By John Helmer in Moscow
One of the reasons for pornography is that it provides a low-cost alternative to the real thing. Not to mention the chance to fantasize immediately about a future pleasure that isn’t likely to materialize — or to be affordable if it does.
The announcement on Tuesday of Russia’s agreement in principle to supply up to 70 billion cubic metres per annum of natural gas by pipeline to China is like that. Deputy Prime Minister Igor Sechin needs to show that his command of Russia’s energy concessions is capable of delivering cash into the counting-house. A UK High Court trial, also under way this month in London. of claims relating to the management of the state-owned oil shipping company Sovcomflot has exposed the lengths to which Sechin, other government officials, and commercial allies in oil trading, ports and tankers, have already gone for this cash. A damage assessment in Moscow of the disclosures in the London court has the potential to cause problems for Sechin, if on top of everything, the counting-house goes short.
This week’s announcement in Beijing is also a pointer to the state of Sechin’s rivalry over the future of Gazprom with the former chairman of the Gazprom board, now President Dmitry Medvedev, and those close to him. If Sechin had returned to Moscow without the appearance of a deal for Gazprom to sell gas to China, Medvedev and his allies were bound to take advantage.
But appearances can be deceiving, especially on the morning after, so it’s worth asking – what deal has Sechin struck with the Chinese? Or to put the matter the right way round — if the Chinese haven’t agreed on a price for the gas, is there a real deal to sell it? As they say in the sex business, no pay, no get.
Consider, for example, how long it took for the Russians and Chinese to consummate their deal to build a pipeline delivering crude oil between Angarsk and Daqing. The initial proposals came off the drawing-boards and into negotiations by Transneft, the state pipeline company, and Mikhail Khodorkovsky’s Yukos Oil Company in the late 1990s. Between 2001 and 2003, there were talks between Yukos and the Chinese, culminating in a memorandum of understanding between Yukos and the China National Petroleum Corporation (CNPC) in May of 2003. The final deal, including oil volumes, pipeline financing, and the crude oil pricing formula, was not finalized by Sechin until February of this year. That makes six years to a decade of talking without finishing.
On October 13, this is what Gazprom has announced officially. “Alexey Miller, Chairman of the Gazprom Management Committee and Jiang Jiemin, President of China National Petroleum Corporation have signed today in Beijing a Framework Agreement on major terms and conditions for natural gas supply from Russia to China on the basis of the previously signed agreements. The parties reiterated that a high pace of the Eastern Gas Program execution by Gazprom created favorable conditions for further cooperation deepening in the gas sector and for subsequent signing of a long-term contract for gas supply from Russia to China.”
In Gazprom lingo, the Eastern Gas Program means the buildup of new gas deposits and new gas pipelines throughout Russia’s fareastern region, including the offshore island of Sakhalin, and an offshore zone around the Kamchatka peninsula. Without the additional deposits, the company has made clear that it lacks the volumes required to justify the infrastructure cost and to fill the pipelines that must be constructed. And without big enough production volumes, Gazprom accepts, albeit silently, that it will be struggling to offer natural gas to China at a cost plus profit formula that can compete with alternative Chinese sources, such as the natural gas pipeline being built across Central Asia, with 30 bcm capacity; or shipments of liquefied natural gas (LNG) from the new West Australian Gorgon project.
The latest Gazprom release refers back to the signing by the same parties of “the Agreement of Strategic Cooperation on October 14, 2004 in Beijing within the official visit of the Russian Federation President Vladimir Putin to China. The Agreement covers a wide spectrum of joint businesses including scrupulous discussion of the issues related to the organization of Russian natural gas deliveries to China by Gazprom. The possible ways of implementing joint gas processing and gas chemical projects in eastern Russia and in third parties are being studied.”
In press statements, Miller said the deal contemplates gas shipments to China of up to 68 billion cubic meters of gas per year, and move in two pipelines that have yet to be built. Sechin said Gazprom and CNPC might set a price in the course of further talks and sign a contract in early 2010. In that event, supplies would likely start in 2014 or 2015, he said. Note the conditional verb.
For this week, all that has been agreed, apparently, is volume and timing. Still, both fall into the wishful category, because the wellhead production capacity doesn’t exist yet.
Industry analysts in Moscow report that pricing is still the sticking point with CNPC that it has been since at least 2006. While Gazprom doesn’t speak on the record, it is generally understood that the Russian proposal is parity with the price Gazprom sells to Europe. That in turn remains tied, for the time being at least, to the crude oil marker. The Chinese counter–proposal is
For a significantly lower price, based the currently low spot prices for gas in the depressed demand circumstances of the European market; the projected delivery prices for natural gas from Turkmenistan and LNG from Gorgon; and the huge volume CNPC is offering to take.
Miller indicated that the framework agreement of this week allows for a final contract that “will include a price formula and principles of setting the price which will be based on Gazprom’s experience in gas exports and principles of international trade.” If that sounds one-sided and wishful, it is. 70 bcm for China represents roughly half of Gazprom’s current export volume to Europe, so the proposed magnitude committed to China represents a colossal shift in strategic orientation for Gazprom.
It is also hugely speculative at this point to project China’s capacity to absorb gas. As a report by Alfa Bank research head, Ronald Smith, suggests, “putting a value on Chinese sales is fraught with difficulty. The reserves, while enormous, are undeveloped and located in remote parts of East Siberia. When produced, they will be sold into a country that currently uses little gas (undermining our certainty of its ability to absorb the volumes) at an undetermined price and demanding uncertain amounts of capital.”
And what valuation should Suzie Wong be putting on the Russian proposal?
The Alfa Bank report suggests “a back-of-the-envelope valuation based on reserve and production multiples.” Skipping the small print, and basing the calculation on the value of the gas reserves required, the volume on offer is worth at the moment $5.9 billion, or about 4% of Gazprom’s current market capitalization in the share market. A second calculation, based on the market value of current production by Gazprom, suggests the proposed contract is worth $6.2 billion, or roughly the same 4% of market cap.
These numbers, Alfa concedes, look on the cheap — make that the Chinese side. According to Smith, “the Chinese will likely prove reluctant to agree to full European pricing in the near future. Therefore, we see the summer 2010 deadline [for the final deal] as anything but certain, and we will have to restrain our optimism, and final analysis, until those pricing details are finally
hammered out and committed to paper.”
Artem Konchin of Unicredit Securities, the brokerage arm of the European banking group, sees commercial value, ahead of politics, in promoting the deal now, because of the current reluctance of European customers to accept as much Gazprom gas as they had contracted for last year; or to pay the contract penalties for not taking the minimum volumes that were committed. “We see Gazprom’s move to the east as a strong potential hedge against European efforts to move away from the take-or-pay principle. Although we do not see 70 bcm of annual supplies as achievable by 2015, the figure implies a hedge of over 40% of expected 2015 sales to Europe, which would be a strong argument for Gazprom when negotiating future European sales contracts.” So, Tuesday’s news from Beiing looks “somewhat encouraging for the company’s sales outlook [in Europe].”