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Global Market Scan: Russia launches the Power of Siberia

Dmytro Konovalov
Global Market Scan: Russia launches the Power of Siberia

The first phase of “The Power of Siberia” (Sila Sibiri), the largest infrastructure project of the Russian company Gazprom, was officially launched on Dec. 2, 2019. Construction of the pipelines that connect Russian gas fields with the Chinese market started in September 2014. Construction was preceded by the signing of a 30-year gas supply agreement between Gazprom and China National Petroleum Corporation (CNPC). Over the period of the agreement, Russia will sell to China approximately one trillion cubic meters of natural gas. The total estimated value of the contract is around $400 billion USD.

The total cost of the project is estimated at $55 billion USD. It includes not only construction of the pipelines, but also development of two massive gas fields, Kovykta and Chayanda, with a projected output of about 25 billion cubic meters of gas per year each. The construction of a gas processing plant with a capacity of 42 billion cubic meters of natural gas per year, as well as looping facilities and compressor stations, is also part of the project.

According to the contract, every year Gazprom will sell to China 38 billion cubic meters of natural gas. The projected volume will be achieved in stages by 2025. The gas transportation is planned to reach five, 10 and 15 billion cubic meters in 2020, 2021 and 2022 respectively.

The first phase will transport gas from the Chayanda field only. The transportation will be going through a 2,157 kilometers pipeline connected on the border to the Chinese gas transportation system near the city of Blagoveschensk. To reach the full capacity of the project, Gazprom will have to bring to planned production levels another large gas field — Kovykta. This is expected to be done by 2025. In the next phases of the project, Gazprom will need to build another 2,293 kilometers of gas transportation, including a connection pipeline between the Kovykta and Chayanda gas fields of approximately 800 kilometers.

At the beginning of 2019, Gazprom announced that it is considering an increase in the gas supply to China through the Power of Siberia by six billion cubic meters per year, in addition to the originally planned 38 billion cubic meters per year. The company stated that by 2035, the potential supply of natural gas delivered to China through pipelines will reach 180 to 290 billion cubic meters per year. By that time, the estimated volume of Russian natural gas is likely to range from 80 to 110 billion cubic meters.

According to the US Energy Information Agency (EIA), in 2017 China became the world’s second-largest importer of LNG, surpassing South Korea, and in 2018, the largest natural gas importer, surpassing Germany and Japan. The policy of the Chinese government towards the replacement of coal by gas for power generation in urban areas resulted in a significant increase in demand for natural gas. According to the Russian Kommersant newspaper, the import of natural gas to China reached 117.5 billion cubic meters in 2015. In 2016, 2017 and 2018, imports went up by 21 per cent, 27 per cent and 32 per cent respectively.

An increase in supply of natural gas from Russia to China in the long-term seems likely, especially in the context of potentially lower oil prices, as the price of gas in the Power of Siberia contracts is related to the price of oil. This will make Russian natural gas less expensive. However, there is competition for Power of Siberia from a Turkmen gas pipeline, as well as a pipeline from Myanmar.

China also imports significant amounts of LNG from Qatar and the United States. With the increase of shale oil production in the US, prices for American natural gas and exported LNG have decreased dramatically. This indicates US LNG supply to China will also offer serious competition to Russian pipeline gas from Power of Siberia.

The Power of Siberia is one of the largest and most complicated infrastructure projects in the world. It depends on the construction of many kilometers of gas pipelines, the development of gas fields, and construction of massive processing and infrastructure facilities in regions with severe weather conditions. In addition, the project faces technological challenges with natural gas extraction at the Chayanda gas field also containing large crude oil reserves. Extraction of natural gas from the field might result in lower pressure and potential damage to crude oil production.

At this stage, the economic and business sides of the project remain unclear as well. The capital costs might increase significantly due to technological and environmental risks.

On the revenue side, the price formula for the contracted gas is connected to the price of oil (according to the Russian “Vedomosti” newspaper). With high capital costs and low profitability — i.e., Russian analysts estimate a payback period of about 28 years — the Power of Siberia is likely to face consistently low gas prices in the long-term due to growth of renewable energy sources and decreasing demand for oil.

Dmytro Konovalov has over 10 years of experience in equity research and analysis for global markets at leading international financial institutions.

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