Russia-China Mega Gas Deal: A Threat to US Producers? - Analyst Blog

After a decade long deliberation, Russian natural gas giant Gazprom and China National Petroleum Corporation have finally signed a natural gas supply agreement. Per the agreement, Gazprom will supply 38 billion cubic meters of natural gas to China annually from 2018 for the next three decades. The supply volume may increase to as much as 61 billion cubic meters annually.

Value of the Deal

The historic deal is expected to be valued at $400 billion. The Russian officials were tight lipped about the value of the natural gas prices at which the deal was finalized, but confirmed that the pricing was made at market rates.

What Expedited the Deal?

Well, one can only muse why a deal that took 10 years in the making was signed overnight in the wee hours of the morning in Shanghai. It appears that the threat of imposing stricter sanctions on Russia following its misadventure in Ukraine from the western world must have led Russian top officials to seal the natural gas supply deal with neighboring China. The increasing possibility that the EU will spurn gas imports from Russia (EU imported 160 billion cubic meters of gas in 2013) must have been a lurking fear for Russia to seek a trade ally.

China for its part has shown phenomenal growth. Though fears of a slowing Chinese economy have stalked the markets lately, the proposed introduction of capital market reforms from the government might act as a catalyst going forward. It goes without saying that industrial growth is powered by the energy sector and China needs more gas for running its factories. This bilateral trade relation between China and Russia is also an important symbolic step.

We also believe that the shale gas boom in the U.S. and the gradual permissions given by the U.S. Department of Energy to export natural gas have also prompted the Russia-China natural gas supply deal.

China Drives a Hard Bargain

Undoubtedly, China will need more energy to sustain industrial growth. China utilized 170 billion cubic meters of natural gas in 2013 and this will increase going forward. So, finding a reliable supplier of natural gas at a favorable price was a top priority for China. It seems Gazprom has offered China gas at a lower price than what they charge the EU for gas exports.

Natural gas export contributes a major chunk of Russian export revenues. Sanctions against Russia due to mounting tensions with the West regarding Ukraine and other issues must have driven it to find another gas market. China made the most of the situation, driving a hard bargain.

Will the Deal Impact U.S. Operators?

The deal is sure to strengthen ties between Russia and China. But the important question is whether it will affect the prospects of the U.S. operators. It is time to check some ground realities and ascertain the extent of demand for energy in China. Per a report from the U.S. Energy Information Administration EIA, the total energy usage in China will increase to 219.9 quadrillion Btu in 2040 from 115.5 quadrillion Btu in 2012.

Per the deal, the supply of natural gas will begin only from 2018 and the volume supplied will by merely 1/5th of the total volume consumed by China in 2013. So, there will be enough room for other natural gas operators to supply gas to the country.

Moreover, going forward, natural gas usage will not be sufficient to meet the increasing Chinese demand for energy. China will willy-nilly have to depend on coal and other alternate energy resources. Here the U.S. companies like coal supplier Peabody Energy Inc. BTU and solar module maker First Solar, Inc. FSLR will come into play among others.

Finally, if the E.U. decides not to import natural gas from Russia, new opportunities will open up for U.S. operators like Noble Energy, Inc. NBL which has a presence in the Leviathan Basin in offshore Israel and Anadarko Petroleum Corporation APC with a strong presence in Africa.

U.S. Heading Towards Gas Exports

A current report from the U.S. Energy Information Administration EIA suggests that the shale boom will actually result in 1.6% annual growth of natural gas production in the U.S. from 2012 through 2040. As a result, after meeting domestic demand, the U.S. will become a net exporter of natural gas by 2020. So, from a net importer of 1.5 trillion cubic feet (“Tcf”) of natural gas in 2012, the U.S. will likely be a net exporter of 5.8 Tcf in 2040.

To Sum Up

This deal appears to be a desperate move by Russia to secure an alternative gas market. That said, it is not going to impact the natural gas exports of U.S. operators. China here will continue to be an important market – the shale boom in onshore U.S. will find markets in China and other developing nations in urgent need for cheap gas.