The important new CNPC-Novatek LNG agreement

The announcement of a Heads of Agreement between CNPC and Novatek for a minimum annual delivery of 3mt of LNG to China is highly significant, far beyond the fact that this is the first LNG project based on transport through the North-East Passage.  The driving forces and high-level official commitments suggest that a final contract will be signed as soon as possible and without much delay.

The sellers’ reputation, access to proven reserves and execution proficiency, even in challenging arctic conditions, have prevailed.  With price indexation said to be to the classic “Japan Crude Coctail” – undoubledly cleared with the Chinese government – CNPC makes a powerful long term market statement that will also impact coming LNG negotiations in other projects.

Gone is the flirtation and hope for ostensibly cheap and abundant North American shale gas exported as LNG.  With Novatek accepting a a balanced upstream equity role for CNPC, gas purchasing and project development requirements have again meet in classic partnership and portfolio management.  The Russian stance on pricing has then also prevailed and the financing of at least train 1 (of three planned) would seem virtually assured. The stakes are high in both China and in Russia.

On the seller side the CNPC-Novatek HOA confirms that recent spot LNG prices have strong fundamental support.  Two key elements are towering Chinese environmental problems and high marginal costs of domestic coal, discussed in earlier posts.  Another level of fundamental strengthening can come when Chinese pipeline and LNG infrastructure is further integrated and expanded.

With China now possibly on a new gas shopping spree the competition for gas will be further strengthened, in a market already short on supply and predictability.  US and Canadian LNG export projects should reevaluate their price strategies and also take lessons from CNPC-Novatek.  The resolution of continued project delays from expectations of increased tax revenue in exporting countries and low prices in importing countries is part of this, which also CNPC knows well from its other projects.

One important perspective of the CNPC-Novatek HOA may be a reappearance of old school geopolitics and old partnerships – with business fundamentally driven by trust and lack of trust.   Such a perspective gives interesting hints to what other LNG projects are likely to announce similarly important milestones, or what kind of realignment is necessary.  The race has just started.