New markets in the Far East – China’s growing industrial sector looks to Russia for its energy needs

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, information technology, banking and money laundering during President Vladimir Putin’s March visit to Beijing. In some quarters, these new agreements cemented their fears of a strategic alliance directed against Western, and especially American, interests. But despite the Russian and Chinese consensus on most international issues and increasing cooperation on military and security matters, these concerns are overblown.

Due to Putin’s visit, trade between Russia and China was expected to double from $29 billion in 2005 to $60 billion by 2010, but China’s total trade volume amounted to $1.4 trillion last year. China’s trade with Russia is far different than 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. Considerable constraints must be overcome if a real alliance between Russia and China is to evolve—if this is, indeed, the aim of the two countries.

Russia and China are natural partners on energy, which is, arguably, the most important aspect of their relationship. China, Japan, Taiwan and North and South Korea all lack significant oil and gas fields, making East Asia 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. What’s more, there has been little geological research since the collapse of the Soviet Union, and it’s suspected that the Russian Far East and Siberia may hold the world’s largest undiscovered deposits. Moreover, Russia very much wants to diversify its energy exports following its spat with the Ukraine over gas prices in early 2006 and the disorientation and anger that the disruption of supplies provoked among Russia’s European customers. Russia and China may not be Western-style democracies, but both are moving toward consumer-oriented societies at a brisk pace, and China’s recent emphasis on its 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, a difficulty Russia cannot easily overcome, since it lacks its own infrastructure to transfer this energy from its deposits in the Far East and Siberia. Building the necessary pipelines would cost hundreds of billions of dollars.

During Putin’s visit in March several major agreements were signed to help overcome these problems. The China National Petroleum Corporation (CNPC) plans to provide a loan of up to $400 million to build an oil pipeline to China, with oil expected to start flowing by the end of 2008, while Russia’s pipeline monopoly Transneft is working with CNPC to do a feasibility study on an oil pipeline branch. Building both oil and gas pipelines will be easier now that Russia and China have settled their long-time frontier disputes along their 4,300 kilometer- (2,500 mile) long common border.

But the closer cooperation is complex. Russia has long vacillated on whether to build a pipeline to Japan, China, or both, fearing that a strengthened China could present a challenge to Russia in the future. While these pipeline problems are being resolved, all of Russia’s oil exports to China will continue to go by rail. China expects to import 15 million tons of crude from Russia this year, with Russia’s Rosneft supplying about 70 percent of the total.

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.

Additionally, Gazprom agreed to a memorandum of understanding with CNPC to build pipelines that will supply China with 60 to 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 because cooperation may also mean swapping pipeline supplies for Chinese cargoes of liquefied natural gas.

Implementation of the March agreements began in spring and summer. In April construction started 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 should be complete in the second half of 2008.

Perhaps the clearest sign of the closer involvement Russia and China have with each other’s energy sectors was CNPC’s purchase of $500 million worth of Rosneft shares during the Russian firm’s July initial public offering on the London Stock Exchange. In early August China’s Xinhua News Agency quoted a Rosneft official who said 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 bid 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 visit to Moscow.

In August, the Russian-British joint venture TNK-BP announced that it was joining Rosneft to deliver 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 in the Novosibirsk region. After arriving by rail, the crude would be loaded into a special pipeline linked to the larger trunk line running from West Siberia to Kazakhstan. The export line from central Kazakhstan to China’s Xinjiang region could then ship the crude.

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 contract value of $1.34 billion, while Russia had started 1,912 companies in China with a contract value of $1.52 billion, and actual investment totalling $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 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 even more concerned about China as Chinese shuttle traders began to flood 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. But the problem is even more acute now that China’s economy is twice as large as Russia’s, and growing at 8 to 10 percent per year, compared to Russia’s more modest rate of 6 to 7 percent. Over the long term, these small differences will greatly increase the current disparity and reduce Russia’s relative political power.

Russia, therefore, 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 not focused exclusively on China, and is seeking additional customers in Asia-Pacific. At the annual meeting of the six-nation Shanghai Cooperation Organization in June 2006, Putin said “creating an 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 also to diversify its supply. Eighty percent of its oil imports now pass through the Straits of Malacca. In addition to China’s well-publicized attempts to secure energy and other commodity supplies from the Middle East and Africa, the country has also signed an agreement with Turkmenistan to take delivery of natural gas.

Again, this situation is not really new. Japan also has virtually no oil or gas and has, thus, been highly dependent on nuclear energy and Middle East oil for decades. But as long as the global economy remains highly 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 will avoid too much dependence on each other, but both stand to reap huge benefits if they adopt an approach based more on economic cooperation and less on a competition for power.

By Ian Pryde

Published in Trendlline Russia, a series of sponsored supplements on the Russian economy commissioned by RIA-Novosti and published with the print editions of The Daily Telegraph (UK) and The Washington Post (USA) in November-December 2006.

Appeared in The Washington Post printed supplement on 9 November 2006 and at http://www.washingtonpost.com/wp-adv/specialsale/spotlight2006/articles_v4/supply.html

Subsequently published by Russia Profile as ‘Supply and Demand: China’s Growing Industrial Sector Looks to Russia for Energy’ on 26 September 2006.

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