New Russian Gas Export Projects – From Pipe Dreams to Pipelines

In the twelve months since the collapse of global oil prices and the imposition of Western economic sanctions against Russia, the number of new Russian gas export project announcements has skyrocketed. Only last month, Gazprom signed a memorandum of understanding (MOU) with three European companies to build a second large gas pipeline system under the Baltic Sea called Nord Stream II. This was preceded by the announcement in December by President Vladimir Putin himself of the cancellation of the ambitious South Stream gas pipeline under the Black Sea to be replaced by an equally grandiose project, soon to be dubbed Turkish Stream. Both Nord Stream II and Turkish Stream are designed to bypass the critical transit route through Ukraine utilized by 40 to 50 percent of Russia’s current gas exports to Europe. Russia and Gazprom’s position on whether gas transit through Ukraine will continue after the current agreement expires in the not-too-distant future flip-flopped within a matter of weeks recently – first proclaiming that all transit will cease after 2019, then declaring that negotiation of a new deal has been ordered by President Putin.

In the past year, we have also seen the supposed conclusion of not one but two large gas deals with China. Together with numerous previously proposed liquefied natural gas (LNG) and export pipeline projects, this picture is enough to make even a seasoned energy observer’s head spin. To make matters worse, the mainstream press tends to report each one of these announcements, no matter how fanciful, as if they are all realistic projects that will be completed by the notional target dates even as Russia’s financial position continues to deteriorate. The total cost of these projects is somewhere between $150 and $200 billion, and it is unlikely that Russia (even together with its prospective partners) could muster the necessary capital to complete most of them amidst Russia’s low oil revenue, budget deficits, and falling GDP. Instead, the raft of announcements, postponements, and cancellations in June and July of 2015 suggest that Russia is groping for a viable gas export strategy.

To clarify this confusing picture, we present a list of yet-to-be completed gas export projects that Russia has announced to date, background information on each, and a simple assessment of their likelihood of success in ascending order of feasibility, from the most far-fetched to the most realistic. We focused our short analysis primarily on economic and commercial viability rather than political or geopolitical desirability. Obviously governments have the ability to subsidize selectively economically suboptimal projects (and Russia has an outstanding track record for doing so), but this is beyond the scope of this exercise. In contrast to alarmist geopolitical readings of recent Russian announcements, we hope to show which prospective projects make the most economic and commercial sense, and to demonstrate that because of the significant obstacles facing most of these projects, Russia’s recent gas export expansionism does not pose the strategic threat that some Western policymakers perceive.

10. Vladivostok LNG (postponed) and the Sakhalin-Hokkaido Pipeline (hypothetical)

A Framework Agreement of Cooperation was signed between Gazprom and the Japanese Ministry of Economy, Trade, and Industry to build an LNG export terminal near the far-eastern Russian warm-water port of Vladivostok in 2005. Vladivostok LNG was estimated to cost roughly $7.5 billion, and was scheduled to begin exporting 5 million tons of gas annually (mmta) in 2018, eventually reaching a full capacity of 15 mmta. The facility would have shipped Gazprom gas from eastern Siberia and Sakhalin Island to Japanese LNG import terminals, but the project was postponed in June 2015 as Gazprom shifted its focus to supplying the Chinese market. The economic logic of shipping gas a great distance overland in order to liquefy it for export was never compelling. It doubles the cost of transporting gas to market, thus leading to much lower profits for gas producers.

Japanese lawmakers and companies have also expressed interest in several different undersea pipeline projects to supply Japan with gas from Sakhalin Island. The most recent proposal, reportedly made by Russia in November 2014, would link Sakhalin with Japan’s northern Hokkaido Island. In May 2015, Tokyo Gas stated its interest in constructing a $3.5 billion gas pipeline from Russia to central Japan, likely passing through Hokkaido. While Russia’s large natural gas supply and post-Fukushima Japan’s growing demand make them natural trade partners, delivering Russian gas to areas of demand in Japan by pipe might be difficult. Some experts have claimed that seismic activity might endanger any undersea pipeline to Japan, and Japan currently lacks a domestic natural gas distribution network, relying instead on coastal power plants to convert imported gas to electricity and distribute it to consumers via the national power grid. This infrastructural gap favors Japan’s continued reliance on LNG rather than pipe gas for its imports.

9. Trans-Korea Gas Pipeline (MOU signed)

A gas pipeline running from the Russian Far East through the Korean peninsula to supply both Koreas with Russian gas was first proposed in 1991, and Gazprom, South Korea, and North Korea signed a preliminary agreement to construct such a pipeline in 2011. Initial estimates suggested that the 12 billion cubic meters annually (bcma) pipeline would cost around $6.3 billion to construct. To secure North Korean support for the project, Russia suggested that the North would receive $100 million per year in transit payments if it allowed construction, and forgave 90 percent of the North’s debt in 2014.

Though there have been no recent statements reassessing the viability of this project, there is obvious political complexity involved in delivering energy to South Korea via its northern rival. Until now, North Korea’s impassability has made the South into an energy “island” like Japan, making coastal LNG import terminals a much less risky gas importation option.

8. Turkish Stream 3 and 4 (construction delayed) and the “South European Pipeline”, (MOU signed)

Following the cancellation of the 63 bcma Russia-Bulgaria South Stream pipeline in December 2014, Gazprom and the Turkish Botas Petroleum Pipeline Corporation signed a memorandum of understanding to build the Russia-Turkey “Turkish Stream.” This pipeline system is projected to cost $20 billion, and it would also have a total capacity of 63 bcma, made up of four 15.75 bcma strings to be built in phases. The first string would supply gas from Russia to Turkey, while the other three would serve the European market, allowing Russia to redirect gas flows currently transiting Ukraine. While this project has fueled speculation that Turkey could become a gas re-export hub, Russia and Greece also recently signed a $2.24 billion “agreement” to send all of the EU-destined Turkish Stream gas – 47 bcma –to a newly-announced “South European Pipeline” in Greece, giving Greece the European gas hub role Turkey seeks.

Yet there are many reasons to doubt the feasibility of the third and fourth strings of Turkish Stream, and therefore of the South European Pipeline. As of this writing, Turkey and Russia have not yet agreed on a price for Turkish Stream’s gas, and Gazprom canceled the contract for laying the first string of the pipeline under the Black Sea by Italian services company Saipem in early July. Moreover, an expanded Turkish Stream competes directly with Nord Stream II (discussed below) for European gas demand. The recent announcement of Nord Stream II, with its more direct route to main European gas markets, signals Russia’s lack of confidence in Turkish Stream 3 and 4 and South European Pipeline because these northern and southern expansions and extensions are redundant. Gazprom has also cancelled contracts with Russian companies on expanding the onshore pipeline system to the Black Sea that would feed gas to a Turkish Stream at full capacity.

7. Nord Stream II (MOU signed)

Nord Stream, which runs from Russia to Germany under the Baltic Sea, was completed in 2012 and its two lines can supply Western Europe with 55 bcma of natural gas. A planned expansion was put on hold in January 2015, partly because of EU regulatory hurdles, but in June Gazprom signed an MOU with Shell and Nord Stream customers E.ON and OMV to build a new line (Nord Stream II) that would add another 55 bcma of export capacity. BASF/Wintershall, another Nord Stream customer, is also in talks to join the project. Despite a great deal of attention from the press, an MOU is very far away from a commercial agreement and project realization, especially given that Nord Stream itself is not yet operating at full capacity.

Nord Stream II offers Russia a more viable alternative to the Ukrainian transit route with direct access to major central and western European customers. However, the project is redundant with the South Europe Pipeline and the third and fourth strings of Turkish Stream, and Russia will very likely have to choose between them. None of these Ukraine bypass projects are likely to be in full operation by the time the current transit agreement between Russia and Ukraine expires in 2019.

6. Altai (“understanding” reached)

Negotiations between Gazprom and CNPC on the Altai pipeline route from Russia’s West Siberian gas fields to western China began in 2004, and an “understanding” on the pipeline was reached between China and Russia in November 2014. The Altai route, which would cost between $11 billion and $14 billion, would ship 30 bcma of gas over the Altai Mountains to China, supplementing the 38 bcma Power of Siberia route to the east (discussed below) from eastern Siberia to northeastern China. According to official Chinese statements, a deal on the Altai line will be reached by the end of 2015.

Though this pipeline route makes great sense from a Russian perspective, it would be less than optimal for China. For Russia, the Altai route would provide a nearby alternative market for the massive West Siberia gas fields, which mainly supply Europe. For China, however, this route would require massive investments by China in a new domestic pipeline to bring the Russian gas thousands of miles from Xinjiang province in the far west to consumers in China’s prime gas markets in the east. Russia’s continual interest in this so-called western route distracts from China’s prime focus on the eastern route (discussed below).

5. Sakhalin-1 (agreement reached)

Exxon Neftegas, a consortium of ExxonMobil, Rosneft, Sodeco, and ONGC Videsh, began producing oil and gas from the Odoptu, Arkutun-Dagi, and Chayvo fields offshore of Sakhalin Island in 2005. In 2013, Rosneft agreed with ExxonMobil to develop a $15 billion, 5 mmta gas liquefaction facility on the island, with the goal of exporting to the growing Japanese gas market.

Despite the strong rationale for building out the infrastructure needed to export LNG to the large nearby market in Japan, complications with a major partner in the project and competition between major Russian gas companies may kill Sakhalin-1’s LNG facility. Though ExxonMobil has not pulled out of the project over U.S. and European sanctions on Russia, in April the company filed a $500 million lawsuit claiming that Russia overcharged it in value added taxes on the Sakhalin-1 project. Perhaps more importantly, Rosneft indicated in May that it may move its LNG facility off Sakhalin island because Gazprom, which operates the nearby Sakhalin-2 LNG export terminal (discussed below), is denying Rosneft access to the gas pipeline it would need to export its gas.

4. Turkish Stream1 and 2 (construction delayed)

The proposed second line of Turkish Stream would add 15.75 bcma capacity to serve Gazprom current gas customers in southeastern Europe while bypassing Ukraine. If Turkish Stream 3 and 4 are canceled, Turkish Stream 2 would be the only Russian pipeline delivering gas to Europe via Turkey. This would contradict agreements to route 47 bcma of Russian gas to the EU through Greece via Turkey, but this outcome seems more likely. While Turkish Stream 2 faces many of the same economic hurdles as lines 3 and 4, it would serve a more nearby market where Gazprom has a virtual monopoly on imported gas currently. However, once it passes through Turkey to EU soil, Turkish Stream will face the same regulatory hurdles on unbundling of gas production from transportation and open access to pipeline capacity that bedeviled the now cancelled South Stream project.

The first line of Turkish Stream would carry only 15.75 bcma of gas to the domestic Turkish market, supplementing the existing Blue Stream pipeline and replacing the Trans-Balkan gas pipeline, which together delivered 27.4 bcma to Turkey in 2014. Turkish Stream 1 is likely to be finished, though not necessarily by its projected December 2016 completion date. Most of the capital commitment to the first line of Turkish Stream is already sunk because it replaces the first line of the cancelled South Stream pipeline to Bulgaria. Russia and Turkey have extensive energy relations and the current impasse over gas prices may be temporary. The experience of the Blue Stream project which protected Turkey against supply disruptions stemming from Ukraine transit and Russia’s interest to compete in the growing Turkish gas market may yet overcome any commercial obstacles.

3. Yamal LNG (construction underway)

Situated at the Arctic port of Sabetta near an estimated 22 trillion cubic meters (tcm) of gas reserves, the massive Yamal LNG project is one of the few Russian gas export projects not operated by Gazprom. Novatek, Total, and CNPC jointly own the Yamal LNG export project, which has an anticipated construction cost of $27 billion and aims to eventually supply 16.5 mmta of LNG to European and East Asian markets, especially China. If exports begin in 2017, as scheduled, Russia will tap new gas reserves and be better able to circumvent Ukraine in its gas exports to Europe, as well as diversifying the market for more of its gas to Asia.

Despite recent difficulties, it appears that Yamal LNG’s stakeholders are committed to ensuring its completion. U.S. sanctions on Novatek and U.S.-EU financial sanctions on Russia have made borrowing difficult, but since January, Russia’s National Wealth Fund and Russian and Chinese banks have committed roughly $20 billion to the project, and Novatek is reportedly seeking $5 billion from global export finance agencies. Yamal LNG also made deals to pre-sell some of its LNG in June, and Novatek Chief Executive Leonid Mikhelson aims to have the project’s financing secured by the end of 2015.

2. Power of Siberia (construction underway)

A decade after beginning negotiations, Gazprom and CNPC signed a $400 billion, 30-year gas sale agreement that included a 38 bcma pipeline route from eastern Siberia to northeastern China. The Russian portion of the pipeline and the development of the two gas fields that feed it will cost an estimated $55 billion, and the system as a whole is projected to cost $77 billion. Construction of the Russian portion of the pipeline began in September 2014, and the Chinese portion was underway as of June 2015. The system is scheduled for completion in 2018, and is planned to provide China with over 4 trillion cubic meters of gas over the following 30 years.

Uncertainty over gas price with the sharp decline in oil prices and spot LNG price in Asia after the contract was signed last May, as well as weaker Chinese gas demand with a slowing economy and the technical and financial challenges of complex gas field development raise doubts over the completion date. Though Power of Siberia may be delayed by one or two years, it is very unlikely that the route itself will be altered or canceled given the strategic interests of both countries. In addition to exporting gas, Power of Siberia is important for economically connecting eastern Siberia with the Russian Far East.

1. Sakhalin-2 LNG Expansion (agreement reached)

This project is the most feasible because it builds on an existing project. Gazprom, Shell, and Japanese companies Mitsui and Diamond Gas operate the Sakhalin-2 LNG export facility on the southern end of Sakhalin Island. The LNG terminal is fed by the Piltun-Astokhskoye and Lunskoye oil and gas fields, and export 10 mmta of gas mainly to Japan and South Korea. Gazprom and Shell’s CEOs first agreed to upgrade the facility to 15 mmta at the 2014 Sochi Olympics, and committed to the expansion - estimated to cost somewhere between $5 and $7 billion – in June 2015. Given the relatively low cost of this incremental project and Gazprom’s apparent intention to stifle Rosneft’s rival Sakhalin-1 LNG facility, it seems more likely than any of the others to actually be completed.

This ranking is, of course, imprecise and subject to debate, which this commentary hopes to spark. One way of judging likelihood of economic success is to consider whether the export project:

a) Taps new gas supply through the most economic route, which makes good commercial sense – (Sakhalin-2 LNG expansion, Power of Siberia, Yamal LNG);

b) Redirects existing gas supply through a new, more expensive route, which makes economic sense only if the goal is to increase redundancy or meet future demand growth – (Turkish Stream, Nord Stream II, Altai, South Stream); or

c) Directs new supply through a more expensive route, which can be prohibitively expensive or uneconomic (Sakhalin-1, Vladivostok LNG, Sakhalin to Hokkaido pipeline; Trans-Korean pipeline).

To be sure, economic efficiency may not be the critical criterion for Russia on selecting which of the projects to fund. Yet given reduced financial capability and reduced access to external financing, economic efficiency is more important than in the days of $100+ oil price. Diversity of supply and supply routes are options to be pursued during times of plenty, not when capital discipline is required. Redirecting existing gas flows through new costly infrastructure leads immediately to lower profits, even if they are strategically desirable in the long term.

Russia’s highly centralized political system and national champion oil and gas companies allow it to project the image of being able to make bold swift decisions on major projects. However, this does little to help overcome the serious technical and economic challenges many of these projects face. Political decisionmaking may even compound difficulties and lead to costly delays, as history has demonstrated.

Moreover, protecting market share in Europe using existing routes has become more important for Gazprom in the current oil price and financial environment. How Gazprom navigates the EU’s evolving regulatory environment is more critical than how to ship gas to China, which is unlikely to start until the end of the decade in any case. Gazprom’s reliance on existing European markets is evidenced by its recent contract flexibility with major customers on pricing, volume, and destination restriction. Indeed, this path dependency even obtains in Ukraine, where Gazprom’s recent gas price offer and admission that transit will continue after 2019 display uncharacteristic reasonableness. As in other spheres, Russia and Ukraine are stuck with each other on gas supply and transit in the short to medium term despite protestations to the contrary by both sides.

It therefore seems likely that Russia and Europe will continue to be tied together by the gas trade. It is consequently foolhardy for Western governments to attempt to supplant Russian gas in Europe with alternatives from the United States and elsewhere, as some who look at energy through a geopolitical lens have proposed. This would bring Western governments and companies into a pipeline or LNG contest with Russia, even though natural gas infrastructure projects are challenging enough on their own, and Russia could defeat any effort to compete with its gas exports if it concentrates its resources and attention. Western governments have neither the tools nor the strategic need to engage in major project development. Focusing on unglamorous efforts to advance market integration and increase open energy trade are more likely to achieve the policy objective of gas import supply diversification than would reviving fanciful, Western-backed projects like the Nabucco pipeline or LNG receiving terminals in parts of Europe where there is insufficient bankable demand to justify such costly projects.

Interpreting the shifting cross-currents guiding Russia’s future gas exports will continue to be an adventure for those who make the attempt. It is best to ignore often misleading headlines and wait to understand fundamental industry drivers in order to judge each project’s economic feasibility and the degree of political preference or government subsidy required.

Edward C. Chow is a senior fellow and Zachary D. Cuyler is a research associate in the Energy and National Security Program at the Center for Strategic and International Studies (CSIS) in Washington D.C.

Commentary is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

© 2015 by the Center for Strategic and International Studies. All rights reserved.

Edward C. Chow
Senior Associate (Non-resident), Energy Security and Climate Change Program

Zachary D. Cuyler