September 21st, 2016. The Bridge Café (Wudaokou).
Speaker: WANG Tao, Assistant Director, Yicai Research Institute; Nonresident Scholar, Carnegie-Tsinghua Center for Global Policy.
Wang Tao addresses the audience at ThinkInChina #54
China and Russia: ‘Not yet an alliance’
‘There is some type of partnership between Russia and China, but not yet an alliance’.
With this strong statement, we can start to consider why the two countries, so geographically close, are cooperating on energy issues. Historically, Russia and China don’t have a very good relationship. They are two players who ‘don’t really know each other that much’, so the negotiations to an energy deal were probably going to lead to some problems.
In 2008, right before the economic crisis, oil prices had reached a record high, but by the end of the year, there was a significant fall. The first big oil deal between China and Russia happened in 2009, soon after the world economy had just collapsed, heavily affecting Russian economy. Meanwhile, China’s energy demand was rocketing and the most pressing issue was finding a reliable oil supply. At the time, there was little media attention to the deal, since the majority of oil imported by China was still coming from the Middle East (mainly Iran). The deal seemed like one of the many others China had signed with oil nations, and it also included the creation of a pipeline from East Siberia to the Pacific Ocean.
The road to the 2014 deal
Two events helped creating the path for the huge deal closed in 2014 between China and Russia. The first one was in 2013, when air pollution levels reached record highs in Beijing, creating a lot of pressure for the government to replace the usage of coal with natural gas.
Natural gas had been on the talks between China and Russia for quite some time, as Russia is one of the world’s largest producers, and it sits so close to China. However, an agreement on price couldn’t be reached beforehand, as Russia wanted to charge the same price paid by the European Union (which has a far greater demand than China). Although natural gas is produced in China, it’s has very limited production and distribution.
As the Chinese government got serious about natural gas, Central Asia was seen as an alternative in case a deal with Russia didn’t work out. Such was the cases that Turkmenistan, looking for diversification, now has three pipelines going to China.
The second event was in 2014, when with the Ukraine crisis, there was a major change as Russian relations with the European Union fell apart and sanctions ensued. It was time for Russia to look east, especially Japan and South Korea, searching for new markets as insecurity about supply (which goes to and through Ukraine) preoccupied buyers and sellers alike. Therefore, Chinese and Russians had substantial reasons to close the deal. The frustrations from 2009 were gone and they agreed on a final price (secret, as it is considered a national security issue).
A public friendship becomes present in the media and encouraged by both governments.
Wang Tao smiles for the camera before his ThinkInChina address
Bumps on the road: oil prices and Chinese economy
The falling oil prices in 2014 ended up affecting the deal and slowing down on some of the initiatives. As extracting oil can be very costly depending on geography and technology, a few oil-producing nations with more fragile economies suffered heavily, such as Russia, Nigeria, and Venezuela to keep profits. In this scenario, natural gas directly competes with oil, as Japan is more willing to pay Russia a higher price than China for the gas. Since the oil crisis in 1973, Japan has had a policy of replacing oil with natural gas for generating power.
In this context, China started to reconsider if it should go on with the planned deal.
As China’s economy slows down, the country will stop being the major driver of an increased demand for oil, as it has been for the past 20 years. The Chinese economy is restructuring and the ‘new normal’ has not been found yet. At the same time, there has been a heavy promotion of new and renewable energies, with billions invested in electric cars, for instance.
Renewable energy is seen as strategic, due to technology development, security, and air quality.
Therefore, in the long term, China might not need oil and natural gas as much as predicted.
Trends in 2016
There has been an increase in Chinese import of oil in early 2016, but they are only temporary. The first one was the strategic reserves slowing down along with lower oil prices fueling more imports, and the second are the new policies regarding private refineries in China. With ¼ of Chinese capacity, the private refineries (or ‘teapots’) were not allowed to import crude oil, having to rely on dirtier types of the product. Last year, the government lifted this restriction, allowing them to import the heavier type of crude. These refineries – sometimes poorly regulated and with low efficiency – are now the major drivers of Russia’s oil exports to China. However, the demand is likely to go down soon, as heavy industries will suffer with an economic slowdown.
As Saudi Arabia has been competing with Russia to supply the Chinese market is important to pay attention to the developments in future OPEC meetings.
It seems the balance in the negotiations is now leaning towards China, especially as most Russia and Central Asia nations need Chinese investment in the oil sector. Although there is an imbalanced relationship now, there are still reasons for the partnership to continue.
As the tension in the South China Sea steadily increases and a peaceful conclusion is unlikely, a strong partnership with Russia could be helpful.
Besides that, relying on the Malacca Strait for oil supply is dangerous, so a different route from land is very important for the Chinese government.
Their mutual interest in Central Asia is also a common issue. Russia still sees Central Asia as its backyard, but can see the need for Chinese presence (and money) in the region. Moscow can help Chinese investment by providing security to deals already made and guaranteeing regimes will maintain their promises, even if the government changes.
Finally, it is clear there are uncertainties about China’s needs, as the economy slows down and the usage of renewable energy goes up. At the same time, Russia still sees itself as a European country. Although we can see a friendliness in the short term, there is still a lack of trust between both countries.
As many doubts remain on the strength of this relationship, Mr Wang was asked several questions regarding a potential friendship between Xi Jinping and Vladimir Putin? His response; probably not a friendship, but a very important part of international relations is the relationship between world leaders. Xi and Putin meet each other very frequently and this could indicate they have found common ground to discuss. They definitely understand each other.
Regarding other alternatives for China, Mongolia was mentioned as an interesting partner, similar to Central Asia nations, but more under the influence of China than Russia and in need of investments. Also, Myanmar, as a different route from the Malacca Strait. Japan’s role was also part of the discussion, as the pipelines will not end in China, because Russia is also looking for diversification. As Northeast China suffers with the economy, the new pipelines projected for the area might not come true due to low demand. If Russia decides to use Japan as a bargaining chip for the deal, it would be very problematic for the Chinese government.
China and Russia are still not dependent on each other in their respective energy balances, so it is sensible to think of diversification. The trust between them needs to be improved through understanding, but both countries suffer from lack of transparency and poor interpretation of their actions and inner workings. There have been understanding between governments when it comes to Central Asia, though, as the Eurasian Economic Union and the ‘One Belt, One Road’ (OBOR) initiatives integrated their projects earlier this year.
There is also the important topic of physical infrastructure and the role of the AIB (Asian Infrastructure Bank). The AIB and the OBOR are excellent ideas, but it remains the question of how are going to be the returns on Chinese investment and expectations in the region. Two points were overlooked by Beijing: the poor government regulations in Central Asia and their severe lack of infrastructure.
Could Shanghai become an energy hub for natural gas? Maybe, but China is still lagging behind Singapore. It needs to allow for more transparency and lower regulations on price (more free trade). There is still a big monopoly of state companies and liberalizing is a necessity, as soon as the conversations about this topic return (when oil prices increase again).
Written by Julia Rosa