Russia and China: Old Comrades in Arms New Comrades in Oil and Gas

Published Sep 7, 2011 12:42 PM by The Maritime Executive

No matter how the two countries have diverged in recent decades, China returns to Russia like an old lover that can still perform a vital function.

By Michael J. Economides

It was in mid-June that Chinese President Hu Jintao took his annual pilgrimage to Russia to seek oil and gas. In Moscow Hu talked about “trade” between the two nations growing from $55 billion in 2010 to $100 billion by 2015 and $200 billion by 2020. He did not beat around the bush. It was all going to be “energy.” And since China does not have any surplus energy to export, it was clear what he wanted: imports of Russian oil and gas.

What a difference twenty years can make to two communist countries!

The Back Story

In 1991 Russia and China were reeling from traumatic changes. Russia had suffered a humiliating economic failure in the 1980s after the collapse of oil prices, facilitated by the “encouragement” of U.S. President Ronald Reagan to Saudi Arabia to flood the market with crude. China, on the other hand, was trying to recover from the even more devastating after-effects of the insanity of the Cultural Revolution.

For more than forty years previous, almost thirty of them under the iron hand of Mao Zedong, China looked to Russia as the source of not just ideology but also technology, training, and all manner of doing things. It may appear preposterous today, but China at the time looked up to Russia even as it often wanted to go it alone, be even more revolutionary and proletariat, and destroy everything that resembled other political or social systems. Invariably such notions backfired, sometimes with appalling consequences, such as the starvation of millions.

In 1991 Mikhail Gorbachev was presiding over the dissolution of the Soviet Union with the Cold War all but over. It was a tough time for the former principal rival of the U.S. for world domination, which viewed its own disintegration as akin to a being losing limbs and body parts in gory living color. In just a couple of years the Russian Federation, the biggest Soviet Republic, suffered a fifty percent decline in both its gross domestic product (GDP) and its much-ballyhooed industrial output. Gorbachev, who made household words out of glasnost and perestroika and was adored by the West because of them but reviled for exactly the same reason by his own people, went away to TV land in 1993. Meanwhile, China was thriving with double-digit growth rates, the result of reforms put forth by Deng Xiaoping more than a decade earlier. Those reforms, which made a mockery of the common view of a communist system, had and are still having nation-shaping effects.

Boris Yeltsin replaced Gorbachev and in 1991 was elected the first President of the newly constituted Russian Federation. He ran the country, if that’s the right expression, with slightly less control than was present in the American Wild West more than a century earlier. Privatization at far lower than fire sale prices, mainly of natural resources, spawned an oligarchy that continues to dominate Russian society even today and a corrupt system that, according to Transparency International, puts Russia somewhere between Indonesia and Nigeria on the list of most corrupt nations, very much like Robert Mugabe’s Zimbabwe.

Following Yeltsin’s resignation in 1999, Vladimir Putin was elected President. Along with him came the siloviki, a fraternity of security agency apparatchiks who, according to some estimates, account for over sixty percent of the key positions in the Russian government. In 2001 then-U.S. President George W. Bush looked Putin “in the eyes” and sensed a "remarkable leader," an "honest, straightforward man . . . who loves his family." I wrote at the time that “I looked Putin in the eyes and saw KGB” – something repeated since then by U.S. politicians without attribution. But hey, it’s only a sound bite, right?

It took Putin almost no time to realize two things: First, Russians love power more than money; and second, energy resources like oil and gas are the only means to accomplish international hegemony. By 2004 he had taken over everything, his most striking action being against the nation’s largest oil company, Yukos, and its owner, Mikhail Khodorkovsky, in what Putin’s own economic advisor, Andrei Ilarionov, called the “swindle of the century.” Khodorkovsky still rots in a Siberian prison, an horrific example of Putin’s abuse of power and a blatantly dependent Russian judiciary.

“Energy Imperialism”

What Brezhnev and Khrushchev were unable to do with nuclear weapons, Putin accomplished with oil and gas in what arguably can be termed “energy imperialism.”

The dependence of Russia’s power on its massive oil and gas reserves is well documented and often portrayed by the Russians themselves as both a blessing and a curse. As much as 50 percent of Russia’s GDP depends on the upstream oil and gas sector. According to a 2010 World Bank study, “The magnitude of the Russian economy’s reliance on the oil and gas sector continues to be so large that the country’s economic health is likely to depend heavily on the movement of world oil prices rather than on its achievements in the field of technology and the competitiveness of its goods and services in the international market.”

In terms of oil development, Russia is a wildly successful story. Since Putin’s ascendency in 1999, Russian oil production has grown from about six million to ten million barrels a day and eclipsed Saudi Arabia as the world’s largest producer. With relatively stable domestic consumption of just under three million barrels per day, Russia is able to export the remaining seven million, of which four million is in the form of products such as gasoline. At current prices the value of Russia’s oil exports alone is roughly $250 billion or about twelve percent of GDP.

Russian oil is huge, but natural gas may eventually prove to be even bigger. To begin with, Russia owns the most imposing proven reserves in the world, almost 1,700 Tcf, not counting any gas above the Arctic Circle. It produces about 19.5 Tcf of natural gas annually, second only to the recently-buoyed-by-shale-gas U.S. production of 21 Tcf. But Russia exports 7.3 Tcf of gas, the most in the world by far, and almost all of it to Europe, a continent uneasily and deeply dependent on Russian energy.

Some, even old Russia hands (perhaps more so), have to be reminded that Russia has had a new President since 2008 in Dmitry Medvedev, although the ubiquitous Putin is still the man to be reckoned with – a force barely beneath the surface, constantly mentioned as the real puppet master manipulating the strings of power, just a nod away from being reelected President in 2012. Not that the trimmings of power with energy wealth and control have ever gone away. The last time around Medvedev, who was Chairman of Gazprom, the massive gas monopoly, became President while Putin became Prime Minister and the former Prime Minister, Victor Zubkov, became Chairman of Gazprom. Musical chairs at its finest!

In the meantime, China’s growth has been nothing short of breathtaking. What can be said of a country that has emerged as by far the world’s largest trading nation and whose growth showed double-digit increases in twelve of the last twenty years? The lowest figure was in 1991 (7.6 percent!) and the highest in two very diverse years (14.2 percent in 1992 and 2007), bringing China’s nominal GDP from $409 billion in 1991 to $5.9 trillion in 2010 and making it the second largest in the world, behind only the U.S. at almost $15 trillion.

Russia ranks way behind at number seven with a GDP of $2.2 trillion, between the UK and Brazil. It is an amazing turnaround of events between the two former pillars of the communist world. In 1991 Russia’s GDP was over $500 billion, larger than China’s. China has since then become nearly fifteen times bigger and almost three times the size of Russia.

A Marriage Made in Heaven?

Russia views the Far East and, of course, China, as a necessary outlet for its oil exports. The Eastern Siberia-Pacific Ocean (ESPO) pipeline has been functional since September 2010 with a capacity of 600,000 barrels per day (1,491 miles on line). At full eventual capacity this pipeline will transport 1.6 million barrels per day and be approximately 2,610 miles long.

Despite its established and insatiable appetite for oil, China will be even hungrier for Russian natural gas. The Chinese today use about 4.1 Tcf of natural gas a year, of which more than 86 percent is produced domestically and 14 percent is imported as LNG (about 452 Bcf) or via pipelines (about 125 Bcf). Natural gas represents about four percent of total Chinese energy demand as coal provides more than 70 percent. This kind of energy mix, with all the resulting horrible environmental impacts, has not been seen in the developed world since the nineteenth century. The Chinese government has already decreed that by 2020 the natural gas component of its energy mix should grow to 10 percent. Depending on whose estimate of total Chinese energy demand by 2020 you use, the new share would translate to between 10.6 Tcf and 12 Tcf of natural gas annually.

Only Russia has the kind of reserves needed to play any meaningful role in such massive demand. Of course the Russians know this all too well and are coy about it. They know the Chinese needs, especially for gas. And that is why Putin told Hu that “If a new gas deal can be reached, this would significantly promote cooperation between the two countries.” What he meant was he knows what China wants and what Russia has. If the price is right, pipelines can be built and gas will flow. Because energy is so critical to China’s future, it’s apparent to this observer that Russia currently holds most of the cards in this fascinating game of politico-economic poker. – MarEx

Michael Economides is a professor at the University of Houston and Editor-in-Chief of The Energy Tribune.