1. China and Russia Gas Trade: Is There a Common Ground ? Chi Zhang, Vladimir Drebentsov New Delhi, November 21, 2008

2. Content Introduction and summary of conclusions Overview of market trends Future gas demand and supply Russia’s plans for developing gas supply in Eastern Siberia and the Far East Central Asian gas, where will it go? Pricing issues in China and Russia Is there opportunity for Russian gas in China?

3. Introduction and summary of conclusions

4. Key issue: What will feed growing demand China’s natural gas consumption growth stronger than expected, promoted by −Rapid economic growth −Cheap natural gas price −Environmental concerns −Government strategy for increasing gas penetration −Major supply hike is required to meet expected demand growth: −Indigenous −Imports: LNG, pipeline gas

5. Difficult negotiations to bring stranded Russian gas to China via pipelines: −Original plans: 68 bcma export to China by 2020 −West Siberia (2011), East Siberia (2016) −Yet there is no agreement on price: −Russia wants market price for its gas (LNG price or the price Europe pays) −China considers that price non-competitive There is more progress in bringing Central Asian gas to China Bilateral history: Long and protracted negotiations

6. Sticking questions −Will China really have huge demand growth, as projected, and what price levels will support high growth? −Given “market demand” and alternative import options, is Russian gas competitive?

7. China’s natural gas demand will remain price sensitive. Gas prices are regulated, and in many regions are lower for residential and commercial consumers than those actually paid for imported LNG. If market prices are introduced, gas consumption, particularly by power generators, will depend on policy support (subsidy) The main risk is that the actual gap between domestic demand and supply may be much smaller than currently assumed, if government allows market pricing Chinese gas market is likely to remain compartmentalized with low-income consumers supplied from domestic sources In either current or market environment, Russian gas will likely be able to compete only with LNG, and/or in major industrial centers where economics/geography may favor Russian gas over Central Asian supplies Key findings

8. Overview of market trends

9. Fast consumption growth, enabled by increase in domestic supply bcm Source: IAEA and EcoWin %

10. In spite of impressive growth, China’s gas market is still in its infancy, what will future hold? 2007 Energy consumption Primary Power Coal Natural gas Oil 1980 Energy consumption Coal Primary power Natural gas Oil

11. Consumption by Sector EU bcm Residential fuel Industrial feedstock Industrial fuel Oil production Power gen. Rest

12. Current policy: End-users are prioritized PriorityResidential sector EncouragedIndustrial fuel for high value- added production and reduction of environmental impact (glass, porcelain) RestrictedPower generation ForbiddenChemical feed stock (methanol, DME)

13. Consumption by region: Most gas is used in producing provinces EU NE China bcm North China East China South China Resource provinces Central China West China

14. Demand and supply projections Bcm

15. Expected demand by sector in 2020 bcm Domestic supply200 Total demand302 Industrial fuel150Compete against oil products Residential60Compete against LPG Transportation20 Industrial feedstock20Not compete against coal Power generation52Not compete against coal, nuclear Source: CERA

16. Rapid growth backed by new discoveries and increased proven reserves (3.7 Tcm increase in 10 years to reach 5.36 Tcm in 2006) Infrastructure developments: existing pipelines (West-to-East 1; Shanxi-to- Beijing); planned pipelines (West-to-East 2; Sichuan-to-Shanghai); new LNG liquefaction terminals (Sichuan) – for domestic shipments by road transport Import LNG projects underway, mostly for Eastern and Southern China markets −LNG (1 bcma) −Competes when alternatives are oil based products and LPG −Competes when end-users include residential customers −Does not compete when end-users are large power generators −Pipeline (70 bcma by 2015) −Import deals signed with Kazakhstan and Turkmenistan (40 bcma) −MoU on Russian gas (30 bcma from Far Eats by 2015, as Russia abandoned Altaj pipeline) Natural gas supply potential

17. Possible import pipeline options for China

18. Russia’s plans for developing gas supply in Eastern Siberia and the Far East

19. Originally Russia was envisaging supplying gas to China from West and East Siberia and the Far East via two pipelines (Altaj and Pacific) and as LNG (from Sakhalin and Vladivostok area) In Gazprom’s General Scheme of Development to 2030, Russia has recently focused its targeting of China’s market (North-East and Central provinces, bay of Bohai area), and abandoned Altaj pipeline to save West Siberian gas for domestic and European destinations The General scheme envisages deliveries of pipeline gas to China and South Korea commencing only by 2020. And the projected range is broad; 25050 bcma Russia has recently committed 10 bcma to South Korea for 30 years beginning in 2015. The new pipeline will go South from the Vladivostok area (either via North Korea or via the sea) Hence Russia is prepared to commit 15 to 40 bcma of pipeline gas to China Additionally Russia will offer LNG from new trains in the Far East Russia ’ s plans for developing gas supply in Asia-Pacific

20. Central Asian gas, where will it go?

21. There are various plans for shipping Turkmen gas West- and Northbound (currently there is only 40 bcma Northbound exports via/to Russia, and 10- 14 bcma Southbound exports to Iran). Yet among new routes, there is more progress on Eastbound routes Turkmenistan has committed 30 bcma of gas to China via Turkmenistan- Kazakhstan-China pipeline, construction of which has already commenced (First stage shall be launched in 2009, with full capacity reached in 2011). The pipeline will source West-to-East 2 pipeline Kazakhstan has committed 5-10 bcma from Urikhtau field (developed jointly by KazMunaiGaz and CNPC) and 5 bcma from Aktobe field (developed by CNPC) via Kazakhstan-China pipeline (10 bcma, with potential expansion to 15 bcma) China and Turkmenistan agreed on $195/mcm (likely to be the same for Kazakh gas). Hence China will be getting 40 bcma of imported gas for below $200/mcm Central Asian gas going eastbound

22. Pricing issues in China and Russia

23. Regulated natural gas price Upstream price is low for indigenous gas, lower than price of imported natural gas Retail price are high for consumers, higher than competing fuels −Twice as expensive as syngas in Shanghai −More than double the wholesale price for residential and industrial users −Much more expensive than coal for power producers Domestic gas pricing

24. Approval from NDRC Approval from local price bureau Upstream/Ex ploration Midstream/T ransport Downstream/ Distribution Wellhead price Transport. price Cost Plus Pricing End user tariff Distribution cost + margin Gas price regulation

25. Shanghai gas prices $/MMBtu City GateRetail

26. Guangdong gas prices $/MMBtu City GateShenzhen

27. At market price, gas-fired power generation can be limited without policy support; demand may also be smaller from other sectors The supply gap may be smaller than expected, and be filled without the need for a second pipeline, perhaps until after 2020 Market Demand will be price sensitive

28. Guangdong power on-grid tariff (gas at 5.83/MMBtu) $/MWh

29. Market pricing reform with ultimate goal of integration of domestic with international gas markets Government is committed to market based pricing, but also with some social economic constraints LNG and international fuel prices effectively become benchmark for new domestic supplies Gas pricing may change

30. European markets (primarily in Germany, France and Italy) are key for Russian gas exports, absorbing ca 150 bcma in 2007 (total Russia’s gas exports were 180 bcma). European contracts are long-term and oil- indexed (with a 9 month lag). In the fourth quarter of 2008, an average price for Russian gas in Europe will be $500/mcm (yielding Russian netback of close to $400/mcm). In spite of EU’s desire to diversify gas imports, Russia will remain the key European supplier in the foreseeable future (Russia currently supplies 26% of European gas consumption) Lower oil prices will mean lower European prices for Russian gas. Yet if the oil price does not average below $60/barrel for a prolonged period, netback for Russian gas sold in Europe is likely to remain around $100/mcm. Russian domestic gas prices are envisaged to reach European netback level in/or after 201. Gazprom has recently requested that government introduces a guaranteed minimum domestic price of $80/mcm beginning in 2011 Gas pricing in Russia

31. Is there opportunity for Russian gas in China?

32. Price at the border $/mcm LNG price formula based on JCC at $70/bbl with slope of 0.124 Transmission cost based on WEP !: CNY1 for 4,500 km within China Exchange rate $1 = CNY 6.83 European parity price at Altai-China border: Source: xyz energy

33. Russian pipeline gas may compete against LNG for market Geography and government policy will be crucial factors determining whether Russian pipeline gas would be able to compete with other exporters of pipeline gas to China If China’s gas demand does not exceed 200 bcma, there will be only very limited scope for Russian pipeline exports to China Russian opportunity