What is the Potential Impact of the Ukrainian Crisis on Asian LNG Markets

The current crisis surrounding Ukraine and the annexation of the Crimean peninsula has once again focused attention on Europe’s reliance on gas imports from Russia. In 2013 Gazprom exported 162bcm of gas to the European continent, with 86bcm of this total passing through the Ukrainian transit system, and there is clear concern that this supply could be put at risk of the political conflict escalates further. Indeed, Gazprom CEO Alexei Miller has already raised the possibility of a 2009-type crisis emerging, which could be inspired by increased prices of Russian gas to Ukraine announced this month as well as by the potential failure of Ukraine to pay off its existing debt for gas purchases from Russia, currently standing at more than $2bn.

At any time Gazprom could decide to stop supplying gas to Ukraine, which could catalyse a response that could see an interruption to gas flows to Europe either from a direct shutdown of the transit pipe or more likely the diversion of gas from Europe to Ukraine’s domestic market. The threat of either eventuality has been enough to rekindle urgent discussions in the EU about a need to find alternative sources of gas and overall energy supply that do not involve Russia.

Although it will be very difficult for Europe to achieve this goal in the short term, Russia clearly understands the longer term threat to its western export business, and this has added an extra urgency to the country’s long term ambitions to diversify the markets for its gas towards the expanding demand in Asia. As long ago as 2009 the Russian energy strategy foresaw up to a quarter of the country’s gas exports coming from the East by 2030, and negotiations have been continuing for more than a decade to secure a deal for pipeline exports to China. Indeed the failure to secure this deal has been one reason why producers such as Qatar, Australia and Malaysia have been able to find such a ready market for their gas in NE Asia, but it may now be the case that the crisis in Ukraine is the final spur needed to push Russia into a more commercial and competitive strategy towards its potential eastern markets. This could have significant implications for other suppliers in the region who have projects planned for the next decade.

The China pipeline deal remains at the heart of Russia’s eastern export plans, and the signing of a deal could be the trigger for a major expansion in gas supply from East Siberia. The next major milestone for the negotiations is likely to be President Putin’s visit to Beijing in May, when a deal could finally be signed if the political will to demonstrate the potential for Russian gas in Asia overcomes previous commercial reluctance to commit to a price agreement. The construction of the Power of Siberia pipeline could then see 38bcma arriving in China by 2019, with a further 22bcm travelling to a new LNG plant at Vladivostok (VLNG) and onto the NE Asian market. This could also be the trigger for the expansion of the Sakhalin 2 liquefaction facilities, as Sakhalin 3 gas would no longer be required for VLNG, and Gazprom could then become a major force in the Asian gas market. Furthermore, if the projects do go ahead on schedule and budget then they could deliver gas at a very competitive price level, estimated by the Oxford Institute for Energy Studies at $10-12/mmbtu, allowing it to match the likely price of US LNG exports into the region and to potentially undercut gas from more expensive projects in Australia, Canada and East Africa.

Of course there is no guarantee that a pipeline deal with China will be signed, especially as the negotiators from CNPC may attempt to drive a harder bargain on price if they perceive that Russia’s bargaining position has weakened. However, Gazprom is no longer the only Russian producer with aspirations to export gas to Asia following the ending of its monopoly on LNG exports, as Novatek and Rosneft now also have plans to send gas from their Yamal LNG and Sakhalin 1 projects to eastern consumers. As can be seen in Figure 1 the likely volumes would be smaller if Russia’s plans were focussed solely on LNG (either with or without Vladivostok LNG), but the impact of these new Russian entrants into the market could still take on greater significance as a result of the Ukraine crisis. In particular Igor Sechin, the Rosneft CEO, has been on an extensive tour of the Asian region over the past month, visiting countries such as India, Japan, Korea and Vietnam to generate support for Russian export sales.

Figure 1: Potential Russian gas sales into Asia
Image 1

Source: Henderson, J. & Stern, J. The Potential Impact on Asia Gas Markets of Russia’s Eastern Gas Strategy OIES, February 2014

Sechin is no longer confining himself to potential LNG sales, though, as he has also asked that access be granted to third party gas in the Power of Siberia pipeline to China, should it be constructed. This is a very controversial request, as it would imply the breaking of Gazprom’s pipeline export monopoly which has always been held sacred as a balance for the company’s domestic market obligations. However, as Russia’s possible need to diversify its gas markets becomes more urgent, the Kremlin may be prepared to countenance previously unthinkable measures in order to catalyse increased export sales, providing more competition into the Asian gas market. Although we are some way from a resolution on this issue a trend towards more potentially radical outcomes appears to be emerging.

Having said this it remains clear that the real key for unlocking Russian gas sales in Asia is the reaching of an agreement with China over pipeline sales. The potential impact of this deal on LNG to Asia is demonstrated in Figure 2, from a recent OIES paper, which shows a projection of already contracted supply and possible demand for LNG in Asia. This illustrates a number of important points. For about 5 years starting in 2014 there is contestable demand which is likely to be filled by short term and spot LNG; it is unlikely that any project which has not yet started construction will contribute supply prior to 2019. For a short period post-2019 there is likely to be over-supply in Asia, which would certainly be prolonged by the start of Russian pipeline exports to China. But also, because Figure 5 does not include any projects which have not yet signed contracts or started construction, it is clear that the early 2020s could be a very competitive period for LNG supplies to Asia. There will be only a modest requirement for additional LNG, with the situation being exacerbated if the China-Russia pipeline contract is signed, with projects from Australia, East Africa, North America and probably elsewhere, competing for that demand.

Figure 2: LNG Supplied to Asia by Contract Category 2010 – 2012 and Illustrative Contestable Demand to 2025, including US LNG Projects

Image 2

Source: Rogers, H.V., and Stern, J. (2014) Challenges to JCC Pricing in Asian LNG Markets, OIES Paper NG81, Oxford Institute for Energy Studies

The Bottom Line
In conclusion the Ukraine crisis has heightened the need for Russia to focus on finding alternative markets for it gas, with Asia being the primary objective. A deal to export gas to China via pipe would be the foundation for the expansion of piped and LNG exports from Russia into NE Asia, and a final agreement in May would now appear to have a greater chance if President Putin senses a need for a political demonstration of a new Russian energy link. Even if the deal fails though, alternative Russian gas producers are also increasing the momentum for Asian LNG, and possibly pipe, exports, with the Ukraine situation providing ammunition to their arguments for greater opportunity. As a result, the chances of Russian gas becoming a major competitor in the Asian gas market would appear to be increasing as the risk to its western market sales increases in the aftermath of the annexation of the Crimean peninsula.

 

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