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The Gordian Rail Tie: Russia’s Mythic Belt and Road Cooperation

 
 

Much like Bismarck’s Europe, Eurasia is a geographic expression rather than anything approaching a unified political or cultural space. That doesn’t stop China from adopting grandiose facades for its geopolitical aims with phrases like “community of common destiny.”

Rail connections lie at the heart of China’s attempts to redraw Eurasia’s trade map and help project the image of positive connectivity without any reference to the messy politics underneath the surface of the Belt and Road Initiative (BRI). Russia’s ability to weather the negative economic effects of its failure to reform, lower oil prices, and post-Crimea sanctions partially depend on taking part in BRI to attract infrastructure investment.

High-profile rail projects labeled “BRI” showcase the fact that Russia’s deepening relationship with China is not the complete embrace feared by many western observers. Russia’s railpolitick – its flailing attempts to logistically dominate the post-Soviet space – has become the art of praying for the impossible while struggling to pay for the necessary. BRI certainly dreams big.

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In late August, a working group from Russian Railways (RZD) and China Railway Corporation (CRC) released joint statements calling a proposed high-speed rail route from Berlin to Urumqi “promising.” The name of the route: Eurasia. The project is to be built between 2018 and 2026 and, according to estimates, has the potential to carry 36.9 million passengers and as much as 20 million tons in trade annually by 2050. Capital expenditures are estimated at nearly $118 billion in total, $62.5 billion of which would have to be spent on the Russian section of the route. Experts have serious doubts about the Eurasia megaproject. No work has been released assessing the route’s impact on neighboring rail systems or air traffic.

A high-speed line connecting Moscow to Kazan, part of the route, was first proposed in May 2013. The project was estimated to cost roughly $30 billion when it was included in RZD’s investment program. For 2017, the company set aside roughly $8 billion for new rail lines, repair, and related expenditures. Only about $113 million was set aside for construction on the Moscow-Kazan route. At the end of September, an RZD subsidiary issued a small $65,000 tender to study aerodynamics for the future construction of high-speed rolling stock. The Eurasia route is little more than a talking point. Just last week, RZD failed to reach a financing agreement for the Moscow-Kazan leg.

No Credit Where Credit is Due

China Development Bank (CDB) reportedly offered nearly $7 billion in debt financing over 20 years at a 4 percent annual interest rate for Moscow-Kazan. China also signaled willingness to commit over $900 million in capital stock for the stretch running from Moscow to Nizhny Novgorod and $1 billion to connect Nizhny Novgorod to Kazan. RZD felt that the interest rate was too high, sought more in financing, and a longer timeframe to pay it off.

For comparison, Rosneft managed to negotiate for $34 billion in loans from the CDB at an annual interest rate of 5.69 percent in 2009. Rosneft also approached China National Petroleum Corporation (CNPC) to help organize up to $30 billion in loans to finance its acquisition of TNK-BP and East Siberian oil and gas assets, but in the form of prepayments rather than loans. China’s energy security needs and the profitability of the oil industry help Rosneft pay off higher annual interest rates and reach prepayment deals to flexibly manage debt. RZD isn’t so lucky.

RZD’s net income was about $928 million for the first half of 2017 while spending $4.37 billion on investments. The only way it can afford to stake much money for the Eurasia route is debt. The company’s debt has grown from 606 billion rubles in 2013 to 1.025 trillion rubles this year (a bit over $17.8 billion at the current exchange rate). In September, RZD sold 6-year bonds worth 450 million Swiss Francs and is currently showing ruble-denominated Eurobonds to European investors. But there are too many other high-priority projects to ensure the money goes towards relevant projects.

RZD was looking to attract 30 percent of the necessary financing from the government as of July, an estimated $7 billion. Private investors and Chinese counterparts were supposed to make up the rest. Raising funds and reaching investment agreements have proven difficult for years. Given the commanding role the state plays in economy and such investments, there’s little attraction or profit for private capital without the government shouldering most of the cost.

The government allocated roughly $520 million for RZD’s infrastructure investments on top of the company’s own budget in April, a small infusion. A further $230 million were just allocated, mostly for projects around Moscow, a common problem as the capital’s economic heft sucks up resources needed elsewhere. RZD’s total authorized capital for necessary expenditures stands at about $38.5 billion under the current budget, far from the total needed for the Eurasia route or even the Moscow-Kazan leg with other priorities. In an unsurprising move, RZD just announced that it would instead build a line with help from private investors to Vladimir for roughly $8 billion total. After that’s completed, the proposed concession agreement could be extended to Kazan. These financing issues speak to the need for reforms and improved profits if RZD and the Kremlin are going to press forward with marquee BRI projects like the Eurasia route.

No Cure For Concessionaire’s Disease

Reforms will have considerable implications for RZD’s profitability and available capital to spend on these projects. There is no clear agreement between the different lobbies for structural reforms within the rail sector. RZD has lobbied for 2 percent investment surcharges increase on existing freight tariffs and surcharges as a means of raising capital to repair tracks and purchase newer locomotives manufactured in Russia for next year. Maxim Oreshkin and the Ministry of Economic Development have resisted further increases for a simple reason: it’ll raise costs for domestic freight and the economy relies heavily on the rail network.

A 1 percent surcharge increase that might also go towards rolling stock and locomotive purchases received tentative support in early August. But Russia’s Anti-Monopoly Service argued against expenditures on rolling stock, a prime example of the various deficits facing RZD as its rolling stock ages. Even when capital is raised, it remains unclear how it will be spent. The single biggest problem for China and Russia’s private investors are concession agreements for construction.

The Anti-Monopoly Service has argued for changes in regulations to allow tariff agreements to be set within individual concession agreements with private investors. At present, domestic and foreign investors suffer the whims of the Ministry of Transport, RZD, and whoever else happens to take interest in the project in Moscow. Unless investors can set terms under which they can profit, project profits will be based on construction and operation costs rather than viability, thus preserving state negotiating leverage. The Ministry of Economic Development — the most conservative reform lobby and most likely Putin’s favorite — made it clear at the end of September that this year’s surcharges are a one-off matter and are excluded in the Ministry’s tariff indexations through 2020. Concession reform is not publicly part of major reform blocs’ agendas either.

Brake Pipelines

RZD is also a victim of Russia’s successful oil export increases, namely to China. Oil cargoes accounted for 15 percent of the company’s freight revenues excluding the costs of shipping empty rolling stock in 2014 and 2015 and dropped 8 percent to roughly $5.26 billion last year. RZD discounted deliveries of 600,000 tons of oil to Finland 45 percent earlier this year and has adopted more widespread subsidies to compete with other forms of transport. Russia’s pipeline monopolist Transneft has not indexed its tariffs every year like RZD, making the country’s pipeline network more competitive. Rosneft new oil supply deals with Chinese firms and pipeline capacity expansions for the Eastern Siberia-Pacific Ocean pipeline aren’t helping.

Figures showing increased freight turnover driven by BRI reflect the tariff problem. Through April, freight turnover was up 7.3 percent for RZD. Transit container traffic is up 74 percent to 245,000 twenty-foot equivalent units (TEU) for the first three quarters of 2017. Imports are also up 52 percent to 394,200 TEU thus far this year. Sino-Russian trade is up 22.4 percent to $61.4 billion so far this year and the company has revised upward its projected usage of the Trans-Siberian and Baikal-Amur Line routes in the Far East for its investment plans through 2025. Yet with all of this, the company is not becoming more profitable. Container traffic from China makes little difference for RZD’s balance sheets. China’s coal imports are up but tariffs don’t net as much as oil, which is declining. RZD is planning tariff increases through 2025 but is limited by inflation and its too-big-to-be-profitable role in Russia’s economy. The potential privatization of 25 percent of the company’s shares would raise a huge amount of capital but has stalled.

Log(istic)ocentrism

Discourse surrounding China’s BRI has led many to suggest that Russia is increasingly comfortable accepting the status of junior partner in its strategic partnership with China. It’s quite easy to cite the various projects that have been touted and trade statistics in support of an evolving Sino-Russian bloc in some sense. But as Bismarck once quipped, agreements in principle signal a complete lack of willingness to act in practice. Fixation on BRI’s oratorical aspirations is reminiscent of linguistic logocentrism in its primacy of speech over the written word in the language of Belt and Road. The pretty words exchanged by Putin and Xi Jinping trace the startling lack of concrete agreements signed on building new projects. They speak to an absence, not a presence.

Evidence is mounting that public statements on Russia’s BRI cooperation are geopolitical signals rather than commitments of real policy for audiences in China. In late August, sources in the Ministry of Transport signaled that they were leaning towards ending cooperation due to lack of financial resources, project delays, and the increasing attraction of the Baku-Tbilisi-Kars (BTK) railway. China supports the BTK, a sore point for the Kremlin. Russia can’t attract the capital necessary to pay for BRI projects, is wasting its own resources pursuing them, and dislikes China’s growing logistical presence and perceived interference in its traditional sphere of influence. Whether it can do much about it is another matter.

Rosneft, the current centerpiece of China’s self-designated BRI presence in Russia, ironically threatens the political institutions necessary to carry out reforms that would make BRI possible in Russia. In the last decade, Rosneft has gotten tens of billions in loans, prepayments, and deals from Chinese firms. Pressure on Gazprom’s monopoly may foster competition for gas exports, but Putin has largely withdrawn from domestic elite disputes. Figures associated with the security services and Rosneft are more aggressive in using their own resources to achieve their aims. CEO Igor Sechin’s attack on former Economy Minister Aleksei Ulyukaev over his support of privatizing a majority of Rosneft’s shares proves that reformers must tread lightly. China’s indifference to the inner politics of its northern neighbor does not show brilliant foresight or adaptability in BRI’s implementation. Instead, it speaks to a lack of understanding affecting other potential areas of cooperation. The security and intelligence service cadre affiliated with Rosneft is likeliest to undermine relevant concessions reforms that would aid China in order to preserve Russian sovereignty.

It’s clear that little has come together on the ground despite closer Sino-Russian ties. But to suggest that these projects will get going in coming years is a mistake. That would require wholesale reforms unlikely as long as Putin is in power and Rosneft remains influential. Much like the glories of communism once promised by the Soviet Union and China, there is the rhetoric of Sino-Russian partnership and its really-existing truth. The two countries are not so close as they would like the West to believe. The penumbra cast by BRI helps obscure that fact as long as one ignores what they’ve actually put to paper.

Nicholas Trickett holds an M.A. in Eurasian studies through the European University at St. Petersburg with a focus on energy security and Russian foreign policy.

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