Crossroads Asia

The Reality of the Sino-Russian Oil Alliance

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Crossroads Asia

The Reality of the Sino-Russian Oil Alliance

Russia’s oil ties with China are deepening but markets, not politics, drive the evolving relationship.

The Reality of the Sino-Russian Oil Alliance
Credit: Russian Presidential Press and Information Service

As Moscow turns toward Asia’s oil markets, Russia’s growing dependence on China’s energy consumption draws a lot of attention. Often taken as evidence of a growing “oil alliance” or strategic partnership, the Sino-Russian energy relationship tends to be misrepresented. Analyses often mistake greater trade with greater trust. Economic facts on the ground complicate Russia’s political aims in finding a broader range of energy security partners as it seeks a bigger role as an energy security guarantor in Northeast Asia and the Asia-Pacific at large. Any political strategy using oil diplomacy lives and dies at the whim of market forces far beyond Russia’s control, a fact often lost in the never-ending chatter about Russia and China’s complicated relationship.

Trade deepens with China

Talk of a so-called Sino-Russian oil alliance or strategic partnership dates back to Rosneft’s landmark deal with CNPC in 2013, reportedly worth $270 billion over 25 years. But the political optics are an all-too-convenient cover to proffer concerns about Russia and China’s supposedly shared interests in disrupting the unipolar world built by the United States.

For one, Rosneft’s deal to send up to 600,000 barrels of oil daily by pipeline mirrored an agreement reached nearly a decade earlier by private firm Yukos, which Rosneft then hungrily devoured via legal blitzkrieg against Mikhail Khodorkovsky and his firm. Yukos was not negotiating with its Chinese counterparts on the basis of Russia’s strategic interests and its original pipeline proposal morphed into the Eastern Siberia-Pacific Ocean (ESPO) pipeline running to Vladivostok. Much lobbying from Japan, the promise of more flexible Asia-Pacific oil exports, and those in the Kremlin who preferred to avoid tying Russia’s regional oil fortunes to China alone won out, though Russia-China pipelines were still built as spurs of the larger ESPO system.

Rosneft’s artful maneuvering with Chinese partners — the company has taken tens of billions from CNPC and others to pay off debts without major concessions, has used Indian partners as counterbalance, and sells China natural gas assets to irritate Gazprom — has not stunted momentum in deepening oil trade between the two countries. CNPC began construction of an expansion of pipeline capacity from ESPO to the old oil town of Daqing last August per the 2013 supply deal. China’s crude imports from Russia have also been growing, evidenced by the fact that Russia overtook Saudi Arabia and supplied China with an average of 1.05 million barrels per day in 2016. ESPO plays a key role in that change.

Back in 2011, only 8 percent of ESPO oil went to China, dwarfed by the collective 75 percent bought by Japan, South Korea, and the United States. China bought nearly 70 percent of all oil traded through the ESPO port of Kozmino last year, roughly 445,000 barrels a day. Japan and South Korea — Russia’s preferred regional trade partners to balance China — have reduced their take of Russian oil, finding crude supplies from Iran and Saudi Arabia more attractive. These trends fit into broader regional dynamics Russia must negotiate if it wants to use its oil wealth as an instrument of foreign policy in the Asia-Pacific.

Changes on the Chinese market

China faces a production problem: its largest fields are maturing and expensive to maintain, low oil prices are hurting investment and accelerating production decline, and its oil demand is going to keep growing. Recognizing this reality, Beijing began giving licenses to independent “teapot” refineries in 2015 to ease along market reforms that would make China’s state-owned oil firms more competitive. Teapots contributed over 90 percent of China’s import growth in 2016, a trend that will likely continue.

Paired, these developments create more flexibility for Russia’s non-state owned firms to compete, create greater flexibility for Chinese firms to trade oil outside of long-term supply contracts, and make rising Russian oil imports a necessity distinct from discussion of China’s “Malacca Dilemma,” the pressing security concern that reliance on imports traveling through sea routes patrolled by rival powers’ navies could pose an existential threat in a time of crisis.

In January, Rosneft and CNPC concluded agreements on a feasibility study for a refinery in Tianjin that will be built to refine ESPO blend crude oil, guiding future production growth towards the Chinese market. But the agreement was a pragmatic choice for the Russian oil giant, not one borne out of political partnership when one considers the regional picture.

Russia and the Asia-Pacific oil market

Historically, Russia’s ESPO blend has struggled to find its footing in Asia. But changes in China’s environmental policies call for low-sulfur crude oils such as ESPO, Sokol, and Russia’s Far Eastern blends. Rosneft has also closed a similar refinery agreement with Indonesia’s national oil company Pertamina called Tuban, with an eye towards letting Pertamina take stakes in Far Eastern oil projects that would feed the refinery. Russia has seen greater openings for its oil blends since the OPEC cuts took effect across Asian markets but it remains unclear if an end to the cuts would choke off these newer gains.

The region’s production will also affect the viability of Russian trades. Mackenzie Wood projects the Asia-Pacific’s oil production to decline a million barrels a day by 2020, led by developments in China. But low oil prices have hurt production in Indonesia, Vietnam, Thailand, and anywhere else where shallow or deepwater offshore projects require higher prices to stay profitable. Rosneft may be seeking to aid Vietnam in developing its oil reserves in the South China Sea but it can’t yet turn a profit doing so, particularly since most fields in the Asia-Pacific are small or medium-sized. The infrastructure needed to service a small field is not much different from a giant field, making relative development costs higher. On the whole, low prices are exacerbating the Asia-Pacific’s dependence on imports by strangling investment in production.

Rosneft’s acquisition of the Vadinar port in India will allow for new oil flows from the Russian east. Indian importers have also been buying more of Russia’s Ural blend, usually reserved for European markets, since the OPEC cuts took effect. The trades came as a surprise, but fit into a new wrinkle in the region that comes with promise and pitfalls for Russia. The United States and Brazil are now exporting more oil to China and other Asian markets, denting the effect of the OPEC cuts. The announced cuts led to a scramble for oil tankers to ensure companies accessed markets, pushing oil freight rates up. Since then, production increases elsewhere, declining Chinese production, and uncertainty on the use of the OPEC cuts have kept freight rates lower, making oil from the Americas and Russia more competitive on markets that historically have not been accessible. A proposed consumption tax in China on certain petroleum products may also hit tanker demand, preventing much in the way of a rate rise and possibly giving Russia and others a longer window to capture a share of newer markets.

Even with Russia’s greater direct access, the United States seems better positioned to more quickly increase its production than Russia given greater flexibility, innovation, and access to credit for American firms. Russia’s oil diplomacy in China may have a political dimension but is an absolute necessity for a country in need of oil and gas money, one now coming into greater conflict with the United States’ increasing profile as an exporter.

Emerging markets have consumed more oil than developed economies for four years now and Europe, Russia’s energy cash cow, is not the wave of the future for oil. In 2015, Russia already sold about 32 percent of its oil to non-European markets. That balance will likely tilt more as Russia’s production moves east, driven most by China by dint of its sheer size, needs, and import insecurities rather than political partnership. However, the unforeseen opening of Asia to Atlantic oil means that the neighborhood is growing more crowded. Saudi Arabia is also proving more willing and assertive in approaching Asian partners. As Rosneft and other Russian firms try to lock in deals in China, it’s time to retire the trope of a Sino-Russian oil alliance. The two are stuck together, whether they like it or not, and it’s not clear they much like it.

Nicholas Trickett currently works at a think tank in Washington D.C. He is finishing an M.A. in Eurasian studies through the European University at St. Petersburg with a focus on energy security and Russian foreign policy.