Xi’s Just That Into You

Just as President Barack Obama landed in China to try to salvage his vision of an American-led trading order in Asia, Russia and China took a giant step toward closer economic and political ties with an agreement on another massive energy deal that promises to tighten the bear hug between Moscow and Beijing for decades to come.

The preliminary accord, which comes just months after China and Russia inked a landmark, $400 billion natural gas deal, is a reflection of the shifting balance of power in Asia. It’s a marriage based on needs: Russia’s to break out of the isolation imposed by the West in the wake of its annexation of Crimea and China’s for reliable and affordable sources of energy.

Coupled with China’s economic offensive in Asia — which includes everything from new trade pacts with U.S. partners such as Australia and South Korea, to a push for Chinese-led development banks that can wrest financing muscle from the West — the latest gas deal shows what kind of challenges await the U.S. economic and diplomatic pivot to Asia.

"Whatever changes occur on the world arena, we will consider enhancing our cooperation as a priority area in our foreign policy," Chinese President Xi Jinping said in announcing the deal. Russian President Vladimir Putin said that the two countries acting in concert helps make the world "more stable and predictable."

At a time when the United States is pushing back against China on a host of fronts, "China would like to show openly that Sino-Russian energy cooperation is no longer driven by necessity but forms a core part of strengthened, strategic-level cooperation between the two countries," said Keun-Wook Paik, an associate fellow at Chatham House and an expert on China-Russia energy dealings.

On Sunday, Nov. 9, Russia and China signed a memorandum of understanding on a second gas-export route from western Siberia to China’s western provinces. The 30-year accord, if consummated, would see Russia ship 30 billion cubic meters of gas to China starting in 2018 and would see Russia gain a big new customer right as it is feeling the squeeze from Western financial sanctions. Together with the deal signed in May, Russia could supply at least 68 billion cubic meters of gas annually to China, or about one-fifth of that country’s expected gas demand in 2020.

The deal is far from complete. The two sides laid the groundwork over the weekend, but a host of unresolved issues remain, especially regarding the price China will pay for the gas. The first deal took more than a decade to hammer out and involved substantial concessions by Moscow on pricing.

This time, Moscow fears it will have to make even more concessions. Crude oil prices are falling; the Chinese gas contracts are linked to the price of oil, meaning they’re already worth less to Russia than just a few months ago. The prices paid under oil-linked contracts vary as crude oil’s value fluctuates: As oil gets cheaper, so too will Russia’s gas. Of course the inverse is also true.

At the same time, the new deal was always expected to be less lucrative than the eastern Power of Siberia pipeline because Russia will be shipping gas to China’s sparsely populated west. From there, China will have to ship the gas thousands of miles overland.

"Russian gas supplied by the western route should be cheaper than gas shipped by the Power of Siberia pipeline," said Mikhail Korchemkin, head of East European Gas Analysis, an energy consultancy. "The eastern pipeline delivers gas close to Harbin and other major consuming centers of northeastern China, while the western route crosses the border in the middle of nowhere."

Even so, Russia has been eagerly anticipating this second big deal ever since the ink dried on the first one in May. Moscow has long sought more energy trade with Asia but has intensified its drive east since the West slapped punishing sanctions on its energy, defense, and finance sectors in retribution for its aggression in Ukraine. Snagging another major contract with China would significantly offset its reliance on the European market and give Moscow a powerful ally when friends appear hard to come by. Gazprom boss Alexey Miller said that the new gas deals could eventually eclipse Russia’s gas trade with Europe.

"Moscow’s own Asian pivot was already underway before the crisis in relations with the West started, but I think that the crisis has made Russia more intent on securing deals, even unfavorable ones, with the Chinese to avoid the appearance of isolation," said Jeff Mankoff, deputy director of the Russia and Eurasia program at the Center for Strategic and International Studies.

A bigger question might be why China suddenly warmed to the deal. Even though Russian officials, including Putin, were bullish on the western gas route all year, Chinese leaders remained mostly mum. A host of factors seem to have changed China’s mind.

First, there’s the simple energy part of the deal: As China seeks to clean up its economy and reduce the importance of coal in its energy mix, it will need huge amounts of natural gas. While the country ramps up its own production and has gas-import deals with Central Asian countries and more than a dozen gas-importing terminals mushrooming on the coast, Russia’s massive gas fields offer a close and ready supply of clean fuel.

At the same time, big gas pipelines — whether from western or eastern Siberia — present a potentially safer option than seaborne shipments of liquefied gas. Chinese leaders have never been comfortable with the country’s growing dependence on seaborne energy imports, especially crude oil, because it exposes a critical vulnerability in a world still dominated by the might and reach of the U.S. Navy. Piped gas from Russia also dovetails with Moscow’s desire to edge out the prospects of American liquefied natural gas (LNG) exports to Asia.

"Well before the arrival of U.S. LNG to the Chinese market, Russia needs to carve out its pipeline gas market against U.S. LNG," Paik, of Chatham House, said. "China will be the battleground for the U.S. and Russian pivots to Asia policy."

More broadly, China’s push into Central Asia, including existing energy deals and the latest "Silk Road" economic drive, has raised tensions with Russia, which historically has viewed Central Asia as its stomping grounds. Signing another major contract with Moscow is a way to mollify it.

"Obviously Russia is going to occupy a fairly prominent position in any transcontinental infrastructure plans Beijing may have, so it makes sense to keep the Russians onside as much as possible," Mankoff said.