EAU Perspectives May 2014

Eurasian Union Perspectives May 2014

By Chucheng Feng Copyright 2014 Eurasian Union Institute 5/5/14

Energy Cooperation Between Russia and China: Prospects, Impediments, and Impacts to the Region

Overview of Sino-Russian Energy Cooperation

Russia is known for her abundance of oil and natural gas in Siberia and her Far Eastern Region; however, these resources have long been irrelevant to China, while the energy cooperation between these two countries did not appear to be significant until recent decades. On one hand, Sino-Russian relations were jeopardized in the mid-20th century; on the other hand, China in the late 20th century, though open to international markets as a result of Dengs economic reform and opening up, still shut the door to the soviets as Deng refused to negotiate for any further economic cooperation until they retreated from Afghanistan and no longer posed a threat to Chinas border. Meanwhile, the price of crude oil on the international market remained stable and relatively low consequentially, China saw no incentives to seek energy cooperation with USSR and its successor Russian Federation, though the latter saw energy cooperation with China as an alternative to stabilize and to recover its national economy.

Chinas energy policy experienced a rapid shift in the wake of 20th century and in the beginning of 21st century. First, Chinas reliance on oil and other natural resources increased dramatically as she wanted to sustain high-speed economic development with a double-digit annual increase in GDP. Second, the international oil price escalated greatly as a result of the unstable environment in Middle East as well as Chinas increasing demand. In this period, China began to be interested in Russias oil reserves along with their proximity and sought to accomplish some form of energy cooperation. Nevertheless, Russia in this period showed little interest in such cooperation with China as Russia was able to absorb much more money and Foreign Direct Investment (FDI) than it could in the initial years after the collapse of USSR because of the rise of international oil price.

China and Russia had long been unmatched on the intention of energy cooperation through most of the two decades after Chinas economic reform. However, the situation quickly shifted in the first decade of 21st century. China and Russia were able to sign the Treaty of Good-Neighborliness and Friendly Cooperation in July 2001, which marked a major milestone in the diplomatic relationship between the two countries. The signing of this friendship treaty opened the door for both sides to re-approach each other in many different fields, while energy



cooperation was without doubt a major focus of the discussion. Meanwhile, Russia and China, with the push of Vladimir Putin and Chinas President Hu Jintao, were able to propose a grand plan of energy cooperation which included the eventual construction of numerous pipelines, joint ventures in Far East energy sectors, and more. Russias energy cooperation with China was greatly accelerated after former President Medvedevs visit to China in 2008. Russia and China took the initiative in the same year to launch the China-Russia Energy Cooperation Commission, a vice-premier level bilateral negotiation mechanism aimed at eliminating obstacles of future cooperation between the two. Such acceleration was partially a result of the global economic meltdown when China became the powerhouse of world economic growth. More importantly the border issues between Russia and China, which had played the role as a disturbance for quite a while, were gradually settled. The energy cooperation between Russia and China, because of the occurrence of a series of internationally significant events, became strategically vital to both Russia and China.

Currently, the energy cooperation between Russia and China has reached an historic peak with an incredible scale. The ESPO Pipeline was opened for operation in January 2011, which was expected to export 15 million tons of oil to China per year with a term of 20 years. By the end of 2013 the petroleum export from Russia to China had already reached 40 million tons. During the same year, 2011, a memorandum of understanding was signed regarding the export of natural gas from Russia to China. According to the framework agreement Gazprom and PetroChina were to construct two major pipelines, the Altai Line and the Sakhalin-Khabarovsk-Vladivostok, both of which will be fully operational in 2018 bringing 38 million m3 of natural gas to China per year.

At the same time a comprehensive agreement was reached covering multiple energy/resource sectors. Russia agreed to; export 3 million tons of LPG to China per year for a term of 15 years, transmit electricity to China (which reached 2.6 billion kW*h in 2012), and joint development of oil and gas fields in Eastern Siberia of which Russia holds a 51% share.

Incentives of Sino-Russian Energy Cooperation

From a political perspective, the energy cooperation between Russia and China is a result of the stable political trust and diplomatic relationship between the two. Russia and China are the largest neighboring countries of each other; a promising and productive diplomatic relationship



between these two countries, thus, is of the best geopolitical strategic interests for both sides. Moreover, Russia and China had already developed a multi-dimensional cooperative mechanism on political sphere prior to developing their energy cooperation. Under the framework of the Shanghai Cooperation Organization (SCO) Russia, China, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan are capable of resolving regional security issues amongst themselves while providing military capability for regional stability. Meanwhile, cooperation between Russia and China on higher education, culture, and religion has brought huge progress in these areas for both countries. It is easy to see that energy cooperation is just a part of the huge package that Russia and China have been exchanging for several decades.

It is important to understand the significance of energy cooperation between Russia and China under the current set of geopolitical circumstances. Alongside Russias recovery after the collapse of USSR, we have seen the eastward march of European Union, NATO, and the United States towards Russia from the late 1990s to today. The European Union (EU), known as the European Communities at the time the USSR collapsed, was no more than an economic cooperative organization with only 15 member states at the end of 1990. However, within two decades the EU has permitted membership of another 12 states, of which many are former Republics of the USSR. At the same time NATO has extended its membership towards the East giving the United States the opportunity to increase her military presence in Eastern Europe with the deployment of a missile defense system during the initial years of 21st century. The expansion of EU and NATO, though not directly targeted at Russia, has in fact eliminated the traditional buffer zone between Russia and her historical opponents which has placed both sides into a security dilemma as Russia most likely sees the expansion of EU and NATO as a potential threat to its sovereignty and territorial integrity. Under these circumstances one of Russias considerations is to improve her partnership with China its important for Russia to further stabilize her eastern borders with China thus allowing her to maintain focus westward. In fact China proved to be valuable as a strategic partner during the 2008 Georgias War and the 2014 Crimea Crisis by backing Russia in the United Nations Security Council. Sanctions imposed by G7 in response to Russias annexation of Crimea have been somewhat diluted by Russia's relationship with China. It highly likely that Russia will seek further cooperation with China in the near future.

While cooperation with China has become an alternative for Russia to avoid direct confrontation with the Western powers, the cooperation is also strategically important to China.



The rise of China has been seen by some as a threat to the traditional world order as her revival has been associated with borderline disputes and maritime issues with many of the East Asian states and South East Asian countries. China currently has territorial disputes with South Korea, Japan, Vietnam, the Philippines, and several others. At the same time Taiwan remains a hotspot with a potential for conflict that could potentially put China into a position that is at odds with the United States. President Obama has announced his re-balancing strategy which includes an increase in US military presence in the Asian-Pacific region. Therefore, China needs Russias energy support as an alternative to the Malacca routes otherwise, China would face severe a energy shortage if a conflict were to take place in the South China Sea. In short, energy cooperation with Russia will make China less dependent on the Malacca route and possible blockade on the South China Sea.

Chinas steady economic growth also creates huge incentives for Russia to seek energy cooperation. China became the powerhouse of world economic growth after the 2008 global financial meltdown, as her annual GDP growth has been staying at a rate higher than 7%. Moreover, Chinas GDP surpassed that of Japan in 2010, which promoted China to be the second largest economy of the world. It is estimated that China will surpass the United States in GDP sometime between 2025 and 2030. In this case it would be foolish to neglect potential economic and energy cooperation with China. From Russia's perspective Chinas massive industrial and economic growth creates a huge demand for energy and natural resources. Russias economy, with heavy reliance on these exports, is now highly complementary to China's growth. It is in Russias best interest to cooperate with China for its own economic growth.

Impediments in the Future

Despite the incentives that will further promote the energy cooperation between Russia and China it is undeniable that several factors might possibly impede energy cooperation in the near future.

First, the positions of Russia and China in this arrangement are not equal: its foreseeable that the international price of energy will remain at a relatively high level while Chinas energy demands to sustain her economic growth will not diminish; therefore, China might be forced to look to both Russia and OPEC members for energy. China's continued energy demands will put Russia in a position of advantage. Russia as the seller and exporter has more options than China.



Europe has been Russias largest energy importer consuming more than 70% of Russia's energy exports; thus, the demand of energy, especially for natural gas in Europe, most likely will not decline in the near future, even taking the Ukraine crisis into consideration, giving Russia the upper hand with China.

Second, the domestic environment of Russia may become an impediment to energy cooperation with China. Russia has been known by some for inconsistency of her economic policy. While Russia is among the largest exporters of energy recently she is not particularly fond of FDI in some sectors. Foreign investment in the energy sector and other strategic industries is strictly prohibited by federal regulations. At the same time heavy tariffs and taxes are often imposed on foreign companies and investors. Local interest groups and various forms of influence can also play a significant role in Russias economy. All these factors can influence Russias cooperation with foreign countries including China.

Impacts to the Region

The energy cooperation between Russia and China will have several major impacts on the region:

First of all, the energy cooperation will greatly increase Russias foreign exchange earnings thus improve the federal governments fiscal and budgetary positions. As a result, Russia will be able to recover her national economy in a faster pace and to stabilize its society. While East Siberia and Far East regions of Russia have been ignored for economic development for a long time, the energy cooperation and the construction of pipelines across the region will bring job opportunities and economic prosperity to the local people; such prospects will largely eliminate the political unrest of the region while providing the federal government with and increased capability to deal with external concerns (i.e. territorial disputes in Far East region with Japan). Moreover, the development of energy cooperation will directly facilitate the local economic development, transportation, and utilities of the region these developments, other favorable policies, and government subsidies will help to integrate the Far East region and the disputed territories more into Russia.

Second, energy cooperation will bring China more options of stable energy supply, which will certainly be beneficial for China as diversifying its energy supply will secure Chinas strategic security that is required for the steady growth of Chinas domestic economy. Moreover,



securing the energy supply and maintaining the market price of energy in a relatively stable level will also positively affect the legitimacy of Chinas Communist Party, as popular survey has shown the correlation between living condition of the common Chinese people and the popularity of the central government of China.

Third, energy cooperation between Russia and China will present other regional players a good example of such cooperation. It is possible that Korea and Japan will join into the energy cooperation with Russia. This will help to stabilize the entire Northeast Asia while providing a chance for these countries to settle their territorial disputes with Russia; at the same time this will help Russia to integrate into the regional economy and energy market that were not traditionally a part of Russias grand plan. However, there is a risk that Russia could potentially dominate the regional energy market in which case stability would be reduced if major regional players were to be placed in a position of conflict over energy as Russia would be in a position to manipulate energy prices.

Chucheng Feng is a Fellow Member at the Eurasian Union Institute with a focus on Sino-Russian relations. Mr. Feng can be reached at [email protected]

The Eurasian Union Institute is a San Francisco Bay Area think tank focused exclusively on various types of commerce found in the Eurasian Union. Our focus allows us deliver high quality actionable information to businesses that seek entry or greater penetration into Eurasian Union markets.

Eurasian Union Perspectives is a periodic publication of the Eurasian Union Institute.

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EAU Perspectives May 2014

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