Article / 15 December 2015 at 11:30 GMT

Russia-China gas megadeals turn into millstones

Russia oil and gas expert
United Kingdom
  • Oil price has collapsed since Gazprom's Siberian deal was signed
  • Crucial funding deal for Novatek's Yamal LNG project is delayed
  • Russian govt might question why Novatek should get state cash
 Gas deposits development and gas transmission system  in eastern Russia. Pic: Gazprom

By Nadia Kazakova

As the Russian prime minister Dmitry Medvedev yesterday embarked on a largely ceremonial four-day visit to China, a pair of flagship natural gas collaborations between the two superpowers are looking increasingly troubled. Both Gazprom's Power of Siberia pipeline and Novatek's Yamal LNG projects seem to turning from shining investment beacons to albatrosses around the companies' necks. 

Underlying the difficulties the projects have been encountering, Reuters reports that Gazprom has been looking around for third party gas to fill up the Power of Siberia pipeline should it prove unable to finance and develop its own gas resources in time.  

This gas megadeal between Russia and China was signed on May 21, 2014, when the Brent oil price was at $109/barrel. At the time, the contract gas price for China (which is linked to the oil price) was estimated at around $350/1,000 cubic meters. 

Gazprom's share price and the ICE Brent Index, 2014-15


It took another year for the Russian parliament to approve the project, by which time the oil price almost halved. Construction of the pipeline has started regardless, but the official completion date for the entire project (which includes development of a giant gas field) remains uncertain: sometime in 2019-21.

power of siberia
Russia's Valdimir Putin and China's Zhang Gaoli sign off
on the start of the Power of Siberia build. 
Picture: iStock

For Gazprom, there are two immediate problems. The first one is the negative effect that the current collapse in the oil and gas prices is having on the company's cash flow and its ability to finance any large-scale projects, at least in the short run. 

The second problem is the long-term oil price and oil-linked gas price, which the company and its banks must be using when making investment decisions. Gazprom (and its banks) might be waking up to the fact that low-prices-for-longer will have to be seriously considered, rather than dismissed as a temporary phenomena.

It is actually heartwarming that Gazprom is making an effort to reduce costs by looking for cheaper third party gas. Then again, it could be just the result of a growing realisation that the development of its own field could lead to massive losses of perhaps $50-60/b of oil (given export gas prices below $200/1,000 cubic meters), and these losses would inevitably show in company's financials within five years. 

Gazprom's investors seems to be aware of the risks, judging by the share price performance.

Novatek's situation looks a bit more complicated.

Kommersant newspaper reported on December 11 that there seems to be a delay in closing of Novatek's sale of 9.9% of the Yamal LNG project to the Chinese Silk Road Fund (SRF), a deal that was announced in early September. According to the terms of the agreement, Novatek's share was to be reduced to 50.1%, Total and CNPC would have 20% each and the SRF would have a 9.9% interest. 

Based on a note published by Moody's rating agency, the sale of the stake to SRF would have been complemented by the provision of a loan from SRF to Yamal LNG by December 10. In other words, the deal should have been completed last week.

The delay is not the only problem. This deal is more than just a sale of a stake. It is meant to be part of a much larger refinancing effort for the $27 billion project. Yamal LNG shareholders have invested over $10 billion (i.e. this is risk sitting on their balance sheets) and have been looking to raise some $20 billion in external finance. 

It should include $12 billion from Chinese banks. Presumably, the Silk Road Fund's purchase of a 9.9% stake and the accompanying loan would have been a part of that larger arrangement. 

The remainder ($8 billion) would come from Russian banks, export credit agencies and the Russian government. Just over $2 billion of the $8bn has already been provided through Russia's National Wealth Fund: RUB 75 billion ($1.21bn) in February 2015 and another RUB75bn in late November ($1.14bn). 

It is unlikely that the government will approve any further disbursements. At some point, the government might even ask if the company which managed to pay RUB35bn in dividends (for 9 months of 2015) should be asking for state funds.

The Chinese money is therefore critical for the Yamal LNG project and Novatek itself. The company's total exposure to Yamal LNG was RUB175bn ($2.6bn), or almost 22% of its total balance sheet as of September 30, 2015. There is an additional $3bn in off-balance sheet guarantees. 

The bulk of the investments will have to be made over the next two years (the first LNG train is to come on line at the end 2017). Apart from keeping up with the LNG project finances, Novatek is also facing a $600 million Eurobond repayment in February 2016.

So far, equity and debt investors seem to be taking all this news in their stride. Novatek's bondholders must have taken heart from an upbeat note from Moody's rating agency on November 25, admittedly published before the latest drop in oil prices. 

The equity investors seemto be also holding on, hoping for better times. Novatek's shares are trading higher than they were a year ago when the price of Brent was at $63-64/b. Indeed, they outperformed both the oil price and Gazprom shares over the last twelve month.

Relative performance of Novatek and Gazprom shares and the ICE Brent Index


While Gazprom's share price seems to have adjusted for a potentially value-destructive gas deal with China, Novatek's investors are yet to fully adjust for risks related to its LNG venture and the tight financing situation, facing Novatek in the coming year.

– Edited by Clare MacCarthy

Nadia Kazakova is a specialist on Russia, particularly the oil and gas sector

fxtime fxtime
For major capex projects such as this incurs colourful accounting. Predictive values are nigh on impossible as the economic cycles of Russia and China will ebb and flow likewise demand / supply constraints. Growing manufacturing base and population demographics also have effects to such project assessment(s). Building of such infrastructure will obviously provide employment even if transitory and for a socialist state it must be an appealing project. I totally agree with your excellent analysis above but when politics become entangled with such projects there is always a bigger picture to the decision(s) of going ahead/abandonment of these projects. In any country projections and vialbility of such projects is akin to accountants claiming their three year cash flow forecasts are accurate when in truth only a 6mth forecast is viable with real accuracy. Probability schematics come to the fore here and to second guess China or Russia for guarantees is shall we say difficult :-(
Nadia Kazakova Nadia Kazakova
Don't disagree, it is a very long-term projects with plenty of variables, including politics. However, bankers as well as accountants tend to be keen on cash flow analysis and rate of returns. It is sort of tough to get a multi-billion dollar loan approved with negative IRR. Even for a socialist banker. With lower oil prices being a much higher probability scenario (at the moment), the interest on loans and equity risk premium would need to go up.
fxtime fxtime
Valid points :-)
Warren Buffet007 Warren Buffet007
The oil prices is down because is manipulated as the actual economies need it!, but this will be for not to long time!. The normal oil price is around $80 not $150 like one year ago and not $40 like actual. China needs urgently gas supply due the big problem of contamination, because the actual energy are by a high contaminating carbon.!
yuiyui yuiyui
Although not up to date, in the charts, we can see a dramatic increase in production vs rig count in the US. I am wondering if Russia is benefiting from the same diminution in the cost of production and therefore, with the devaluation of the Rouble, the actual impact on the economy could be different than previously thought.
Do you have any thoughts on that?
Nadia Kazakova Nadia Kazakova
I guess the difference is that higher output/lower production costs in the US are mostly down to technological factors. In Russia, production costs might be lower after the rouble devaluation, but they have little impact on level of output. While Russian oil companies invest more in rouble terms, it is low-tech investment with low efficiency (mostly conventional drilling). The ageing Russian fields need fracking/directional drilling, I,e. technology which needs to be imported.

The oil output in Russia was up y/y in 2015, but this has to do with few new fields coming on line, not low costs. It takes a while for new fields to get developed in Russia, they tend to be relatively large( there is not much of an independent oil sector with small fields and flexible output). Some of the new fields were developed when the oil price was above $100 per barrel, but started to produce when oil price dropped. Basically, there is a significant lag between the oil price and oil production.
Nadia Kazakova Nadia Kazakova
It seems that Novatek moved a bit closer to selling 9.9% of Yamal LNG to the Chinese Silk Road Fund. See below the link to today's press release to the London Stock Exchange. The risks, in my view, remain elevated for the company, both in terms of financing and execution of the LNG project.
yuiyui yuiyui
Thank you
yuiyui yuiyui
Great answer BTW


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