper than LNG. Will LNG be able to compete with pipeline gas, where that is an option, and with other sources of energy? We’ve got a lot of expensive LNG coming on line. So it comes back to another big question--are we heading to an LNG glut towards the end of the decade? There’s 150 bcm in capacity that is being constructed at the moment. How much LNG demand will there be to soak up this capacity? What will happen to prices? Will there be enough liquidity to create an Asian hub? Where will the hub be--in Shanghai, Singapore or Tokyo? That’s just adding more to the uncertainty and complexity.
Q: In the Western context, energy security is thought to be achieved through liberalized energy markets. How does Russia’s perception of energy security differ?
A: It seems at times that Putin’s view is like the realist perspective in international relations- that states are vying with one another in a zero-sum game. Therefore, energy security is something obtained through interstate, bilateral agreements. That’s also a part of China’s going out strategies-- to use its state companies to secure and control access to supplies of natural resources. So that’s one sort of state-centric model of obtaining energy security supply.
Now the alternative to that is the neoliberal model, which says that we need functioning markets and functioning markets will guarantee security of supplies because that’s what markets do. So you’ve got two completely opposing points of view about how to get security: one that you have bilateral deals and the other that what you need is a functional market.
Q: How will success or failure of Russia’s energy strategy toward Northeast Asian countries influence global energy security?
A. Russia diversifying its supplies to Asia can be a positive thing. It is not the case that Russia is able to play Europe off Asia by redirecting gas to Asia that could otherwise go to Europe. If the second pipeline from Altai materializes, Putin might want to say that Russia has linked the two markets. But the reality is the cost of moving gas the long distances to Europe doesn’t make any sense. The gas reserve is significant enough to meet the demands of both markets.
Without damaging European energy access, increased Russian exports to Asia could assist the energy security of a number of Asian countries by reducing the amount of the gas travelling through the Strait of Malacca, for example. That has to be a positive, not a negative, thing from the Asian perspective. China is pursuing a policy of multiple energy suppliers, as is Japan. That means these countries will not find themselves overly reliant on any one particular supplier. At the moment 10% of Japan’s LNG comes from Russia. In an oversupplied market, even if that percentage doubles, it wouldn’t be a threat to Japan’s gas security as there are many other places to get gas.
Dr. Michael Bradshaw is Professor of Global Energy at Warwick Business School, UK. He is a leading expert on the development of the Sakhalin oil and gas projects in Russia’s Far East. In October 2013, published a book entitled Global Energy Dilemmas through Polity Press.