In a continued shift toward the east, Russia has inked a second major natural gas deal with China.
The latest deal, worth a bit less than the landmark $400 billion natural gas deal in May 2014, could see major volumes of natural gas flowing into western China. Exact terms have yet to be agreed upon.
What is unique about this deal is that the natural gas will actually come from fields that also service European customers. The move would provide Russia with enhanced flexibility, giving state-owned natural gas company Gazprom the ability to shift natural gas exports from Europe to China if it sees the need to do so.
However, it could come at a price.
The first natural gas deal was sealed this past May after several years of impasse. The breakthrough in negotiations came as a result of the standoff between Russia and Europe over Ukraine, which made Russian President Vladimir Putin more anxious to cut a deal with China. As a result, China prevailed over Russia on its pricing demands. That agreement could see 38 billion cubic meters of Russian gas exported to China beginning in 2018. It would involve the development of natural gas fields in Siberia, plus the construction of new pipelines connecting into China at multiple points in the east.
The latest deal will likely be even more lopsided in China's favor. That is because Russia's leverage has been severely diminished in just the few months since the May 2014 deal. Western sanctions have struck a severe blow to the Russian economy. A 30 percent decline in oil prices is likely blowing a huge hole in the Russian budget, which depends on oil and gas exports for 52 percent of its budget revenues.
The Russian currency, the ruble, has plummeted 25 percent over the last few months as capital leaks out of the country. All of this puts Russia in a weaker bargaining position vis-à-vis gas exports to China.
But more importantly, connecting Russian gas fields to China's western provinces is not as critical to China, where much of its industrial needs are in the east. "The new deal is less attractive to China, Gazprom might need to agree on a serious discount to get the contract," Alexander Kornilov, a Moscow-based energy analyst, told Bloomberg in an interview.
The head of commodity research at Nomura Holdings, Gordon Kwan, agreed. "Given weaker oil prices and rubles, we believe China can extract even better terms on this second deal versus the first," he said in the Wall Street Journal.
Nevertheless, if completed, the deal would add an additional 30 billion cubic meters of natural gas exports to China each year. Combined, the 68 billion cubic meters would be enough to make China the largest export market for Russian gas, surpassing Germany. This would bolster Russia's shift away from unfriendly customers in Europe. For China's part, the two deals could account for 17 percent of its natural gas needs by 2020.
A lot still needs to be ironed out, but if the two deals come to fruition, it would have major impacts on worldwide natural gas trade. A slew of massive liquefied natural gas (LNG) export projects would take a hit. Australia and the U.S. are in the midst of an enormous build out of LNG export capacity, banking on the rising demand in China, Japan, and Korea. If China were to suddenly get about one-fifth of its natural gas supplies from onshore pipelines, that would cut into demand projections for LNG.
Moreover, Japan is inching closer to bringing some of its nuclear reactors back online. Two reactors have obtained most of the necessary government approvals to return to operation. They could come online in early 2015. If more are to follow, Japan's LNG demand could also be lower in the coming years.
The LNG benchmark price in Asia is now at a three-year low.
Again, it is important to note that China and Russia still need to agree to some important commercial details before the latest natural gas deal can be sealed. But, if they can come to terms, it would further cement a growing energy relationship between the two countries.
By Nick Cunningham of Oilprice.com. 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.