China's CNPC drives hard bargain for impending Power of Siberia 2 gas deal with Russia

State-run China National Petroleum Corp., or CNPC, is negotiating to bring down the price of gas supply under the proposed Power of Siberia 2 pipeline amid expectations that a deal could emerge as early as this year if the parties agree, according to multiple sources.

The highly anticipated deal, which opens a new conduit for Russian natural gas supply into northern China, has been on the drawing board for nearly two decades and could become one of the most significant cross border energy deals signed by a Chinese state oil and gas company in recent years.

The circumstances under which Power of Siberia 2 gets finalized will be significantly different from when the project was first conceived, with major geopolitical ramifications due to the ongoing situation in Europe and the growing rift between the US and China, as well as China's vastly changed economic and energy landscape.

The most likely window for signing the bilateral deal could be during Russian President Vladimir Putin's proposed visit to China for national day celebrations in October, according to a Beijing-based source close to the discussions.

Other company sources confirmed that discussions were ongoing with two remaining hurdles – CNPC looking to lower the gas price as Russia is desperate to find an alternative to Europe, and some concerns internally on the feasibility of more pipeline gas amid weak demand and losses on domestic gas sales.

The Power of Siberia 2 deal was almost finalized in March during Chinese President Xi Jinping's visit to Moscow when Russia said that almost all details had been agreed with China, but Beijing refrained from a final confirmation.

CNPC has been taking advantage of its negotiating leverage to lower the price at which gas would be imported into China from the pipeline, which is now expected to be routed through Mongolia instead of its initial plan of western China.

Bargaining power

The delivered cost of Power of Siberia 2 is expected to be cheaper than most new LNG imports in the northern and central coastal demand centers in China for several reasons, Jenny Yang, senior director, S&P Global Commodity Insights said, while noting that no deal had been signed yet and pricing details are often not disclosed.

"From a market negotiation perspective, Russia needs to find a new market for its Western Siberia gas, while China still has other supply options including new LNG imports and additional Central Asia pipeline imports," Yang said.

"Unless Gazprom offers a good deal to China, China can go with other supply options with perhaps better flexibility and diversification like LNG imports," she said, adding that from Russia's side, Western Siberia gas is already developed with low breakeven cost to Gazprom and a shorter route via Mongolia that lower the project cost.

"If Power of Siberia 2 pricing is at a similar level at the border compared with Power of Siberia 1, the delivered cost to Beijing-Tianjin-Hebei region will be even cheaper than Power of Siberia 1, given that Power of Siberia 2 entry point to Beijing-Tianjin-Hebei is less than half the distance for Power of Siberia 1 to reach that market," Yang said.

She said Power of Siberia 1 landed price is already low, estimated to be equal to a single-digit slope of around 7% of oil prices.

China currently imports pipeline gas from several countries out of which Power of Siberia is already the cheapest. Beijing stopped publishing detailed pipeline gas data in 2022, but customs data from 2020 and 2021 showed that pipeline gas imports from Russia's Power of Siberia 1 was the cheapest.

In 2020, for example, Russian pipeline gas averaged $4.15/MMBtu compared to more than $9.08/MMBtu for pipeline gas from Myanmar, and around $5-$6/MMBtu for gas from Turkmenistan, Kazakhstan and Uzbekistan, customs data showed.

Yang also said that both Gazprom and PetroChina are known to be able to build pipelines quickly and sanctions are not expected to impact project execution. Gazprom and CNPC did not respond to queries, and Russia's energy ministry declined to comment when reached out by S&P Global.

Domestic gas sales

CNPC, China's largest oil and gas producer, has also faced some internal wrangling over the deal's commercial feasibility as it incurs losses on downstream pipeline gas sales due to caps on end-user retail prices for residential use and for winter consumption, a source said.

However, CNPC's pipeline business division has been keen on expanding its assets after the NOCs domestic pipelines were transferred to state infrastructure company PipeChina in 2020 as part of a nationwide restructuring, the source added.

"The current pricing regulations already deregulated wholesale prices for pipeline imports projects with commercial date after 2014. Currently, Power of Siberia 1 is the only pipeline import project that falls into this category. If this regulation remains unchanged, wholesale prices for Power of Siberia 2 will be deregulated too," Yang said.

Overall, China's gas demand is still expected to grow.

In 2023, China's gas consumption is estimated to reach 385 Bcm to 390 Bcm, according to the China Natural Gas Development Report 2023 published by the National Energy Administration.

Total natural gas imports are expected to be 158.2 Bcm in 2023, accounting for around 41% of total demand, data from CNPC's research arm ETRI showed. China's LNG imports are expected to reach around 64.2 million mt, or 89.1 billion cu m, in 2023, accounting for 40.6% of its total gas imports, according to ETRI data.

ETRI said in 2021 that China's natural gas demand is expected to grow during the 14th Five Year Plan period to reach 420-500 Bcm in 2025, and in the same year the NEA forecast demand to reach 430-450 Bcm in 2025 and 550-600 Bcm in 2030.

Annual gas supply from Power of Siberia 1 is expected to reach 22 Bcm in 2023, 30 Bcm in 2024 and 38 Bcm in 2025, based on the current schedule, up from around 15 Bcm in 2022, according to state media. A proposed expansion could add another 7-8 Bcm/year, while Power of Siberia 2 is expected to reach 50 Bcm/year at full capacity.

"It could depend on which supplier offers the price and conditions more favorable," a China-based trading source said, referring to the various pipeline projects being proposed.