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Russia Loses Leverage With China on Gas Deal

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Russia has become more eager to seal the deal on the prospect that Europe will increasingly shift away from Russian gas.

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Russian President Vladimir Putin obviously thinks that preventing Ukraine from moving closer to the West is a strategic interest and one that is important enough to risk international condemnation. Seizing Crimea has led to negative international opinion, capital flight, deteriorating relations with Europe, and a potential enormous toll to the Russian economy. It has also threatened to permanently damage the commercial relationship Russia has with its largest energy customer -- Western Europe.

That has clearly accelerated the deal that Russia is trying to finalize with China on natural gas. It may seem odd that the two countries have let a gas deal go undone for so long -- they are some of the largest energy producers and consumers in the world, respectively, and are close neighbors. But with very few interconnections and a dispute over pricing, Russia hasn't been able to sell much natural gas to its neighbor. To get gas flowing into China, Russia will need to build a $22 billion pipeline -- the Power of Siberia pipeline -- that traverses Siberia and runs all the way to Vladivostok on the Pacific Coast. Along the way, the pipeline will have three interconnecting points on the Chinese border, allowing China to offload natural gas in a variety of places. Once completed in 2018, Gazprom (OTCMKTS:OGZPY) could send 38 billion cubic meters per year to China, which is equivalent to about 24% of the total that Russia sells to Europe.

Related Article: Russia's New Weapons: Passports and Pipelines

But Russia has lost leverage in the negotiations with China as it has become more eager to seal the deal on the prospect that Europe will increasingly shift away from Russian gas. Russia's Deputy Prime Minister appeared in China April 9 and made news by saying that the two nations are zeroing in on a deal. He said that he hoped a deal could be signed in May ahead of Putin's visit to Beijing.

"We're working now to sign a gas contract in May," said Deputy Prime Minister Arkady Dvorkovich, according to ITAR-TASS. "Consultations are continuing and Gazprom's leaders are holding talks with Chinese partners on the contract terms. We hope to conclude the contract in May and believe it should come into effect by the year end. Base price is the only problem to be solved," Dvorkovich said at a session of a Russia-China intergovernmental commission on energy co-operation, co-chaired by Chinese Vice-Premier Zhang Gaoli. Also, Gazprom said on April 10 that its Asian customers may be willing to pay for their shipments in euros, a strategy the company is likely seeking to avoid being trapped by US sanctions.

Dvorkovich seems to have downplayed the importance of the base price, which has been a sticking point holding up the deal for years. With a newly determined European Union seeking to improve its energy security, Russia has few other options but to give in on pricing. China has been seeking a price for natural gas below that which Europe receives, around $10.50 per million Btu. Bloomberg notes that Gazprom needs to sell at a price of around $13.50 per million Btu to make the yet-to-be-developed pipeline and natural gas fields profitable. But, it appears Russia may be willing to eat the costs to get the deal done.

Related Article: Russian Sanctions and the Negative Effect on Global Energy Security

Vladimir Putin would like the world to think that the deal would be a coup for Russia. It would demonstrate to Europe that Russia has other customers hungry for its energy resources, and that Russia does not fear a confrontation with the West over Ukraine. And if Russia's Asian customers pay in euros, Russia is also showing that it does not fear even the heaviest of moves that the US would be able to muster. Still, Russia getting the deal done by caving to China on price would not actually be a show of strength, it would demonstrate Russia negotiating from a position of weakness.

This article was written by Nick Cunningham of Oilprice.com.
No positions in stocks mentioned.
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