The Global Financial Crisis Is Bound to Force Russia to Kick Its Raw Material Addiction
In April of this year Russia and China signed an intergovernmental agreement on oil cooperation, which includes pipeline construction, export of Russian oil to China, and Chinese loans to Russia. Even though the deal is widely praised by the Chinese and Russian authorities as an example of long-awaited strategic cooperation in the energy sector that benefits both countries equally, the agreement appears to be creating a “dependency” pattern for Russia, which is at risk of being permanently typecast as a raw material exporter.
In international political economy, the dependency theory, which originated in the 1950s and describes the relationships between the developed and developing countries as the former taking advantage of the latter, is now out of fashion. However, China appears to be taking on the role of the “exploiter” of natural resources needed to feed its economic growth, and this turn of events is ironic: further changes in the structure of international relations now seem imminent.
According to the much-touted agreement, China and Russia will jointly build and operate a pipeline that will connect Skovorodino, a city in Siberia, to Daqing in China, via Mohe, a Chinese city located on the border with Russia. The Russian section of the pipeline will be 64 kilometers long, while the Chinese portion will extend through 965 kilometers. The pipeline is planned to go into operation in 2011, and will have an annual throughput capacity of 15 million tons of crude oil. The China Development Bank will provide $15 billion in loans to the Russian oil company Rosneft, and $10 billion to the pipeline operator Transneft, at an estimated annual interest rate averaging 5.69 percent. This interest rate will be based on the London Interbank Offered Rate (LIBOR) interest rate index plus an agreed-upon margin. In exchange, Moscow will supply 15 million tons of oil every year, or about 300,000 barrels a day, to Beijing over a period of 20 years, in essence locking in at least five percent of its oil exports.
In July the Russian President Medvedev announced that the oil-for-loans agreement would be worth $100 billion. This statement immediately spurred speculation on the formation of the price of oil in the agreement. Most analysts came to the conclusion that the oil would be sold at a discount. Even though the price formula for oil is usually based on the market price on the day of delivery, there are many ways to manipulate the price downward by including the discount, amortization costs (for the pipeline), or any other conditions and ceilings into the formula. The press release issued by Rosneft discussing the details of the agreement states that the price would be determined on a monthly basis by the market price at the moment of delivery to the oil terminal in Kozmino, or to the ports of Primorsk and Novorossiysk. The estimated oil price at the time of signing was $50 per barrel. The exact formula determining the price of oil in the sale contract was not disclosed.
For a decade, Russia and China have been talking about a cross-border oil pipeline without much success, until now. Among Russian oil exporters, the Chinese buyers had a reputation of avid bargainers who would challenge the terms of the contract even after the contract gets signed. The Chinese are also known for their patience, and it now seems that their patience has paid off. Before the financial crisis Russian oil was in high demand, Russian oil companies could obtain credits easily, and an entire successful year (2007) caused the pessimists who did not believe in rapid economic growth in Russia to have second thoughts. However, as the price of oil has dropped and cheap credit dried up, time has come for the Russian oil companies to look east, since they desperately need cash to invest in infrastructure and the development of new oilfields in Siberia. In the meantime, the Chinese are importing record amounts of crude oil, as well as investing into oil companies all over the world in order to secure a stable supply of oil.
China is the second largest consumer of energy, and imported a record 4.6 million barrels of crude oil per day in July. The United States, for comparison, imports about ten million barrels a day. China’s recent stimulus plan, which injected $585 billion into the economy, critically improved the Chinese capacity to import even more oil. This active buying mode influences world oil prices, as they almost doubled between January and August of this year, which makes China one of the most influential clients for OPEC members and other oil-exporting countries.
China has a similar, aggressive strategy in pursuing another important raw material – iron ore. This year China bought a record amount of iron ore, 32 percent more than a year ago, to satisfy its growing demand for steel. It is now challenging to get a bargain as the price goes up together with demand, and China itself is partially to blame. The spot price of ore jumped up to $110 a ton in August, while in April it was only about $58 a ton. For a long time the China Iron and Steel Association has been unsuccessfully negotiating a 40 to 45 percent discount from Vale of Brazil, Rio Tinto and BHP Billiton. However, in mid-August China struck a deal with the Australian miner Fortescue Metal to supply iron ore at a 35 percent discount from last year’s prices, praised as a face-saving breakthrough in negotiations with the stubborn suppliers as the deal with Fortescue sets a new price benchmark. The catch is that China offered to provide $6 billion in loans that will allow Fortescue to expand its production. This arrangement is reminiscent of the Sino-Russian oil agreement, with the Chinese “buying” the deal with generous financial commitments, which, by definition, are used as a bargaining tool to negotiate even better conditions. In essence, the Fortescue deal is insignificant in terms of the amount of imported ore, but its symbolism should not be overlooked.
The Chinese government seems to be engaged in strategic spending of U.S. dollars to boost its economic development and stockpile commodities. In June, Sinopec bought the Swiss oil company Addax Petroleum for $8.9 billion. Over the course of three years, Chinese cross-border acquisitions, including some in Norway, Kazakhstan, and Nigeria, amounted to over $35 billion. It is an aggressive strategy of capturing resources, and the Sino-Russian agreement is part of this plan. However, the difficult question is: who benefits more from the deal?
From the Russian perspective, the Chinese are a “sponsor” in the Russian oil sector and provide a market for oil, even though a mere few years ago Russia looked at hard-bargaining Chinese oil buyers with suspicion. However, with the strategic diversification efforts of the Chinese, it seems that Russia would not be able to manipulate its position with its neighbor as easily as it did with Europe over gas. Russia’s political leverage is weakening. When the price of oil was high, the Russian government viewed the Russian natural endowments as economic and even political instruments. The economic crisis pulls the romantic curtain down from the energy sector, reminding everyone that Russia has been and, at least for the moment, remains a raw material exporter.
Irina Aervitz, Ph.D., is the vice president of the Federal News Service in Washington, DC. She is also an adjunct faculty at George Mason University, where she teaches globalization.
