Russia and the Chinese LNG Market

China’s surging demand for liquefied natural gas should be a boon for Russia, but competition is fierce.

While the landmark $400 billion Gazprom deal stole the headlines during Russian President Vladmir Putin’s recent visit to China, another smaller deal, this one involving Russia’s second-largest natural gas producer Novatek, also warrants attention. China has contracted Novatek to supply 3 million tons of liquefied natural gas (LNG) annually.

Given Chinese enthusiasm for replacing coal with gas and Russia’s ambition to acquire a 15 percent share of world liquefied natural gas (LNG) exports, the two countries potentially have significant shared interests. While many of the elements of a far-reaching partnership are taking place, long-term success will depend heavily on the ability of Beijing and Moscow to agree on prices.

According to a BP estimate, China consumed 143.8 billion cubic meters (bcm) of gas in 2012 (125 million tons of oil equivalent) up 9.9 percent from the previous year. Of this, 21.3 bcm was sourced by pipeline from Turkmenistan and 20 bcm was imported as LNG (with more than half of that coming from Qatar and Australia). The remainder was domestically extracted.

At present, natural gas constitutes a modest 4.4 percent share of China’s energy consumption, but Beijing plans to raise that to 7.5 percent in 2015 and then to 10.0 percent by 2020. This would mean that next year China would be consuming 260 bcm of gas annually, with 90 bcm imported and the remaining 170 bcm (ambitiously) planned to extracted domestically.

China will be placing a particular focus on imports of LNG, which is sees as a key element of its national gas-for-coal strategy and a prime source for city consumption. LNG will give China another plank in its energy security, given that its transportation does not involve pipelines and troublesome transit disputes.

Also important, the more eco-friendly nature of LNG will help China deal with its increasingly pressing pollution problem. A poll by Pew Research Center in 2013 revealed that 47 percent of Chinese rate air pollution as a “very big” problem (up with 31 percent in 2008 and 36 percent in 2012). The environment jumped to fourth place on the list of concerns for Chinese, after rising prices, corruption, and inequality. As China experiences more situations like the one in Harbin in October 2013, when the PM2.5 index topped 1000 (compared to a WHO recommendation of no more than 20), the importance of the shift to LNG will only rise.

At present, three state-owned enterprises handle LNG in China with LNG terminals and regasification units: China National Offshore Oil Corporation (CNOOC), PetroChina, and Sinopec. The LNG is sourced through long-term contracts of 20-25 years with Australia, Qatar, Indonesia, Malaysia and Papua New Guinea. For instance, CNOOC has contracts with Australia for 3.7 million tons for the period 2006-2031 and another and 3.6 million tons for 2014-2034. It also has deals with Qatar for 2 million tons (2009-2034) and 5 millions tons (2013-2038), along with similar arrangements with Malaysia and Indonesia.

PetroChina likewise focuses on imports from Qatar and Australia, while Sinopec concluded the biggest contract of all, agreeing to buy 7.6 million tons of LNG over 20 years (2015 to 2025) from the Australian APLNG project, in which the Chinese company has a 25 percent stake. Over that same period, Sinopec will also import 2 million tons of LNG from Papua New Guinea.

These existing contracts will give China 42.4 million tons of LNG by 2015, if the declared LNG terminals are built on schedule. In fact, CNOOC representatives announced in September 2013 that the company would be ready to import 35-40 million tons of LNG in 2015, an estimate that looks feasible given the LNG terminals that are already operational. Moreover, China has plans for another eight projects in the coming years, including the first floating LNG terminal in Tianjin. These new terminals will service the coastal provinces of Guangdong, Jiangsu, Zhejiang, Liaoning and Hebei.

Additional impetus for development of the LNG industry was provided with the relaxing of Chinese legislation that required operators to have long-term contracts in place before constructing regasification terminals. Now Chinese companies expand infrastructure development first, relying in part on spot market deliveries that is used for seasonal LNG purchases in winter and summer periods. In fact, analysts expect that Chinese LNG demand in the spot market will continue to grow toward 2020 to meet demands for household heating in the northern part of the country from December to March. The geography of gas imports will thus expand dramatically. For instance, Beijing purchased four LNG contracts in December 2013, two of which, from Nigeria and Equatorial Guinea, have already been delivered.

China’s LNG terminals are concentrated near littoral cities, close to the main areas of residential gas demand. It is economically unpalatable to expand pipes to small and mid-sized towns from the three domestic gas-bearing basins (Tarim, Ordos and Sichuan), which makes imported LNG all the more irreplaceable for China. At present, Beijing is developing a national market for LNG through an expanded distribution network.

Another factor for rising Chinese LNG demand: the country’s initiatives to improve the quality of automobile fuel and transition to the China IV standard that will reduce sulfur emissions to 50 parts per million (ppm), down from the current level of 150 ppm for gasoline vehicles. In 2017, Beijing plans to impose a China V standard that will lower the sulfur content limit to 10 ppm. The new regulation will accelerate the conversion to gas as an alternative to petroleum and diesel fuel. According to Standard Chartered, the market for vehicles running on natural gas in China will expand to 2.5 million vehicles in 2015 (up from 1.6 million vehicles in 2013) and 5 million vehicles in 2020. Although gas engines cost twice as much as petroleum models, the extra outlay is recouped within a year because of competitive gas prices (with discounts of 30-50 percent) and state subsidies. China is also rapidly adding gas fueling stations. While it is premature to speak about global changes in this sector, the emerging trend points to the formation of a new market and a smooth transition from oil.

Expanding Chinese LNG consumption offers Russia a significant opening, given Moscow’s ambitious plans for oil and gas field development in the Arctic and LNG plant construction. However, Russia faces significant competition with leading LNG producers Australia and Qatar. Australia plans to increase LNG deliveries from 2014 thanks to new liquefaction capacity and is targeting a 25 percent market share by 2030. It has already concluded long-term export contracts with China that make it harder for Russia to find an importer.

Russia could conceivably face a situation in which the Chinese LNG market is fully served in 2018, the year Rosneft’s “Sakhalin LNG” (5 million tons a year), Novatek’s “Yamal LNG” (16.5 million tons a year) and Gazprom’s “Vladivostok LNG” are scheduled to come on-stream. Currently only Yamal LNG has a confirmed contract, thanks to Novatek’s recent deal, and that is because CNPC is a 20 percent stakeholder. That is unlikely to be sufficient to establish a stable, long-term partnership.

If it is to take advantage of China’s burgeoning demand, Russia will need to be more pragmatic in opening up LNG markets, otherwise Moscow will fail to keep pace with competitors that have become more aggressive in light of the U.S. shale gas boom.

Arthur Guschin holds an MA degree in China studies from Saint-Petersburg State University. His current research focuses on the PRC’s economic integration within Asia-Pacific and Sino-Russian cooperation in the Arctic. He is currently an intern at S. Rajaratnam School of International Studies.