China Has Decided Russia Is Too Risky an Investment

The economics of a major oil deal seemed to make sense. But when energy companies are arms of the state, economics aren't the only factor.

Chinese President Xi Jinping and Russian President Vladimir Putin at the West Lake State Guest House on Sept. 4, 2016 in Hangzhou, China. (Wang Zhou - Pool/Getty Images)
Chinese President Xi Jinping and Russian President Vladimir Putin at the West Lake State Guest House on Sept. 4, 2016 in Hangzhou, China. (Wang Zhou - Pool/Getty Images)

On May 4, the planned investment by the Chinese company CEFC China Energy into Russian state oil giant Rosneft fell apart, eight months after it was first announced. The tie-up’s failure reveals the strict limits on the potential for energy cooperation between China — which is in the process of taking ownership of CEFC — and Russia, and with it a broader political alliance between the two countries.

Beijing has come to view Rosneft more as a tool of the Russian state than a traditional oil company, and to the extent the two countries don’t share political priorities, China has little interest in any significant economic relationship. Although China is actively searching for new political and economic partners around the world, it seems to have decided the Russian government is too risky a political investment.

Rosneft makes little effort to disguise its political motivations and its status as a major domestic political player throughout the Vladimir Putin era. When Yukos, then Russia’s largest oil company, was seized in 2004 following oligarch Mikhail Khodorkovsky’s fall from grace, its assets were ultimately transferred to Rosneft. Rosneft subsequently controlled 16 percent of domestic oil production. Today, the firm claims to produce about 40 percent of Russia’s oil output.

Since Igor Sechin was named its CEO in May 2012, Rosneft has increasingly become a foreign-policy instrument. Sechin had previously overseen energy policy in his role as vice premier of Russia, and he foreshadowed his future plans for Rosneft in negotiating with BP over its Russian operations and by personally taking a leading role in developing Russian-Venezuelan cooperation. Within a year of being named Rosneft CEO, Sechin oversaw the purchase of BP’s Russian operations, resulting in the British oil major taking a 19.75 percent stake in Rosneft itself. Sechin was feted in London, and many in Moscow saw the deal as a way to align Russian and Western interests.

Just one year later, Sechin found himself on Western sanctions lists as relations between Russia and the West soured following Moscow’s annexation of Crimea and invasion of Ukraine. That same geopolitical shift brought Russia closer to China. President Vladimir Putin famously traveled to China in May 2014, when he reportedly agreed to Chinese pricing demands on a 30-year gas export agreement.

Russia’s shifting geopolitics coincided with Chinese President Xi Jinping’s launch of the Belt and Road Initiative to invest in and develop trade with dozens of countries, using China’s economic pull to enhance its influence and deepen political ties. Rosneft, which had recently agreed to double deliveries to China in one of the oil market’s largest-ever deals, seemed poised to benefit. Meanwhile, the previously little-known CEFC was launching its own foray into global markets, seemingly taking its cues from Beijing.

Subsequent events attest that CEFC was following the Belt and Road playbook of investing in locations that are strategically significant for the Chinese state. CEFC’s first major foreign efforts came through its heavy investments into the Czech Republic. The company’s founder, Ye Jianming, was even named an advisor to Czech President Milos Zeman, who in 2015 was actively seeking to boost relations with Beijing. Ye was essentially borrowing from Rosneft’s playbook. Chinese state holding company CITIC then agreed to buy in to CEFC’s Czech assets, though these are far removed from its core business.

CEFC also appeared to be executing Beijing’s foreign-policy aims through another blockbuster deal when in May 2016 it agreed to buy 51 percent of KMG International — a subsidiary of Kazakhstan’s state energy giant, KazMunayGas. The deal was seen as crucial for Kazakhstan, where Xi had launched the Belt and Road program, and which was suffering from its own economic slowdown. CITIC is reportedly considering buying in to its stake in Abu Dhabi’s onshore oil concession as well, in which the state-owned China National Petroleum Corp. is already invested.

All this raises the question of why the investment into Rosneft — although professedly also in the spirit of Belt and Road — has now been allowed to collapse. When the $9.1 billion deal was announced in September 2017, it appeared to be a new crest in the burgeoning Russian-Chinese energy partnership. Much coverage of CEFC since Ye’s detention in late February and speculation into CEFC’s downfall has focused on the significant debts the company amassed. CEFC’s debts may have been cumbersome, but Russia’s state-owned VTB offered to provide much of the financing for the tie-up, though Beijing could easily have done so as well.

Beijing was also clearly willing to deepen its oil ties with Moscow — in 2016, Russia displaced Saudi Arabia as China’s main oil supplier, with the lion’s share being delivered by Rosneft. Just days before the deal’s cancellation, it was reported that a separate five-year supply contract between Rosneft and CEFC, agreed last November, was being adjusted but would continue. However, a direct CEFC investment into Rosneft proved a bridge too far.

Rosneft’s geopolitical machinations ultimately are to blame for the CEFC deal’s collapse. Sechin has allowed Rosneft’s debt to balloon as it seeks to counteract the cost of U.S. sanctions, continuing his mission of prioritizing potential geopolitical reward over financial risk.

While Beijing’s willingness to continue financing the Venezuelan regime appears to have been exhausted, Rosneft has only doubled down. Just last September, Rosneft agreed to make multibillion-dollar loans to Iraqi Kurdistan, less than a month before its independence referendum. Conversely, China has avoided overtly involving itself in Iraq’s internal squabbles. Furthermore, Rosneft’s effective takeover of India’s Essar Oil, finalized last June, allies the oil giant with New Delhi. This may ultimately provide geopolitical rewards to Moscow, and CEFC’s stake would likely not have been sufficient to influence Russian decision-making with regards to one of Beijing’s main rivals.

The cost of Rosneft’s geopolitical machinations has often been borne by its partners. Its shareholders have failed to see returns comparable to other oil firms, even those also concentrated in Russia, amid the oil-price recovery. Last month, BP CEO Bob Dudley joked that he would have advised a younger version of himself to avoid Russia, though his firm is very much still invested in Rosneft. Beijing appears to have heeded that warning.

Nine years after Igor Sechin launched the first bilateral commission on Russian-Chinese energy cooperation, his machinations have demonstrated that cooperation’s limit. While China and Russia now describe their relationship as “strategic partners,” the collapse of the CEFC tie-up demonstrates that this is still some way off from an alliance.