On 2 December 2019, Russia and China inaugurated the Power of Siberia pipeline, a new gas infrastructure that will boost diversification in China’s gas supply and ensure an enhanced role for Russian gas on the Chinese market. The new, 3000-km pipeline will probably reduce the weight of Turkmenistan and Australia in China’s foreign gas supplies, currently at 35% and 25.7% of total gas imports respectively ,and cover China’s rising demand for additional gas.
China represents the fastest growing market in the world for natural gas. According to the International Energy Agency (IEA), between 2018 and 2024 Beijing will account for 40% of global growth in natural gas. The increase is strictly connected with the energy policies embraced by the Chinese government, which considers a priority the reduction of coal consumption in the national energy mix, currently at 58%. The use of natural gas underpins the National Air Pollution Action Plan, adopted in 2013 and updated in 2018. Accordingly, in 2018, China’s natural gas consumption rose by 17% compared to the previous year, and imports increased by 30.8%.
Demand in China will more than double by 2035, and it will continue to grow, largely driven by strong air-quality policies. Where will the gas for China come from?
In 2018, 55% of Chinese demand was covered by domestic supply. Local supply could grow from 153 bcm in 2017 to 230 bcm in 2035, resulting in a decline in the domestic supply share to 45%.
An additional 27% comes from piped gas, mostly from Turkmenistan via the Central Asia–China pipeline (35 bcm per annum [bcma]) and Myanmar (three bcma). This share is increasing as Russia’s Power of Siberia pipeline came online in 2019 and reaches its full capacity of 38 bcma by 2025. There is also growth in utilization of the Central Asia–China pipeline (current capacity is 55 bcma) and construction of the fourth pipeline, line D, from Turkmenistan, with a capacity of 30 bcma. Liquefied natural gas (LNG) projects provided 18% in 2018 and balanced the market.
In the future, all balancing volumes may come as LNG or via new pipelines. The demand yet to be met is projected at about 50 bcm in 2025 and about 100 bcm in 2035 (excluding demand already covered by current LNG supply).
There is a promising option for delivering additional Russian gas to the Chinese market through expansion of the Power of Siberia pipeline and competition with LNG to conquer market share:
- Russia has abundant gas reserves in western and eastern Siberia.
- Compared with LNG cargoes, Russian natural gas delivered to China has a competitive cost, including all additional capital expenditures.
- Alternative monetization options for Russian gas (for example, gas to chemicals and fertilizers) have less scale and do not allow for extensive development of the abundant resource base.
In 2018, Russia produced 669 mtoe of gas; 58.4% (390.8 mtoe) of this was consumed domestically, and the rest was exported, mainly to Europe by pipeline. Russia’s LNG exports grew by 62% to 25 bcm in 2018, while pipeline exports grew by only 1.5%. Russia has 70 trillion cubic meters of recoverable gas reserves and a reserves-to-production ratio of about 100 years. The main natural gas production region is the Yamalo-Nenets Autonomous Okrug (YaNAO) in western Siberia, accounting for 80% of production and 55% of reserves. Another promising area with significant gas reserves is eastern Siberia (Krasnoyarsk, Irkutsk, and Yakutia).
The cost of legacy gas production in Russia is $.50 to $1.00 per million British thermal units (mmbtu) at the wellhead, including capital expenditures and the mineral-extraction tax. New supply from eastern Siberia is more expensive (Exhibit 4).
Currently there is no pipeline taking natural gas from YaNAO to eastern Siberia and further to China, but the Power of Siberia pipeline managed to connect China with eastern Siberia in 2019 (Exhibit 5). The additional distance of approximately 1,500 kilometers (half the length of the current Power of Siberia pipeline) should be covered by a new pipeline to connect western and eastern Siberia (the Tomsk and Irkutsk regions, respectively).
*On December 2, 2019, Power of Siberia was brought into operation and the first-ever pipeline supplies of Russian gas to China were launched.
The total cost of natural gas delivered to China through the potential new pipeline from Russia is about $6 per mmbtu for eastern Siberian gas and $6 to $7 per mmbtu for western Siberian gas, including the cost of transportation from YaNAO to Tomsk, the new Tomsk–Irkutsk pipeline capital expenditures, and all taxes. This is $1 to $2 per mmbtu lower than the future full cost of key LNG players (excluding Qatar). When we add about $1 per mmbtu as a transportation tariff from the Russian border to the demand center in eastern China, Russian gas remains one of the cheapest options.
This makes extra gas volumes from Russia potentially competitive against future LNG cargoes. Another 50 to 70 bcma of Russian natural gas could find its way to China in 15 to 30 years, providing up to a $3 billion shareable surplus per year to Russian producers and Chinese customers.
The main alternative monetization option for Russian gas from YaNAO is LNG: even without tax allowances, the full cost of LNG from the Yamal peninsula in China is $6 to $7 per mmbtu, depending on the shipping route (the Northern Sea Route is cheaper). At the same time, LNG is not a viable option for the landlocked resource base of eastern Siberia. Alternatives are ammonia and urea production, methanol and derivates production, and gas to liquids. Proven technologies for these options are capital-expenditure intensive ($1.0 billion to $1.5 billion per one bcma of gas feedstock) and support a maximum unit capacity of 1.5 to 3.0 bcma, which is not comparable with the typical pipeline capacity of ten to 30 bcma.
The possibility of delivering additional gas volumes from Russia to China through an expanded Power of Siberia pipeline should be considered by Russian and Chinese oil and gas companies as well as by global LNG players in their strategic perspectives.
*This contribution is an update of a McKinsey's article titled: "The Road to China: an opportunity for Russian Gas to Play Out"