At long last, Russia signs massive gas deal with China

Russia and China have at long last signed a natural gas supply contract valued at over $400 billion, in the first major deal signaling Russia's defiance of isolation by the West since the crisis in Ukraine unfolded.

The deal between Russia’s state-owned OAO Gazprom and China National Petroleum Corp. will involve 38 billion cubic meters of gas flow from fields in eastern Siberia into China over the next 30 years. It marks an important transition by Russia — a petrostate that holds the world’s largest reserve of natural gas — toward burgeoning Asian markets.

“This is the biggest contract in the history of the gas sector of the former USSR,” Russian President Vladimir Putin said shortly after the deal was announced. “Our Chinese friends are difficult, hard negotiators,” he added, noting that talks on the deal, which has stalled over pricing for nearly a decade, went on until 4 a.m. Wednesday.

Putin and Chinese President Xi Jinping witnessed the deal in Shanghai, where Putin was on a visit to forge ties as part of a gradual rapprochement between the two Eastern powers. A day earlier, the two leaders presided over an unprecedented agreement to bypass the U.S. dollar and use local currencies in certain international transactions — a shot across the bow of U.S. global financial hegemony.

The gas deal was struck at a pivotal moment for Moscow, which has vaunted its prospects for forging economic and political independence from the West in the wake of sanctions imposed as punishment for perceived Russian aggression in Ukraine. In the face of growing geopolitical isolation, Putin even threatened to shut off the Gazprom pipelines that supply Europe with about 30 percent of its natural gas.

“B. Obama should abandon the policy of isolating Russia: It will not work,” said Alexei Pushkov — a Putin loyalist and senior member of the Russian parliament who was personally subject to U.S. sanctions — in a tweet after the Gazprom deal was finalized.

Regarding the commercial benefit of the deal, the devil is in the details for Russia. Price had been the key hurdle that held up the deal for nearly a decade, with Russia demanding a higher price than China was willing to pay.

China has long been able to buy gas from Turkmenistan at a relatively low price, whereas Gazprom has a “much sterner bargaining position in Europe,” said Liza Ermolenko, an emerging markets economist at London-based Capital Economics.

Gazprom CEO Alexei Miller did not disclose any of that information in a press conference after the deal was announced, but sources told Reuters that Gazprom outright refused to sink below $350 per thousand cubic meters — a price comparable to what European utilities pay.

Putin confirmed that pricing structure and said it would continue to be tied to the market value of oil. He also said China would cover up-front costs of $20 billion for the infrastructure necessary to start gas flows.

But in the grand scheme of Russia's energy exports — more than $100 billion in oil and gas flow to European Union countries each year — the deal is medium-sized. Russia is not likely to abandon its energy investments in Europe anytime soon, contrary to threats issued in the heat of the Crimea showdown.

“From the commercial standpoint, Europe is the most profitable market for Gazprom. Exports to China can generate a small profit, but only if the government makes it free of taxes and duties,” said Mikhail Korchemkin, who founded Eastern Europe Natural Gas and has consulted for Gazprom in the past. “China is just not as desperate as Russia about this gas deal.”

Russia is the world’s third-largest producer of oil after Saudi Arabia and the United States. With its hydrocarbon, oil and gas revenues accounting for more than 50 percent of its federal budget, it is considered a petrostate.

Analysts say the Ukraine crisis has compounded pressure on Russia to diversify its export markets. Another brash foreign policy venture could have disastrous consequences for its one-note gas export structure.

“Because of the sanctions threat, Moscow is just as keen to diversify its energy customer base and international banking relationships as Europe is to diversify gas supply,” said Chris Weafer, a founding partner of Macro-Advisory, a Moscow-based consultancy.

But analysts say this particular deal did not come out of nowhere. Russia’s urgency to sell gas to China is part of a global trend by energy conglomerates to shift marketing of exports toward Asia and away from Europe. ExxonMobil, among others, has indicated that European demand has plateaued and is expected to decline in the coming years as environmental regulations clamp down on energy consumption.

Separately, Gazprom has also been subject to an EU antitrust lawsuit that could undercut the energy giant’s dominance on the continent. At the 2012 Asia-Pacific economic summit in the Russian city of Vladivostok, Putin said it was primarily this suit that was pushing him away from the European market, according to an energy analyst who attended the conference.