China, Russia reach major natural gas deal

May 21, 2014: 9:02 AM ET

Agreement reached after a decade of negotiations; deal will supply quarter of what China consumes in a year.

FORTUNE -- Russian gas may soon be flowing into China, the latest move in a raw game of energy power politics being played between Moscow and the European Union.

The move allows energy Gazprom (OGZPY), and Russia in general, to expand its trade with Asia, a hugely symbolic move that breaks with its long tradition of sending its gas westwards to Europe. As such, it could reduce Russia's vulnerability to EU moves to reduce its own dependence on Moscow in the wake of the crisis in Ukraine. Gazprom currently supplies 30% of Europe's gas, according to the Journal report, half of which flows through Ukraine. The recent crisis in that country has led to fears of a disruption in gas flow to the Continent.

After a decade of negotiations, Russia and China finally signed an agreement Tuesday for Gazprom to pump 38 billion cubic meters of gas into China per year, according to a report in the Wall Street Journal. That's about a quarter of what China currently consumes in a year, but its gas demand is growing so fast that the Russian deal only represent a much smaller fraction of future consumption.

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There's no arguing over the size of the deal, but it is far from clear who will make how much money from it. Russian news agencies quoted Gazprom CEO Alexei Miller as putting a $400 billion tag on the overall value of the contract, which will run for 30 years. However, he said the pricing of the deal "is a commercial secret."  A rough calculation dividing $400 billion over 30 years of supplies would give a price of around $350 per 1,000 cubic meters, fractionally below the $360 that Europe paid on average last year, according to the newspaper Vedomosti. However, the big difference is that Gazprom will first have to build a new pipeline from its fields in eastern Siberia, which Vedomosti said could cost $30 billion.

Russia and China have haggled for years over price, and even late Tuesday, the Financial Times was quoting an official from Chinese energy company Petrochina as saying that the company is already losing money on imported gas because of low prices at home. Mr. Miller said the sides envisaged a "preferential" tax regime for the gas exports, suggesting that Russia will have limited room to use the contract to fill its own treasury. Most of Russia's budget revenues still come from oil and gas exports.

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