Endgame for Russian LNG: Why China Won't Salvage Novatek's Profits Lost in Europe

Because of the full-scale war against Ukraine, the EU is now actively seeking to reduce its reliance on Russian LNG suppliers, including Novatek. However, some vested corporations with continued interests in doing LNG business with Russia propel the scare that supposedly China can save Novatek from US/EU sanctions if the Western export route for Russian LNG is closed. This is categorically false and misleading for several economic and political reasons.

From a superficial first glance, China, undeniably a major LNG consumer, might seem like a natural savior for Novatek among impeding Western sanctions. However, unlike Europe’s historically high gas prices in 2022, which benefited Novatek, the Chinese market is known for being fiercely competitive, with much lower average gas/LNG prices. Unlike Europe where Russians could in the past act in a seller's market, China has always ensured that it has a plethora of piped and LNG suppliers (Central Asian states, Burma, various LNG suppliers ranging from the US, Australia to Qatar and many others).

China imports LNG from more than 20 countries and Russia’s share is marginal. Australia ranks as the largest supplier with a 40% market share, followed by Qatar with 11%. Looking at the long-term LNG contracts announced by Chinese companies analyzed by Nikkei, Russia will not be one of the main suppliers either. It appears Beijing is more prone to sign long-term LNG deals with countries other than Russia to win some favors from Washington D.C., Doha, Canberra, and Kuala Lumpur based on balanced considerations geopolitically and energy-security-wise.

Billions of euros and dollars continue to flow to the Kremlin via Novatek as it still sends LNG to Europe and China. This hard currency provides a lifeline for Russia’s war machine and hybrid warfare which is now waged not only against Ukraine, but indirectly against Europe.

China’s National Energy Administration (NEA) has set the goal of ensuring that the self-sufficiency of natural gas supply should be no less than 50% in its annual policy papers. NEA and its officials have emphasized on numerous occasions that a sufficiently high rate of natural gas self-sufficiency is crucial for China's energy security and that it is a long-standing principle that will be upheld. This means that China's appetite for imported gas (whether piped or LNG) will not be big in the medium to long term. According to the China Natural Gas Development Report 2023, the country’s natural gas consumption was 364.6 bcm in 2022, while 217.8 bcm of it came from domestic production. This means that China's natural gas self-sufficiency rate was close to 60%.

If one just looks at the map, one could also see a problem with logistics. Shipping LNG to Europe from Russia’s Arctic projects is a relatively short journey compared to the vast distances involved in reaching China. These longer distances translate to higher transportation costs for Novatek, further squeezing profit margins.

Regardless of choosing the Red Sea or taking the Arctic route, the logistical and time costs of getting Russian LNG into China are much higher than for pipeline gas. This makes China inherently less interested in Russian LNG. Last summer, Gazprom made the first delivery of LNG to China from a port near St. Petersburg via the Arctic Northern Sea Route as receding ice sheets rendered the route more viable, but it still took nearly a month.

China’s LNG infrastructure is concentrated along its eastern coast, far from the major gas consumption centers in the north and central regions, making the journey longer for LNG tankers even when they reach China’s territorial waters. This necessitates additional pipelines or costly coastal transportation, again adding to Novatek’s LNG price tag. That is another reason why China has traditionally preferred to get mostly Russian piped gas rather than LNG as the gas fields that feed Russian export pipelines to China are much closer than Novatek’s LNG production sites.

In fact, all past track record for piped and LNG gas shows that China is using Russia as a sort of a swing supplier, on a residual basis and structures deals with the Russian counterparts from a position of strength, exploiting Russian logistical, political, and economic limitations and exposures. Moreover, for both oil and gas Beijing has always acted from a position of strength vis-a-vis Russian suppliers even at the time of China’s rising demand, combining commercial logic with security and political interests.

Which brings us to the point that not only China is skillfully using the market environment (buyer’s market) to its advantage, it is also carefully weighing its political and security needs which leave Novatek and Russians in general in a poor negotiating position. Unlike Europe, which was historically a seller’s market, keeping the upper hand and commercial rationale in negotiations is always following first and foremost Communist Party's line. Despite all the rhetoric on friendship, China has always preferred to keep all Russian energy suppliers—Gazprom, Rosneft, and Novatek—on a short leash where they had to agree to much worse prices and other conditions then they could get in Europe.

Meanwhile, China has developed much stronger gas relations with established LNG suppliers like Qatar, the U.S., and Australia not only because it makes sense commercially but also because the Chinese government wants to diversify their supply sources and routes of delivery and they see a benefit in having mutually beneficial projects in this strategic industry. These non-Russian players have well-developed infrastructure, cutting edge technology, and long-term contracts with Chinese buyers, making it extremely difficult for Novatek to gain a significant and long-term foothold. And importantly for Beijing, what these players don't have are massive western sanctions, technological lag, and harsh Arctic conditions with production centers on the other side of Eurasia.

At the end of the day big binding long term contracts—not verbal assurances of friendship by Chinese officials or Memorandums of Understanding (MoUs) by Chinese energy companies—talk volumes of China’s actual scale of interest in Novatek’s LNG supply. The interest is there but as to a residual supplier, one of many “backup” options. According to recent Russian figures derived from the Chinese customs Russian LNG supply to China increased last year to 8 million tons from 6.5 year-on-year. Even if that is true, the way Russian propaganda is spinning it is an exaggeration, these are still small volumes for China (given its import requirements of around 90 millionn tons) and not a way to diversify from Europe. Thus, it is counterproductive and misleading for Western stakeholders to help Russia spin this as a successful ability for Novatek "to substitute the West for the East."

As for frequent exaggerated projections of Chinese future demand for Russian LNG from 2030, they are mostly not taken seriously by any independent and commercially minded investors in energy majors or other gas market players who mostly do not place their financial commitments beyond the 3–5-year horizon. The overwhelming number of long-term projections for supposed big demand for Russian gas have been traditionally exaggerated by select western corporate or institutional analysts. There are many reasons for that, but most important is a constant desire to exaggerate Russia's energy importance either by vested corporate and partisan interests in the West or by gullible but not knowledgeable outsiders or lobbyists in the press.

Given real limitations of the Chinese market for Novatek’s LNG and the potential for further sanctions, a full Western embargo on Russian LNG emerges as a much more effective strategy for both European energy security and crippling the Kremlin’s war chest. Full embargo does not require overly complicated measures. Industry analysis by Razom We Stand and Uregwald shows targeted sanctions against ice-class Russian LNG tankers and sanctions against the provision of shipping services, insurance, and any other financial services for the export of Russian LNG can alone choke all Novatek’s LNG exports. The past two years of reduced Russian gas imports to Europe already showed that the EU can easily survive without Novatek’s LNG and not upset its energy supply in any dramatic way.

Meanwhile, billions of euros and dollars continue to flow to the Kremlin via Novatek as it still sends LNG to Europe and China. This hard currency provides a lifeline for Russia’s war machine and hybrid warfare which is now waged not only against Ukraine, but indirectly against Europe. The EU is literally subsidizing the Kremlin via Novatek LNG to undermine its own security and democratic institutions. A complete embargo would not give breathing space for Novatek in China but in Europe it would positively accelerate EU’s diversification efforts away from Russian gas altogether. It would incentivize investments in renewable energy and energy efficiency projects and would significantly reduce income stream to the Kremlin, making it harder for Russia to sustain its aggressive actions against Ukraine and Europe. A full Western embargo sends a clear message: Europe will not be a party to Russia’s aggression, and it is willing to pay the price for its freedom and security.