China Has Russia Over a Barrel

Chinese officials are notoriously tough negotiators, especially when they know you’re in a pinch. Just ask Gazprom, Russia’s natural gas giant, which is on the brink of capitulating to Beijing on a massive energy project, 10 years in the offing. Gazprom and China National Petroleum Corp., one of China’s oil giants, are gearing up to sign a 30-year multibillion-dollar deal to send natural gas from Russia to China through a colossal new pipeline network.

A week before Russian President Vladimir Putin was set to meet his Chinese counterpart, Xi Jinping, in Shanghai on May 20-21, Russia’s deputy energy minister described the deal as "98 percent ready." However, a Chinese deputy foreign minister was far cagier, noting in mid-May: "We are still exchanging views with Moscow, and we will try our best to ensure that this contract can be signed and witnessed by the two presidents."

On the surface, this seems the kind of win-win outcome that Chinese diplomats regularly tout as the solution to nearly every international problem. Russia sits on the world’s largest natural gas reserves, much of it buried in the Siberian hinterland north of its border with China. As the world’s largest energy consumer, China is an obvious partner for Russia’s economy, in which natural resources make up 70 percent of exports and over 50 percent of government revenue.

But energy trade between Russia and China is surprisingly limited, with only 9 percent of China’s oil imports and 1 percent of its gas imports coming from Russia. China is eager to increase and diversify its energy supplies away from overreliance on expensive  and volatile sources in Africa and the Middle East that have to pass through precarious sea lanes in the Strait of Hormuz and the South and East China seas. (Beijing really does worry about all the talk among U.S. strategists on how to blockade China’s energy supplies in the event of armed conflict.)

Yet China has been unwilling to pay the premium prices that Russia has traditionally charged in Europe. Now, with Russia’s worsening economy and an increasingly competitive Asian energy market, Beijing holds most of the cards — and time is not on Moscow’s side. Gazprom has little choice but to make what Chinese industry experts are calling a "big concession" on price. Although outlines of the deal are sketchy and may remain secret even after it is signed, China will reportedly help finance the related infrastructure, which could cost as much as $80 billion. This is reportedly in exchange for a price of $10-11 per cubic foot of gas: a rate below what Gazprom has long considered its break-even point of at least $12 per cubic foot. So it’s still a win-win — but a much bigger win for Beijing.

Why is Russia more eager to close a deal than China? It’s tempting to credit the Ukrainian crisis and the subsequent warming of geopolitical ties between Beijing and Moscow. After all, isn’t this all about Russia finally breaking with Europe and pursuing its fortunes in the East?

Hardly. The real precipitating factor is Russia’s economic free-fall, whose roots run far deeper than the protests in Kiev. According to the International Monetary Fund, Russia’s anemic economy is teetering on recession, projected to achieve only 0.2 percent growth this year, as the country confronts a corrosive mix of rampant corruption, stagnant growth, high inflation, and a shrinking population.

To dig out of this hole, Russia will need Chinese customers to supplement European consumption. If Putin manages to sign this deal, it will send 38 billion cubic meters of natural gas to China annually — less than a quarter of what Russia currently sells to Europe, but still a shot in the arm for Russian export earnings. It could also provide an additional boost for the Russian treasury by igniting broader development of untapped energy resources in Russia’s Far East. Furthermore, the proposed pipeline would be on a different grid from Russia’s gas infrastructure for Europe — in other words, Russia will not divert Europe-bound gas to China.

That’s not to say there aren’t clear benefits for China in doing the deal. Gas imports from Russia would support China’s goal of moving away from carbon-intensive fossil fuels like coal and petroleum that are substantially responsible for the orange haze that often blankets the skies above China’s megacities. On a bad day, breathing the air in Beijing is equivalent to smoking 21 cigarettes. And beyond the immediate environmental and health concerns, pollution is fast becoming a political issue that threatens the legitimacy of the Chinese Community Party. Gas imports provide a potentially promising path to resolve these economic and political headaches — and there’s substantial room to grow, as gas currently accounts for only about 5 percent of China’s energy needs. Domestic production won’t do the trick either: Major efforts to crack the shale gas code in China could eventually diversify gas supply, but serious water, infrastructure, regulatory, and financing challenges make that a long way off.

The major difference is that unlike Moscow, Beijing has options. With the shale gas revolution in full swing, the Asia-Pacific region is fast becoming a buyers’ market, as new producers from all over the world scramble to get in on the action. Gazprom will have to move quickly to lock in the infrastructure and financing commitments necessary for the Siberian pipeline project. Otherwise it risks being beaten to the Asian market by alternative suppliers in Central and Southeast Asia (which already have pipeline infrastructure to China) or by suppliers from North America, Australia, and East Africa that are working furiously to build gas liquefaction and export facilities that can deliver (literally) boatloads of gas to Asia. China is increasingly prepared to be on the receiving end of this boom, with nine existing import terminals and another five on the way. Seaborne cargoes from the United States could start arriving as early as 2015. If Russia doesn’t bend far enough on price, China could look elsewhere to meet its needs.

Even if Putin succeeds in signing up the Chinese to purchase Russian gas, there will be few reasons to pop the champagne in Moscow. This deal isn’t an escape hatch for a country whose relations in the West are quickly souring. Instead, it’s a virtual necessity in Russia’s desperate attempt to shore up its wobbly economy.