As the tension between Russia and Ukraine heated up, and nations around the world got involved by imposing sanctions on Russia; China, and Russia came to terms on a long stalled natural gas deal. According to Russia's Vladimir Putin, it was, "... the biggest contract in the history of the gas sector of the former USSR." And now it's starting to get under way, which could create a bigger opportunity than the market thinks for Gazprom (NASDAQOTH:OGZPY).
10 years in the making
The deal between state-controlled China National Petroleum and Gazprom wasn't an overnight sensation. The idea of a natural gas pipeline connecting the two countries had been around for a decade, but the two countries couldn't agree on a price. Russia's current position as a world agitator, however, appears to have softened its stance, leading to the $400 billion, 30-year deal getting done.
The big compromise was the cost of natural gas. Russia will get $350 per thousand cubic meters, at the low end of the $350 to $380 cost that European utilities pay, according to Reuters. However, locking in a large new customer helps diversify Gazprom and gets Russia away from Europe. And right now that's helpful politically and economically.
That said, new pipelines have to be built in order to send natural gas to China. China will reportedly pitch in up to $20 billion for such infrastructure, which is estimated to cost around $22 billion. More importantly, however, the pipeline construction project is now under way with a goal of first deliveries taking place in 2018.
Diversification or expansion?
That said, it's worth taking a deeper dive into Gazprom's situation to see the impact the China deal will have. For starters, Europe accounts for a huge portion of the Russian company's business, tallying in at around 50% of its natural gas sales. That makes the current row over Russian agitation in Ukraine a big risk, since Europe and the United States are increasingly imposing sanctions on Russia that will impact the energy industry.
So, on that front, getting China as a new customer will help soften any blow to Gazprom's business from sanctions. According to Bloomberg, the new China business will be equal to around 20% of the gas that Gazprom sells to Europe. Thus, shipping to China won't negate the risk of a sales disruption in Europe, but it's a big help.
However, the sanctions so far have been directed at Russia's oil industry, not natural gas. And while Russia is making waves, it has been working hard to ensure that European gas supplies are not, in fact, disrupted. So at this point, there's no reason to suspect that Gazprom will have any trouble selling its gas into Europe.
The big difference between gas and oil is that Europe is as dependent on Russia as Russia is on Europe for natural gas. And there's no easy way to replace Russian gas supplies, which come via pipeline. Indeed, oil has a larger transportation infrastructure and there are plenty of global players in the space. So the risk to Gazprom's gas sales would appear to be more theoretical than real, at least at this point in time.
So, stepping back, that could mean that Gazprom actually found a giant new customer. And that customer has huge energy needs. Gordon Kwan, of Nomura International, told Bloomberg that while the Gazprom China National Petroleum deal would account for about 25% of China's current use, it would amount to just 10% of expected demand in 2020. So this could be a foot in the door to a much larger opportunity.
And at the same time, Gazprom expects demand in Europe to increase, too. Moreover, it's goal is to increase its market share in Europe from 26% in 2012 to 28% by 2030. That's a growing piece of an already growing pie.
The last year has been tough for Gazprom's shares because of geopolitical concerns. However, for those willing to take on a high amount of extra risk, Gazprom's China deal looks like it will make this gas player a better company by expanding its global reach, despite energy industry sanctions and the world's opinion of Russia. This, then, could be a good buying opportunity, but investors should fully understand the geopolitical risk of investing in a Russian energy company beforehand.
Reuben Brewer has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.