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. Last Updated: 07/27/2016

Gas Sales to China a Pricey Risk




Chinese Prime Minister Zhu Rongji arrived in Moscow on Wednesday for wide-ranging trade talks, with gas deliveries from Russia to China high on his agenda.


Russia is the world's largest gas producer, with a quarter of global reserves, and China is expected to face a growing energy deficit as its economy grows.


Hopes are high that a rapid growth of Russian gas exports to China will benefit both sides.


The two countries are due to sign an agreement on developing the Kovykta gas field in eastern Siberia, aimed at feeding the Chinese market, during Zhu's visit.


The problem is that billions of dollars will be required to build a pipeline thousands of kilometers to China and develop a domestic Chinese gas market from scratch.


While Russia's immense reserves and China's potential demand are not in doubt, analysts are divided over whether exports will take off.


"China is a huge market. The problem is, where is the market? And what can the market pay?" said Jonathan Stern, senior vice president of consultancy Gas Strategies.


Kovykta, operated by a company controlled by a joint venture between Russian Sidanko and BP Amoco, is now being tested to see if it contains reserves big enough to justify building a pipeline to supply several Asian countries.


"The problem with Kovykta as it was conceived is that South Korea was going to anchor it, and their demand at the end of the pipeline was going to be the base load and the hard currency on which everything was going to be hung," Stern said.


"When Korea went bad, all of those assumptions went out of the window," he said.


Now for a line to be built, China itself will have to "anchor" the project, developing a gas grid that does not now exist and devising a price policy for electricity, for which the gas will mainly be used, to determine what price China can pay.


"In the current commercial climate with low energy prices and lots of uncertainty in the Far East, is this the time for outside investors to go for this kind of thing?" Stern asked.


Outside investment will certainly be required, as Russian gas monopoly Gazprom will not be able to put up the billions of dollars to build such infrastructure, even though it has often spoken of its wish to develop sales to China.


Gazprom chief Rem Vyakhirev has already kicked off another project to develop a far smaller, cheaper pipeline to Turkey - called Blue Stream - that will bring in revenues much sooner than a line to China.


But even for this to happen, the company has had to rely on external funding for 90 percent of the project's costs.


But on the assumption that a gas pipeline is one day built, the Chinese market is mouthwatering.


"China is the most prospective new market. There are good growing markets, Turkey for example, but the size of the Chinese market outweighs anything in Europe," said Stephen O'Sullivan, co-head of research at United Financial Group in Moscow.


"Russia is a very well-placed player because of the number of supply sources it has," he said.


Russian natural gas would face stiff competition on the Chinese energy market, initially from Liquefied Natural Gas, or LNG, which will take a large share of the coastal market, where the greatest energy demand growth is now found.


Indonesia, Australia, several Middle Eastern countries and Russia's own Far East island of Sakhalin are, or soon will be, competing for China's gas market with LNG.


"If you want gas in just a few select cities, then LNG is fine," O'Sullivan said, but he pointed out that if China plans to develop a natural gas grid, then it needs pipeline gas, and the obvious source is Russia.


"For large industrial markets natural gas is the fuel of choice," he said. "It's also much cheaper [than LNG] to deliver once you've got the pipeline in place."