Thursday, May 22, 2014

China Has the Strong Hand in the Russian Gas Deal

Using energy resources, particularly natural gas, as an instrument of foreign policy and for restoring Russian hegemony won't work in the long run. The Russian economy rests on fragile demographic, market, human capital and social foundations.  Actually, the same could be said for China, but they have demonstrated a more flexible pragmatism than has the monomaniacal President Putin, and the Chinese hold the stronger hand in this energy deal with Russia.

Morena Skalamera's piece for the Geopolitics of Energy Project of Harvard's Belfer School is a good summary of the history leading up to this deal and its implications.

The Sino-Russian relationship dates back to the 1950s, when as Skalamera puts it, Russia viewed China as a younger brother to be assisted and guided, especially in the area of technology and nuclear development. With Khrushchev's renunciation of Stalin, Chairman Mao saw an opening for China to take the reins of the global Communist movement.  This was seen as overreaching, and the brothers fell out.  Their subsequent relationship has been distant and aloof, based on mutual suspicion that has continue to the present moment. The writer correctly points out Henry Kissinger's adroit interposition of the U.S. into the bilateral relationship, making it a strategic troika. Our gains have been meaningful over time, our mistakes legion, and our future leverage is significant.

Analyzing this particular natural gas deal without the historical political context leads to making this appear more significant than it really is.

As President Putin mentioned in one of his communiqu├ęs, Sino-Russian bilateral trade is some $90 billion, making China the single largest trading partner of Putin's Russia. The bilateral trade was some $6 billion in 2000.  Russia, by contrast, is China's ninth largest trading partner.  The composition of their bilateral trade is important to consider.  Russia exports raw materials, especially energy, while China exports finished consumer and industrial good to Russia.  

None of this is lost on the Chinese leadership, and they have very clear objectives for their ongoing economic relationships with the Russian energy sector, which go way beyond cutting checks for overpriced natural gas. 

China has massive liquid resources to invest, and they are looking for equity ownership in Russian energy companies, especially upstream.  Why?  Because, deep down the Chinese leadership is rightly suspicious about Russia's reliability as a secure source of supply for gas.  Where would they get this idea?  From President Putin's own statements and gleeful manipulation and strangulation of Ukraine.  

Russia and its oligarchs don't want anybody from outside the brotherhood getting under the covers at Gazprom or any other energy company.

According to the Harvard report, 30 billion cubic meters of natural gas are covered by the agreement, beginning in 2018 for a period of thirty years.  Nice, big round numbers, for sure.  The Chinese government certainly won't want any part of the great deal that Russia gave to the Ukraine.  As Skalamera's piece points out, natural gas is not a global commodity like oil, which can be priced globally as soon as it hits the water for transport.  Natural gas is a regional commodity, where pricing is clouded by the high fixed cost and indivisibilities of pipelines that can't be switched on and off, or have flows reversed for arbitrage. Beijing, the report says, has an eye on a price close to that of gas on the Kazakhstan-China border.  Russia tried to foist off a formula based on Henry Hub-driven indexes.  Billions in pipeline construction won't begin until the real meat and potatoes of this deal are consummated, and we are far from that.

Our shale bonanza has resulted in diverting gas from our relatively low consumption to LNG exports to Europe where it has driven prices down.  This has not beneficial to Russia.  Each dollar/BTU drop in natural gas prices in Europe costs Russia $4 billion in annual revenue, according to a Citibank report cited by the Harvard researchers. Further, Russia needs oil prices above $107/barrel in order to balance its internal finances, or in other words to keep oligarchs and restless people happy.

China has a very large, well drilled and equipped military, so Russia cannot have any leverage from threats, implied or real. Russia knows well that China could, in a pinch, have ambitions for the sparsely populated areas of Eastern Siberia.  Russia doesn't come into this energy "deal" with the kind of power it is exerting over an enfeebled Ukraine.

Look at this photo of the two leaders.  The gentleman on the left looks very calm, relaxed and understands exactly who and what he is dealing with. The gentleman on the right is thinking, "So what do I really have here besides a photo op?  Dealing with Obama was fun: this isn't."

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