We all know the real reason Putin did a last hour gas deal with China: he wanted to make me look bad.
For yes, mere hours after I declared my perspicacity in doubting that the widely expected deal would get done, the Russians and Chinese announced that they had reached an agreement. So my powers of prognostication were short-lived. Don’t gloat too much, Vova.
That said, I believe that there is less here than meets the eye. Or at least, there are many outstanding questions.
Although the deal supposedly agrees on pricing, the pricing structure is very opaque. Gazprom’s Miller said the pricing was set, but a “commercial secret.” In other words, he would tell us, but he’d have to kill us.
People are widely quoting a number for the price, based on Gazprom leaks and back of the envelope calculations based on announcements of the notional value of the deal ($400 billion over 30 years) and the quantity (38bcm/year). But as I noted in the post a couple of days ago, there is no way that the parties would set a fixed price for the 30 year term. Instead, they would agree to some indexing formula. Gazprom said that a “base price” had been established, and Putin said that the contract utilizes oil indexing. (In my original post I said this was an important thing to look for. On its own, this is a win for Gazprom, which has been a diehard advocate of oil indexing. But given the lack of any gas hubs in Asia, it’s hard to see what other alternative there is. Perhaps indexing off a European hub, but this would present real problems for Gazprom.)
But all that said, the devil is in the details. Since the price is indexed, any statements about a flat price (e.g., $350/mcm) are based on a huge number of assumptions on the indexing formula. Since nobody knows what that formula is, they have no clue on what the real price is. (And since the oil forward curve doesn’t really go out much beyond 10 years, there would still be incredible uncertainty about the revenues that Russia will realize or could lock in by hedging even if the formula was known: given that the gas will not flow for another 6-7 years, the forward prices that would be input into the formula for the last 20+ years of the 30 year term of the deal can’t be known with any precision.)
And the devil is indeed in the details of these assumptions. There are infinitely many ways to create an oil-indexed formula, and the economic outcomes vary crucially with the exact parameters that are chosen as inputs to the indexing formula. (Indeed, the weights can be made to vary over time.)
Moreover, there are some clues that things aren’t quite as final as the public crowing suggests. Putin says that the Chinese have agreed to front $20 billion towards the construction of new infrastructure, with Russia ponying up $50+ billion. But Gazprom’s Miller says that the “two sides were still in talks over any advance.”
Well wait one cotton picking minute. Upfront payments have to be offset by favorable prices over the life of the deal, to compensate the Chinese for the principal amount of the advance and the interest on it. If the upfront payments haven’t been set there is no bleeping way that all of the pricing terms are set. These terms are interdependent.
That little slip by Miller is, my friends, a huge red flag that this deal isn’t as done as the principals claim. Huge. If that part is still under discussion, the entire thing is still under discussion.
Here is my cynical interpretation (and when Russia is involved, and China is involved, cynicism is the order of the day-and when both are involved, oi!). The failure to reach a deal was so embarrassing to Putin that he was desperate to leave Shanghai with his signature on something. So the parties basically memorialized what they had already agreed to, but there are crucial gaps to be filled, and the negotiations to fill these gaps continue. The basic contours of the deal (e.g., some sort of oil link) are known, but the exact parameters, and the upfront payment, are still TBD. The Chinese accommodated, because letting Putin save face cost them nothing, and could benefit them later.
Gazprom stock popped a couple of percent on the announcement, but given the continued ambiguity, and the past fading of these deals after the initial fanfare, I consider that market reaction to be optimistic. I won’t be convinced that this is real until I see pipe being laid. Talk is cheap, and all we have now is still just talk.
So as far as I am concerned, there are still substantial doubts over the solidity of this deal. The admitted lack of agreement over the upfront payment is telling. Until the parties agree on that, they haven’t really agreed on anything.
In other words, things are still as clear as mud.