Russia, China gas deal: The price is wrong. For now. (+video)

Russia and China have yet to close a much-anticipated natural gas supply deal as Russian President Vladimir Putin makes a state visit to Shanghai this week. A deal between Russia and China on gas is still likely to happen, but China will continue to drive a hard bargain.

By , Staff writer

The world's second-largest natural gas producer and the world's fastest-growing gas consumer have again failed to close a major gas supply deal that would realign the global flow of fuel.

Instead, Russia and China have indicated they are inching closer to an agreement that would be vital to both countries' long-term futures. The lack of an announcement during Russian President Vladimir Putin's visit to Shanghai reaffirms a longstanding disagreement over price that has kept gas-supplier Russia and gas-consuming China just short of signing a deal.

"The visit is not over yet. Talks will continue ... substantial progress is reached but there is still work to do on price," Dmitry Peskov, Mr. Putin's spokesman, told reporters. "Talks are going on today, it can happen absolutely any moment."

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The challenge lies in finding middle ground on how much Russia charges China for the gas, and who pays for the pipeline that will bring it from east Siberia to the major population centers in China's northeast. Moscow wants a price similar to what it charges Europe, but it's higher than what China already pays for imported gas, and future suppliers could further drive prices down. Signing a deal with Russia would lock China into a 30-year contract for 38 billion cubic meters it might eventually be able to get from Qatar, Australia, or even the United States. 

"[T]he Chinese still have the upper hand but are obviously not in a position to dictate terms to the Russians," according to Erica Downs, a former CIA energy analyst and now a fellow at the Brookings Institution's John L. Thornton China Center in Washington. "[T]here is still time for Russia and China to complete a deal even if one is not reached this week," she writes via e-mail. "The big obstacle is price, so this is where a meeting of the minds has to occur."

As relations with the West deteriorate, Putin is under increasing pressure to find new customers for Russia's sprawling energy empire. China's urbanizing, modernizing economy demands more energy and sources of it that are cleaner-burning than the coal it currently relies on to fuel growth. Both sides have a lot to gain from one another, but most analysts say Beijing has the upper hand and will continue to drive a hard bargain.

China already has a great deal of gas supply locked in place from central Asian producers, and it expects more liquefied natural gas (LNG) to come online from the Middle East and Australia. The North American shale gas boom means the US could also be a major supplier of LNG later down the road, and China might have a shale gas boom of its own one day. The country is home to the world's largest technically recoverable shale gas resources, but complex geology and a lack of water make them difficult to extract. 

 “China already has enough gas from Central Asia, and now Myanmar, until the mid-2020s,” Shoichi Itoh, a senior analyst at the Institute of Energy Economics in Tokyo told the New York Times. “Unless Russia made a compromise on price, China has no reason to sign it.”

Meanwhile, Russia is dependent on oil and gas revenues for at least half of its federal revenues, although oil plays a much larger role than gas in its economy. The Ukraine crisis has accelerated Europe's efforts to shed Russia's status as the dominant supplier, and the West has threatened sanctions that could quickly curb Russian-European energy flows. Even if trade continues uninterrupted, Europe's growth prospects pale in comparison to what Asian customers offer Russia's gas giant Gazprom.

Natural gas use in Asian countries outside the Organization for Economic Cooperation and Development is expected to rise by an average of 3.3 percent annually, from 13.9 trillion cubic feet in 2010 to almost triple that amount – 36.3 trillion cubic feet – in 2040, according to the US Energy Information Administration. Nearly two-thirds of that growth will come from China, according to EIA. 

Many still expect the two sides to reach a compromise, particularly as Russia hosts a global economic forum later this week. The St. Petersburg International Economic Forum would be a prime opportunity for Putin to announce a final deal, and send a message of solidarity with China amid weakening relations with the West.

But for now, Putin hasn't made the concessions analysts say are necessary to close the deal. Russia could, for example, cut costs by awarding pipeline construction contracts to Chinese firms, according to Mikhail Korchemkin, head of Malvern, Pa.-based East European Gas Analysis. But that would not go over well with companies back at home.

"Apparently, President Putin is not ready to cut the profits of pipeline contractors of Gazprom yet," Mr. Korchemkin writes in an e-mail.  

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