Russia's Shrinking Leverage With China

Chinese and Russian national flags flutter on lampposts in Tiananmen Square, on Oct. 22 Photograph by Imaginechina/AP Photo

This week brought an increasingly familiar sight from Beijing: high-ranking Russian officials shaking hands with their Chinese counterparts. The occasion, just as it has been in recent months, was a slew of new energy deals that will further align the two countries as trading partners and bring Russia one step closer to becoming China’s primary fossil-fuel provider.

On Tuesday, Russia’s largest oil producer, the state-owned Rosneft, announced it had agreed to supply Sinopec, China’s state-owned oil and gas company, with 100 million metric tons of crude over the next decade, a deal that Russian Prime Minister Dmitry Medvedev valued at around $85 billion. In a touch of ominous irony, several hours later, news broke that Rosneft had cut its forecasts for the amount of oil a key field in Siberia is expected to produce, raising questions about Russia’s ability to feed China’s growing demand for crude.

Russia’s second-biggest natural gas producer, Novatek, also announced a deal to supply liquified natural gas (LNG) to China’s largest oil and gas company, CNPC, for the next 15 years. This all follows a 25-year deal signed in June between Rosneft and CNPC that will make China Russia’s largest market for oil.

So everyone’s happy, right? Not exactly. Conspicuously absent from the flurry of new deals was the thing that Russia actually wants the most: a long-term agreement to sell China natural gas through a dedicated pipeline. Gazprom, the world’s largest gas company and by far the biggest company in Russia, left Beijing empty handed, again. Though officials indicated progress was made toward a deal, it’s hard to say that Gazprom is all that much closer to achieving its Chinese pipe dream, something it’s been after for more than a decade.

“I can remember first hearing about this pipeline in 1997,” says Derek Scissors, an Asia scholar at the American Enterprise Institute. The sticking point appears to be the price that China is willing to pay, and the Chinese don’t seem to be budging. China can afford to be patient, while Russia is eager to lock in a price before the U.S. begins flooding the market with cheap LNG exports in the next few years. “I think the Chinese have the upper hand here,” says Scissors.

“The Russians probably need this more desperately than the Chinese,” says Erica Downs, a senior fellow at the Brookings Institution’s John L. Thornton China Center and a former energy analyst at the CIA. Downs says she’s more optimistic about the prospects for the gas pipeline than she was a few years ago, but “another round of talks with no breakthroughs continues to illustrate how big a stumbling block price is,” she says.

Steven Pfier, a Russia expert at Brookings and a former U.S. ambassador to Ukraine, says that Gazprom is becoming increasingly wary of the changes taking place around it in the global energy market. “I think Gazprom is nervous because they see all the unconventional gas production ramping up in the U.S.,” says Pifer.

Not only does Gazprom want to lock in China as a natural gas customer before the U.S. arrives on the scene, it is also worried about losing its grip on Europe, says Pifer. Europe gets about a quarter of its natural gas from Russia. Any competition the U.S. or the Persian Gulf might bring to Europe would certainly lower prices and probably cause Europe to think twice about its not-so-friendly reliance on Russia as its main supplier of natural gas. Russia cut off natural gas in 2006 and again in January 2009 over price disputes with Ukraine, just as Europe faced a wave of freezing temperatures. “Europe is certainly looking for alternatives,” says Pifer.

Making matters worse is that Russia is desperate to diversify its economy away from fossil fuels, a tough task considering that the energy sector makes up 20 percent to 30 percent of Russia’s economic output. This is precisely the dilemma my colleague Brian Bremner wrote about a couple months ago in a Bloomberg Businssweek cover story.

Of course, none of this is lost on the Chinese. Although China has its own problems, including a need to import cleaner-burning fuel, it seems in no hurry to rush into a deal for Russia’s gas if the price isn’t right. Says Downs: “What you have here are two countries notorious for being tough negotiators staring at each other across the table.” The question is, who blinks?

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