Russia’s Rosneft had already suspended drilling for a block of gas finds in Vietnam’s offshore, but has now officially cut its contract with Noble Corporation for cooperation in operations in Vietnam. Mounting political pressure from China forced the company to beg off the project, just as it drove the Vietnamese government to compensate other firms – notably excluding Rosneft – also forced to cancel operations due to Chinese pressure. The episode highlights a growing challenge for multinational Russian companies trying to expand their footprint across Asia: They can’t anger Beijing too much because of the size of China’s power to structurally shape economic relationships as tensions with the United States and broader West escalate.
To be clear, the case of Rosneft in Vietnam is in many respects exceptional. Few Russian companies operate with fixed assets like oil or gas fields located in places contested by Chinese territorial claims, nor are most in sectors as politically sensitive as oil and gas. But Rosneft is China’s single largest trade partner in Russia. It holds long-term contracts with China National Petroleum Corporation (CNPC) and CEFC China Energy, closed prior to COVID-19, to export over 1.1 million barrels of crude oil a day, with further volumes sold via the company’s trading arm. Despite Beijing cooling off on the company and rejecting taking a large equity stake due to its poor returns for shareholders and political risks, Rosneft remains an integral player in Sino-Russian economic ties and an interesting case to consider for the future arc of Russia’s relationship with China.
In Search of Friends
In the wake of sanctions and the 2014-2015 oil shock, Rosneft shifted its business strategy to leverage debt and try and find opportunities and partners beyond the reach of the existing sanctions regime led by the United States. That included courting all possible players in Asia, especially as the firm looked to replace Western service providers with Asian counterparts to preserve the possibility of future investments on the Arctic shelf otherwise too technically demanding to be undertaken without support. Vietnam was crucial in this pursuit because Rosneft could contract Japanese and Korean firms – in this specific case, Japan Drilling Co. – for offshore operations and establish relationships for further investments. Neither Japan nor South Korea applied the same level of sanctions pressure on Russia, offering Russian firms some flexibility in fostering competition between different Asian oil and gas service providers for domestic projects and options in partnering up for international ones.
Rosneft has made China its strategic priority market for most of the last decade. By 2018, Asia had overtaken Europe as the company’s main export market, the vast majority of which are sales to China. That dynamic is more pronounced now as a result of COVID-19. Oil demand in China has outpaced that of other leading economies, and the country’s imports hit record highs of over 11.3 million bpd in June, supported by low prices. Oil demand in India – an emerging market for Rosneft – is hovering close to levels last seen in 2015 and European oil demand recovery has flatlined as new bouts of infections appear and economic growth prospects remain dim. Despite continued weakness among Chinese consumers, aggravated by state policy privileging supply side measures to stimulate the economy, oil demand is set to return to growth in China in a manner it isn’t in Europe. Rosneft is hostage to this reality unless it wants to diversify into renewables and other sectors like BP, Total, and similar oil majors.
You’ve Got the Silver
Last November, Rosneft decided to price all of its supply contracts in euros instead of dollars in order to reduce its exposure to U.S. sanctions and economic reach. Less than half of Sino-Russian trade is now denominated in U.S. dollars, with over 30 percent now denominated in euros – a larger share than the ruble and renminbi (RMB) combined. The increase year-on-year parallels Rosneft’s announcement, and speaks to Russia’s deepening dependence on China to manage its currency reserves. The Central Bank of Russia has also reduced Russia’s dollar exposure, setting a target of 15 percent of its reserves to be held in RMB. The decision has cost Russia billions from exchange rate movements, and strengthened the impact of movements in the value of the RMB – no longer linked to the U.S. dollar – on ruble exchange rates. These twin trends mean that China’s banks and companies are increasingly important for Russian firms and the Russian Central Bank in managing the accumulation of non-dollar reserves. China’s policy actions affect Russian companies’ currency risks, which affect just about every part of any business’ balance sheet.
U.S. sanctions pressures loom large in this dynamic. Russian firms have run up against the problem that few firms across Asia want to risk U.S. sanctions, limiting opportunities to expand out of traditional trade sectors like oil, gas, agricultural commodities, and fish to industrial components and systems. President of the Philippines Rodrigo Duterte personally met with Rosneft CEO Igor Sechin and invited the company to explore offshore claims contested by Vietnam. Two weeks later, the head of the national oil firm PNOC-EC was fired for reportedly “prematurely” approving a deal with Rosneft. Presumably a mix of pressure and concern about Beijing’s reaction, potential action from the United States, or a combination prompted the about-face.
Russia’s potential partners across Asia have to watch China’s reactions closely, just as Beijing and other capitals in the Asia-Pacific have to read and react to Washington. In February, the U.S. Treasury sanctioned Rosneft’s trading arm in Geneva for concealing oil trading activities with Venezuela. Chinese refining giant Sinochem immediately decided to exclude Rosneft’s crude from its tenders, fearing the potential widening of sanctions on the company as political tensions with the United States steadily rise. Rosneft scrambled to find a solution, spinning off its Venezuelan assets and setting up a new trading arm not covered by the existing sanction. Even state-owned Chinese banks in Hong Kong are complying with U.S. sanctions on Hong Kong officials in order to preserve their access to U.S. dollar funding. The reality is that the twin pressures of Chinese and U.S. policy are effectively closing off alternatives for close business ties to China in the Asia-Pacific.
Let the Dollar Circulate
The net effect over time is that Russian firms face a landscape in which they’ll have to operate more frequently through Chinese financial networks in Asia if other countries aren’t willing to risk angering Washington. India is a potential exception given its relative economic weight, but in practice, the limited competitiveness of Russian firms outside of a few sectors – namely defense, energy, and in some cases infrastructure – and India’s limited financial footprint abroad make it a weak counterweight. China’s economic weight exerts a substantial gravity across the region that even a firm like Rosneft, with its considerable leverage as an energy security guarantor, can’t break.
As China further liberalizes capital controls and encourages investment into onshore financial markets, Russian investors are bound to come hunting for yield on their money. Expanded trade ties will, eventually, lead to expanded financial ties, even if that doesn’t take the form of direct investment into projects. The more options Russian firms and investors have in finding value in China’s financials system, the likelier they are to be drawn in as the Chinese government appears ready and willing to use its diplomatic and economic power to browbeat countries and firms away from projects it doesn’t like. Oil and gas have their own peculiar challenges and issues, but the message China’s treatment of Rosneft sends is clear: Russia Inc. is going to have to toe the line when Beijing pleases as competition and pressure with the United States and West ramp up.
Nick Trickett is a political risk analyst and writer with a focus on the intersection of trade, energy, and monetary politics with political economy and foreign policy in Russia and Eurasia. He holds an MA in Russia/Eurasia studies from the European University in St. Petersburg and an MSc in international political economy from the London School of Economics.