Supply and Demand: China’s Growing Industrial Sector Looks to Russia for Energy

The steadily improving relations between Russia and China reached a new high earlier this year when the two countries signed 29 bilateral agreements on energy, telecommunications, IT, banking and money laundering during President Vladimir Putin’s March visit to Beijing. In some quarters, these new agreements cemented fears of a strategic alliance directed against Western, and especially American, interests. But despite Russian and Chinese consensus on most international issues and increasing cooperation not only on energy and trade, but also on military and security matters, these concerns are overblown.

Following Putin’s visit, trade between Russia and China was indeed expected to double from $29 billion in 2005 to $60 billion by 2010, but this is just a fraction of China’s total trade volume, which amounted to $1.4 trillion last year. Despite the increases, China’s trade with Russia is also a far cry from China’s bilateral trade with the United States, which reached $285 billion in 2005. Last year, Russia was China’s ninth largest trading partner, behind such major economic powers as Singapore and Malaysia. In fact, major constraints will have to be overcome if the partnership is to evolve into a real alliance, even if this is the aim of the two countries.

Russia and China are indeed natural partners on energy, which arguably comprises the most important aspect of their relationship. All the major East Asian economic players China, Japan, South Korea and Taiwan, among others lack significant oil and gas fields, making the region highly dependent on outside sources for its energy needs. Russia is ideally placed to supply both oil and gas from its huge reserves in the Far East and Siberia. Moreover, Russia is keen to diversify its energy exports following its spat with Ukraine over gas prices in early 2006 and the disorientation, uncertainty and anger that the disruption of supplies provoked among Russia’s European customers. Russia and China might not be Western-style democracies, but both are moving toward consumer-oriented societies at a rapid rate. China’s recent emphasis on industrial development indicates that the country’s energy requirements will increase sharply in the future.

However, East Asia not only lacks oil and gas fields, but also the distribution infrastructure to transport energy to and around the region. This is a difficulty Russia cannot easily overcome, since it lacks transport infrastructure, particularly from deposits in the Far East and Siberia. Total investment needed to develop this infrastructure will run to hundreds of billions of dollars.

During Putin’s visit, several major agreements were signed to help alleviate these difficulties. The China National Petroleum Corporation (CNPC) will provide a loan of up to $400 million to build an oil pipeline from Skovorodino to China, with oil expected to start flowing by the end of 2008, while Russia’s pipeline monopoly Transneft is partnering with CNPC in conducting a feasibility study on the construction of a branch oil pipeline. The construction of both oil and gas pipelines will be easier now that Russia and China have formally agreed on a demarcation of their 4,300 km (2,500 mile)-long common border, settling their long-running border disputes. These developments, however, do not change the fact that Russia has long vacillated on whether to build a pipeline to Japan or China or both, partially because it fears that “the rise of China” could pose problems to Russia in the future. While these problems are being resolved, all of Russia’s oil exports to China will continue to go by rail. In 2004, China imported 12 million tons of crude oil from Russia – 10 percent of its total imports – and expects to import 15 million tons this year. Rosneft provides around 70 percent of Russia’s exports to China and is expected to export 8.8 million tons of crude to the country in 2006, almost doubling the 4.5 million tons it exported in 2005.

CNPC and Rosneft have agreed to build a refinery in China, and Gazprom’s Sibneft unit plans to sign a deal with China’s Sinopec to refine oil in China. CNPC and Rosneft also agreed to undertake joint exploration for new oil deposits in Russia. There has been little geological research since the collapse of the Soviet Union, and geologists suspect that the Russian Far East and Siberia may hold the world’s largest undiscovered deposits.

Additionally, Gazprom agreed to a memorandum of understanding with CNPC to build pipelines that will supply China with 60-80 billion cubic meters of gas a year within five years. Gazprom was expected to sign a commercial agreement on the pipeline deal this year. Cooperation may also mean swapping pipeline supplies for Chinese cargoes of liquefied natural gas (LNG).

This spring and summer saw important developments in the implementation of the agreements signed in March. In April, construction began on the East Siberia-Pacific Ocean oil pipeline, which will pump up to 1.6 million barrels per day from Siberia to Russia’s Far East for export to the Asia-Pacific region, particularly China. The first stage of the project will connect Taishet in the Irkutsk region to Skovorodino in the Amur region, scheduled for completion in the second half of 2008.

In a clear sign of the two countries’ interpenetration of each other’s energy sectors, CNPC bought $500 million worth of Rosneft shares during the Russian firm’s July IPO on the London Stock Exchange. In early August, the Chinese Xinhua News Agency quoted a Rosneft official as saying that the company would establish a joint venture with CNPC by the end of the year to produce and market oil products. The joint venture could also take part in bidding for licenses to explore and produce oil and natural gas in Eastern Siberia and the Russian Far East. In early August, Rosneft and a subsidiary of Sinopec began drilling an exploratory well on the Sakhalin-3 project under an earlier agreement signed in July 2005 during Chinese president Hu Jintao’s Moscow visit.

Another major development in August was the announcement by Russian-British joint venture TNK-BP that it was joining Rosneft in a plan to send Russian oil to China via Kazakhstan. According to Anthony Considine, TNK-BP Executive Vice-President and Head of Marketing, Sales and Processing, the company had drafted a project to build a special rail reloading facility near Barabinsk rail station in the Novosibirsk region. After arriving at Barabinsk by rail, the crude would be loaded into a special pipeline linked to the larger trunk line running from Omsk in West Siberia to Pavlodar in Kazakhstan. The crude could then be shipped using the export line from Atasu in central Kazakhstan to Alashankou in China’s Xinjiang region.

According to Kazakh officials, this pipeline, which is half owned by CNPC, has already been filled with Russian oil. Russia’s Lukoil also wants to send oil to China through the new pipeline, according to Boris Zilbermints, the company’s head of operations in Kazakhstan. China is keen to develop alternative supplies to avoid heavy dependence on Russia, and has also signed an agreement with Turkemenistan to take delivery of natural gas.

During an online chat in early August 2006, China’s Deputy Minister of Commerce, Yu Guangzhou, underlined that energy resources were key to bilateral trade and economic cooperation between China and Russia, and stated that China had invested in 700 programs in Russia up to the end of July with a contracted capital of $1.34 billion dollars, while Russia had started 1,912 companies in China with a contract value of $1.52 billion U.S. dollars and actual investment totaling $570 million. He also said that China would achieve its goal of investing $12 billion in Russia by 2020.

On the economic and energy front, the two countries are thus recording significant progress, but while bilateral cooperation is eminently natural and sensible, both countries face major strategic problems in their future geopolitical relations with each other.

The “rise of China” is no less worrying to Russia than it is to the United States, Japan and China’s other Asian neighbors, but this is hardly a new problem. Despite the howls of protest from Russian media and politicians about NATO’s eastward expansion in the early 1990s, the Russian Ministry of Foreign Affairs was, at the time, even more concerned about China due to the influx of Chinese shuttle traders into the sparsely populated Far East region, whose population of some 6 million stands in stark contrast to the 110 million Chinese just across the border. Since then, however, the problem has become more acute. China’s economy is now twice as large as Russia’s, and it is growing at 8-10 percent per annum, compared to Russia’s more modest rate of 6-7 percent differences which, over the long term, will increase the current economic disparity even further and thus reduce Russia’s relative political power.

Moscow is therefore concerned about exporting energy and arms as well to a country that is likely to become a global power in the future and could potentially pose a major challenge to Russia’s own position internationally.

In order to balance this challenge, Russia hopes to become a more powerful Pacific player by developing its energy resources in the Far East and increasing its energy exports to the region. Russia is by no means focused exclusively on China and is seeking additional Asia-Pacific customers. For example, at the annual meeting of the six-nation Shanghai Cooperation Organization in June 2006, Putin announced that “creating a SCO energy club is a pressing issue, as is more intensive cooperation in transport and communications.”

For its part, China not only needs to increase its energy imports, but to diversify its supply, partially because 80 percent of its oil imports at the moment pass through the Straits of Malacca. Again, this situation is not really new Japan has virtually no oil or gas either and has thus been highly dependent on nuclear energy and Middle East oil for decades. But, until the global economy becomes far less dependent on hydrocarbons for energy, China and the rest of East Asia will remain vulnerable to pressure from suppliers, including Russia.

Managing this situation and their relationship with each other will present Russia and China with some of their most important strategic tasks in the decades ahead. Both countries are likely to avoid too much dependence, and thus reduce risk, but both stand to reap huge benefits if they adopt an approach based more on economic cooperation and less on great power competition.

Special to Russia Profile, an online and monthly print magazine dedicated to Russia and published jointly by RIA-Novosti and Independent Media, Moscow.


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