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Beijing’s Bear Hug on Russian Oil

Sep 22 , 2014

China stands to gain much more than oil from deepening Western sanctions on Russia. Already in May, Moscow’s tenuous international position prompted it to make concessions in order to sign a landmark gas supply agreement – the “Power of Siberia” pipeline – that had been under negotiation for more than a decade. With additional sanctions announced on Russian energy firms, Beijing is emerging as the biggest benefactor. Not only does it stand to become a key export destination of Russian oil and gas, Chinese companies are also well positioned to gain access to the Russian upstream, which has thus far been off limits to them. Under Xi Jinping’s China, the rocky Sino-Soviet relationship is at its best, without Beijing having had to make a single concession.

Deals, deals and more deals

In early September, Vice Premier Zhang Gaoli co-chaired the 11th meeting of the China-Russia Energy Cooperation Committee in Moscow. He couldn’t have asked for a warmer welcome: Chinese firms were offered a stake in Rosneft’s Vankor field, one of its largest Siberian energy projects and a crucial source of crude oil for the ESPO pipeline that transports oil to China. Zhang also attended a ceremony to mark the start of construction work of the landmark “Power of Siberia” gas pipeline, which will transport 38 billion cubic meters (bcm) to China starting in 2019. He also discussed with his Russian counterpart the prospects for an additional 30 bcm gas pipeline to China.

While Sino-Russian negotiations have been notoriously lengthy, Moscow’s weak international standing could nudge things along at a faster pace. Negotiations on an upstream stake and the second (Western) gas pipeline will likely accelerate in the coming months as Moscow in particular will be keen to generate positive headlines during an October meeting between Premier Li Keqiang and his Russian counterpart Dmitry Medvedev and, more importantly, during a Xi Jinping-Vladimir Putin meeting on the side-lines of the APEC summit in China in November.

A win for China

The deals are vital for Russia as China’s geopolitical support and financing help cushion the impact of deepening Western sanctions. But they are also significant for China: a stake in Vankor would be a win for Beijing that has long sought access to Russia’s upstream. Moreover, the huge onshore field is not challenging to develop, and is already generating significant returns. Vankor and its satellite fields could produce 1 million barrels a day by 2020. If granted the stake, Chinese firms would buy into a highly lucrative deal, bailout cash-strapped Rosneft, and have a stake in the entire supply chain, from the upstream, through the pipeline to the refining.

Additional oil imports would be an added bonus. Crude oil flows from Russia have increased from an average 490,000 bpd over the last two years to more than 600,000 bpd this year, as Rosneft and Transneft repay their 2009 oil-backed loans. An additional 300,000 bpd are tied to these loans. A stake in the Vankor field would probably entail an additional loan to Rosneft, tied once again to more crude oil going to China. For China’s decision makers, investing in the Russian oil sector and creating further potential overland supplies are appealing since this will help cap imports from the Persian Gulf.

Stepping on the gas?

Reports from Zhang’s visit suggest that construction of the “power of Siberia” pipeline is now under way, and that negotiations on the Western route are gaining momentum. If both routes materialize, Russian pipeline gas to China will reach 68 bcm, accounting for 15% of the country’s gas supplies post 2020. To be sure, there are many uncertainties surrounding this prospect: First, construction of the pipeline and upstream development will need to advance quickly in order for gas deliveries to begin in 2019. Yet Gazprom may find it challenging to meet such a tight deadline in its current financial and political situation: Sanctions over Russia’s role in the Ukraine crisis could limit its financing options, and internally, Moscow is also attempting to challenge Gazprom’s export monopoly.

It’s the price, stupid!

In light of Gazprom’s woes, Chinese firms have a greater chance of acquiring stakes in gas fields as well. The precedent set by Rosneft–which secured an energy backed loan from China in 2009, and is now willing to grant China an upstream stake–will place further pressure on Gazprom to cooperate with Chinese financiers and energy companies. But the timeframe for this, and for supplies reaching China is an open question.

Russia will increasingly want to conclude a second gas pipeline deal in the current geopolitical context, but in order for the pipeline to be viable, prices would have to be extremely competitive with contracted volumes from Central Asia, as well as with falling LNG prices. It was no coincidence that Zhang paid a state visit to Turkmenistan where he pledged to further boost energy ties. Turkmenistan has become a model investment for China, one that it would happily replicate in Russia: CNPC has a stake in the giant Galkynysh natural gas field, which will supply some of the planned 65 bcm of Turkmen gas exports to China by 2020. Chinese negotiators will therefore drive a very hard bargain on prices for any new gas supply contracts, considering also that on top of Central Asian and Myanmar pipeline exports, Chinese importers are ramping up their LNG capacity and contracts, while also investing in domestic resources. The challenge for Gazprom to deliver under such circumstances would be even greater, especially if Rosneft were to vie for a share of the gas pie.

Irrespective of how much gas Russia supplies China, Beijing’s bear hug will become an inescapable reality. China’s willingness to support Russia both economically and geopolitically is high, given what is suggested to be a close personal connection between Xi and Putin, but mainly, because it comes at very little cost for China.

Dr. Michal Meidan is director at China Matters, an independent consultancy firm that advises investors and government officials on their China strategies, with particular emphasis on the politics of the Chinese energy sector.

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