Case for Power of Siberia 2 strengthens
There is an increasingly strong case to be made for Russia's development of the Power of Siberia 2 pipeline to China, in light of soaring international gas prices and efforts by the EU to eliminate the country's gas imports over the coming years. But the price of gas supplies through the pipeline is set to remain a sticking point in negotiations between Beijing and Moscow.
Even after steep reductions in supplies in recent months, Europe remains the largest market for Russian gas overseas. But the EU is striving to end Russian gas imports by 2027 in light of Moscow's invasion of Ukraine – assuming Gazprom does not turn off the tap much sooner in order to further destabilise the European energy market.
While Russia opened up the Asian market for its gas with the launch of the 11mn metric ton/year Sakhalin LNG plant in 2009, its efforts to reduce its heavy dependence on the European market began in earnest in 2014, after relations with the West collapsed following Moscow's annexation of Crimea. That year it signed a 30-year supply deal, valued at the time at $400bn, to send up to 38bn m3/year of gas to China via the first Power of Siberia pipeline, which reached completion in late 2019.
China and Russia have been in talks on constructing a second pipeline interconnection for years. A breakthrough of sorts occurred in 2019, when they agreed on routing the 50bn m3/yr pipeline through Mongolia, abandoning an earlier plan to run it into China directly through Russia's Altai region – an option Beijing appeared disinterested in.
The two sides have already completed a feasibility study, and speaking this week, Mongolian prime minister Oyun-Erdene Luvsannamsrai said he expected construction of the pipeline in his country to begin as soon as 2024, with first gas flow anticipated in 2030. However, first Russia and China must strike a supply deal to underpin the project.
"There is a strong case to be made for a Power of Siberia deal on both sides," senior oil analyst Ron Smith at BCS Global Markets, tells NGW. "Gazprom faces the loss of much of its European franchise, and this project is targeted at allowing West Siberian gas to be shipped to China – the same gas that currently goes to Europe."
"This strategic flexibility and diversification would have been valuable to Gazprom before the Ukraine crisis – it would be doubly so now," he says.
From China's point of view, the pipeline would help reduce the country's over-dependence on LNG, and as its demand grows, the project will provide risk diversification regarding source country, source fields and transit country. However, it will nevertheless prove a challenge for the two sides to agree on a gas price. This is what held back negotiations on the 2014 supply deal, which dragged on for over a decade.
"The biggest issue is one of price – this line has long made sense on paper, but the two sides have never been able to agree on price," Smith says. "In this situation, Russia is likely to demand too high a price, based on current spot markets, and China is likely to demand too low a price, looking at the difficult position Gazprom is in vis-a-vis its European exports., and thus they may never agree."
Smith notes that the best time to negotiate a new long-term contract is when spot prices are around the mid-cycle level, as it makes it easier for both sides to see eye to eye. But today, those prices are at heights previously not thought possible.
Meanwhile, Russia also clinched a deal weeks before the war in Ukraine began to sell 10bn m3/yr to China via a proposed Far Easte route. But limited progress has been reported on this project since then.