Energy Development in Russia and China

ABSTRACT

This paper identifies the characteristics of energy development in Russia and China (with the focus on oil sector), investigates the ways of cooperation and related to it problems and how they influence the countries’ economic growth.

In this research, we study the wide range of problems related to the practical implementation of strategic cooperation between Russia and China in the energy sector, including the issue of safe and sustainable development of both countries and the related to this prospects of economic growth.

The relevance of the thesis can be explained by the fact that the oil and gas cooperation is profitable for both Russia and China as they are the largest producers and consumers of energy in Eurasia. The prospects of bilateral Russian-Chinese energy cooperation play a vital role for the countries due to the need to diversify export supplies and delivery of energy resources.

Nowadays, Saudi Arabia and its cartel partners, such as Venezuela, are losing the Chinese market because of the growing cooperation between Russia and China. China and Russia are expanding their settlements in national currencies, avoiding the dollar, and are also implementing billion-dollar projects. Moreover, Chinese companies are getting shares in Russia’s largest oilfields. In addition, by buying more oil from Russia, China reduces its dependence on offshore oil supplies from countries in the Middle East that are prone to weather interruptions and other transaction problems.

The research methodology is based on an interdisciplinary approach, covering economic and political sciences. The application of general scientific principles and methods such as analysis, synthesis, comparison, allow concentrating on reviewing the most important aspects of the subject of study and provide the diversity and integrity of the study. Statistics and econometric models allowed to clearly represent a research problem and make certain conclusions.

Research methods also include: grouping and classification; statistical and graphical analysis; scientific abstraction; SWOT analysis.

KEY WORDS: Energy Market, Oil Industry, Sino-Russian Cooperation, Oil Crisis, Economic Growth, Sustainability, Russia, China.

1.      Introduction

Among all possible ways of cooperation between Russia and China, the energy sector seems to be the most perspective. Nowadays, China as an importer of the energy resources is in a quite difficult situation due to environmental issues, growing population and increasing demand for other kinds of energy that could substitute the use of coal which is the main reason for the serious environmental pollution in the country.

It is hard to imagine today, that China was an importer of oil until 1994. After its own large deposits were exhausted, and the growing economy required ever new volumes of “black gold”, China began to actively buy up foreign oil, becoming the largest exporter in the world. Since 1965, oil consumption in this country has increased more than 25 times, while in the world as a whole less than twice. At some point, China faced the need to find another large seller, who guaranteed the supply of oil for a long time. At the same time, Russia decided to stake on the countries of Asian Pacific Region, starting the construction of the ESPO pipeline, which brought East Siberian oil to the Asian market.

A Chinese direction in oil and gas strategy of the Russian Federation is justified, beneficial, and economically promising. This is due to the stability and magnitude of the Chinese oil and gas market, a constant and growing demand of Chinese industry for oil and gas, geographical and political proximity of the two countries linked by strategic partnership. Moreover, both countries have complementary interests: Russia needs to develop oil and gas resources of Siberia and the Far East, and China needs to diversify energy sources.

In 1993, when China for the first time in its history became a country-importer of oil, dependence on oil imports increased from 7.6% in 1995 to 34.5% in 2003, the Global energy Agency predicts that by 2030 this figure will increase to 80%. According to the forecast, by 2020 China will need 600 million tons of oil per year, which is more than three times higher than projected production in the country.

But as an importer of energy China is in a difficult position. It is critically dependent on the Gulf countries, where it buys a large share of energy from. The route of delivery of oil from this region is long and includes passage through several Straits controlled by other countries. Therefore, the Russian Eastern Siberia, close and politically stable, is a strategically important supplier of hydrocarbons, which in the future should help to diversify the structure of supply.

For Russia the importance of Chinese export of hydrocarbons – is also very large. Today, the Russian hydrocarbon export goes almost exclusively in Western direction: the European Union consumes about 85% of the export of Russian oil and gas. This makes Russia economically and politically vulnerable and too dependent on the EU. Over time the position of Russia in this area can deteriorate, because the integration of European countries within the European Union transforms them into a single, virtually monopolistic consumer of Russian resources.

Besides, the Russian Eastern Siberian and far Eastern regions are now most underdeveloped in the country, which leads to a rapid outflow of population from these territories into the European part of Russia. Moreover, the economic ties of these regions with other parts of the country considerably weakened. To improve the situation in this part of the state, it is critically important to stimulate economic growth in the region and create the infrastructure that connects the East and the West of Russia. The most effective method of implementation of this project is the development of extraction of hydrocarbons, creation of infrastructure for transportation and attraction of foreign investments in these regions. Hydrocarbon resources in the East of Russia is quite significant: about 17.5 billion tons of oil and 60 trillion cubic meters of gas, or about a quarter of all Russian stocks.

The economic effect of oil and gas exploration can significantly develop the economy of the Eastern regions of the country and the Russian economy as a whole.

In addition, oil and gas pipelines that will be built in the East of the country will be connected with existing pipeline infrastructure, which means that Russia will be able to choose directions of export of hydrocarbons. Alternatively, taking into account the “problem” of the West, Russia can access fast-growing and promising markets of the Asia-Pacific region, mainly the market of the PRC, thereby diversify export destination and, again, develop the national economy in general and the economy of the regions of Eastern Siberia and the Far East in particular.

Therefore, based on mutually beneficial prospects for Russian-Chinese cooperation in the oil and gas sector, the topic of this research is extremely relevant.

Thus, today China is a promising market with huge potential, which is sought by many countries and large companies, Russia is also ready to cooperate with China, However, despite repeated discussion of the prospects for the total supply of Russian energy to China it remains unclear, and the possibility of implementing cooperation on the basis of partnership in the fuel and energy complexes in the countries is not used.

However, the boom in the energy industry caused serious damage for both economies. China is the world’s largest emitter of greenhouse gases, its energy consumption has ballooned generating the environmental crisis which, as a result, affected the economic growth and the quality of human capital. At the same time, China is one of the biggest investors in developing renewable energy technologies.

In fact, there are a lot of different ways for the cooperation between the two countries. According to the 2016 data, the economic ties became even stronger making Russia the biggest oil exporter in Chinese market. What problems do these countries face in reaching mutual agreements and maintaining economic growth? How their energy cooperation influences the world oil market?

When it comes to energy in Russian-Chinese bilateral relations, the complexities and contradictions in this sphere increase many times crossing any boundaries. At first glance, these countries are obvious energy partners. Russia is one of the world’s leading countries in energy production: it is the world’s first or second largest producer of oil and the world’s largest producer of natural gas. China, which has become a world factory, is hungry for energy materials, trying to develop its economy and meet the growing needs of the population for electricity and fuel, in order to delay major changes in their political system by constantly increasing the people’s welfare. Anders Aslund of the Peterson Institute characterizes these relations in the following way: “They have a huge complementarity, because Russia has raw materials, and China has cheap labor and productive potential.” But despite recent successes in the field of energy cooperation, public statements by the leadership of the two countries on the great importance of deepening ties in energy sector, this cooperation is moving forward very slowly, which is hindered by mutual distrust and different political goals and tasks. It seems that the “strategic relationship” between China and Russia is not quite what they are trying to imagine.

There are a lot of reading materials regarding this topic. Literature review includes different articles and government reports, as well as statistical data and fundamental works of the famous economists. Using the most recent data would help to create a better picture of the modern situation on the world energy market and would lead to a better understanding of the industrial development of China and Russia.

The main sources that would form the basis of the work could be such periodic publications as BP Statistical Review of World Energy (published every year in June) that provides high quality objective and globally consistent data on world energy markets through tables, charts and regional and country factsheets. Another important publication that takes a lot of attention is the report made by The Oxford Institute for Energy Studies “Energy Relations between Russia and China: Playing Chess with the Dragon” (August 2016) that covers a historical background of China-Russia energy relations from the Soviet times with its “border disputes delay energy cooperation” (1949-1999) till nowadays and “Putin period”. Besides, this work gives very complete information about the oil and gas industry in two countries including brief review of Russia’s eastern oil and gas assets, Chinese oil import requirements, development of the ESPO pipeline and some important negotiation issues and deals.

The publication of Brussels based internet resource “Bruegel” called “The China-Russia trade relationship and its impact on Europe” (2016) by Alicia Garcia Herrero and Jianwei Xu could also be helpful as this paper analyses empirically how increasingly close trade relationship between China and Russia might affect the European Union.

The reports made by U.S.-China Economic and Security Review Commission might also be interesting in my research. For example, “The China-Russia Gas Deal: Background and Implications for the Broader Relationship” by Iacob Koch-Weser and Craig Murray contents the information about the long-term trends in the gas market and China’s energy needs, benefits and risks for China and impact on global gas markets.

To get a better understanding of energy markets of two countries it is also important to learn each market separately, especially their energy strategies.

For China, it is necessary to take a look at such works as “The Domestic Natural Gas Shortage in China” by Ting Guo from Michigan Technological University and “China’s Energy Diplomacy: Resolving The Malacca Dilemma” by Lili Siklos from Central European University, as well as to analyze the recent “One belt – One road” initiative and 13th Five-Year Plan (2016-2020). China is the world’s greatest energy consumer; therefore, its domestic energy policies play a vital role in shaping the global energy market. The Chinese Government pays particular attention in forming energy policies in order to maintain sufficient energy supply so as to satisfy China’s energy demand and to promote further economic growth.

For Russia, it is important to analyze some works of the Russian economists and scholars, for instance, “Energy Strategy – 2050: Methodology, Challenges, Opportunities” by V.Bushuev, N.Kurichev, A.Gromov where they talk about the slow-down of economic growth in Russia and the decrease of external demand on Russian energy carriers, increase of operating and investment costs in the energy sector and the potential of new technologies, as well as the Energy Strategy of Russia itself.

To continue a further analyses of the China-Energy relations it is also important to get some information about different oil market models, such as market power models (cartel behavior models, dominant firm behavior models, target behavior models) and other models like political models and property rights models.

It is also important to focus particularly on oil industry as I believe this specific market plays a vital role in recent China-Russia energy cooperation. Thus, some materials on oil statistics and theory might be very useful while writing this thesis. For example, the websites of Russian and Chinese oil companies where they publish recent news regarding their activities.

Summarizing the literature review, it is clear that there is a lot of information regarding the chosen topic that can be used in the further research, including statistical data about China-Russia economic cooperation, however there are a lot of gaps and misunderstandings regarding the energy sector, especially after 2014, when Russia and China made some important agreements about oil and gas trade and when the economic situation in the world (sanctions and oil crisis) turned Russia into the East with the main focus on China.

2.      New ways of economic cooperation between China and Russia in the “Xi and Putin Period”

2.1. Historical Background

It is no doubt that Russian-Chinese relations are very difficult. They have a long, and sometimes a joint history with common interests. In 2009, the two countries celebrated the 60th anniversary of the establishment of diplomatic relations that survived the Cold War, the transformation of China into an economic power and the collapse of the Soviet Union. These relations also experienced an important transfer of power from Putin to Medvedev, the closure of the market in Moscow where Chinese traders worked, the incident in Russian waters in 2009 when Russian sailors sank a Chinese ship, and the development of their bilateral ties with Washington.

To fully understand current relationships between the two countries, it is important to look through their historical experience as it might give some reasons and explain why Russia and China are where they are in their cooperation. Having common historical paths, China and Russia became close after 1949 – the year of the establishment of the People’s Republic of China and its Communist Party. The Soviet Union offered its help to the new member of Communism by supporting it with different industrial equipment and skilled labor which was aimed at modernizing China. However, everything changed after the Soviet leader’s (Stalin) death which led to ideological miscommunication between the two countries that lasted for over two decades and brought up the military border conflict in 1969 in the eastern part of Zhenbao Island on the Ussuri River and in the western part in Xinjiang. The relationships remained cold even after Mao Zedong’s death in 1976, in addition influenced by Vietnam and Afghanistan wars.

In 1982 Russia and China finally found the ways to compromise on their issues and rebuilt diplomatic relationships. As a result, the Soviet Union initiated oil and gas pipeline constructions, however there was not mutual understanding from the Beijing side as they did not take those energy projects serious due to low oil prices around $20/barrel and oversupply at the market[1].

Sino-Russian relationships came to the new level after the collapse of the Soviet Union in 1991. The Chinese Government supported the new political elite that took power after the putsch, and the new Russian President paid a visit to China that resulted in restoring friendship, intensifying trade and solving border issues[2]. Both countries described their relationships as “good-neighborly and mutually beneficial” which also gave a start to their military cooperation.

Few years later in 1994 the two countries created a Sino-Russian Border Management System, under which they reached an agreement on a border trade and related to it issues, calling the relationships “strategic partnership of coordination[3]”. Later, in 1998 negotiations between Russia and China made the two sides a joint agreement which became one of the first strategic partnership agreements ever made by the Chinese Government.

However, China-Russia relationships were not as perfect as it seems. Russia was more focused on the European countries and the US, which played the first role in Russian foreign policy. At the same time, the Asian direction was placed as a second priority and China was even seen as a threat to Russian relations with the West.

Despite all the good and bad sides of negotiations between the two countries, the energy relations showed significant improvement bringing oil and gas pipeline projects and agreements, such as an agreement on joint development of cooperation in the energy sphere 1996 and an agreement between the Energy Ministry of the Russian Federation and CNPC on organization of cooperation on oil and gas projects in 1997. However, those oil and gas projects mainly stayed on paper, and only almost two decades later they finally began to come into the real life.

After Putin came to power, the relationships between China and Russia turned into even closer cooperation aiming at building a balance to the Western countries. Despite the concerns of the new president regarding Chinese excessive influence in the far east of Russia, the Russian government decided to focus on the Asian vector as it played a crucial role in geopolitics. An article called “Russia: New Eastern Perspectives” confirmed that the Asian direction is as important for Russia as the European one, and China was named an important strategic partner. In 2001 both sides signed a document “Treaty of Good-Neighborly and Friendly Cooperation” gave an official start to a 20-years project of economic, military and cultural cooperation that had been blocked in the past by different misunderstandings and goals of the foreign policies. In fact, the signed documents did not cause any specific big changes to happen but it opened the way to mutual understanding and future collaborations. At the same time, China and Russia became the members of Shanghai Cooperation Organization along with other Eurasian countries, such as Kazakhstan, Uzbekistan, Tajikistan and Kyrgyzstan empowering the Central Asian region.

Later, in 2003 China and Russia made another agreement, under which the two sides promised to maintain friendly relationship no matter what the situation is on the world arena. It was followed by signing another document that resolved longstanding border issues. According to that agreement, China received Yinlong (Tarabarov) and Zhenbao Islands and also half of Heixiazi (Bolshoy Ussuriysky) Island.

However, the political improvements between the two countries did not come along with intensified cooperation in energy sector which still was at a low level. In 2001 Russian privately owned oil company Yukos came up with the project of Eastern Siberia-Pacific Ocean (ESPO) Oil Pipeline which was aimed at linking Russian Angarsk and Chinese Daqing. 3 years later, in 2004, Yukos faced some serious financial problems and was taken over by partly state-owned Russian oil company Rosneft, the director of which made a very important step towards the Chinese side, and as a result Rosneft and Chinese CNPC made a 5-year oil agreement worth 48,8 million tones of oil, which also included receiving 25,1% of shares in one of the blocks of Rosneft’s Sakhalin-3 project by CNPC.

That became a turning point for Sino-Russian energy cooperation. In 2006 the two parties sign other agreements during Putin’s visit to China concerning not only oil and gas projects, but also electricity ones. According to those agreements, another big oil Russian company Transneft made a deal with CNPC about reviving the old Yukos contract and building an oil pipeline from Russian Skovorodino to the Chinese border. At the same time, Russian gas company Gazprom offered a construction of a gas pipeline. For the Electricity side, Russian Eastern Energy company and the Chinese State Grid Company SGCC agreed on trading electric energy between the two countries. Moreover, a year later Rosneft and CNPC created a joint venture for the oil project in Tianjin.

In 2008 Russia’s relationships with the US and EU became more confrontational caused by the war in Georgia which made the Russian side turn even more to the Asian direction and particularly to China which was called the most important partner in Russia’s Asian foreign policy. The Russian Government prepared a lot of important documents[4] aiming at developing the energy sector of its economy with the focus on Siberian and Far Eastern regions and building strategic relationships with China and other East Asia countries in the energy perspective. That Energy Strategy was aimed at guiding Russian private and state owned energy companies until the year of 2030 proclaiming China the main future consumer of Russian energy resources in the Eastern direction. Following those agreements, the year of 2009 showed a significant improvement in the energy trade between Russia and China with an impressive growth in coal and electricity exports to China, as well as another oil deal between Rosneft and CNPC of 15 million tones per year to 2030 through mentioned above Skovorodino – Daqing pipeline.

Russia was so determined about the Eastern direction that in 2012 it created a special Ministry of the Development of the Far East[5] which however made some visible progress a few years later due to some corruption and bureaucratic issues within the country. Finally, the Ministry came up with an idea of Special Economic Zones and Advanced Development Territories in Siberia and Far East of Russian that was aimed at bringing more investment (especially from the Chinese side) into the country by offering low tax rates and and as a result developing poor regions. Following some of those changes and improvements, in 2013 Rosneft signed a deal with CNPC doubling the 2009-year contract for 25 years, as well as making another oil agreement worth 10 million tones for 10 years with Chinese Sinopec with the starting date of 2014.

If we look closer to the statistical data for the first decade of the 21^st century, we can see an increased growth in economic cooperation between the two countries. According to Russian customs statistics, the volume of Russian-Chinese trade increased more than 5 times for the period from 2003 to 2013 (Table 1. Trade turnover between Russia and China 2003 – 2013, million dollars). By the end of 2013, Russia ranked 10th among China’s foreign trade partners. China took the first place among Russia’s foreign trade partners, including 6th for exports and 1st for imports.

Besides, the volume of trade between Russia and the border regions of China (Heilongjiang, Jilin, Liaoning, ARVM, XUAR) increased by 40.56% and amounted to 16.65 billion dollars. However, the most significant was the growth of Russia’s foreign trade with Heilongjiang province (+57,32%), for a long time, occupying the first place on this index among all regions of China.

It is also remarkable that by the end of 2013 in the structure of Russian exports to China, mineral products (mainly fuel and energy products) reached 67,89% in total share of exports[6].

Table 1. Share of oil products in Russian exports to China in 2013, million dollars.

To sum up, China-Russian relationships have experienced a lot of fluctuations in their history, which however made them strategic economic and political partners in the first decade of the 21^st century. The underlying cause that drives the Chinese energy strategy as a whole, and its energy relations with Russia in particular, is China’s inability to adequately provide itself with energy to meet domestic needs. Over the past twenty years, Beijing has turned from a net oil exporter to a net oil importer. This fact underlies China’s energy expansionism, the objects of which are Latin America, Africa and the Middle East. Russia and the former Soviet republics of Central Asia are playing an increasingly important role in ensuring China’s energy security, and China, respectively, in ensuring their long-term economic security. Recent events confirm the reliability of this observation. China has been seeking for access to Russia’s commodities for a long time; Russia has sought to strengthen the Asian vector of its foreign policy in order to create a counterweight to American power, and also to strengthen its foreign policy and economic impact on Europe.

2.2. Oil crisis and sanctions as a result of intensified Sino-Russian economic relations

Economic sanctions are defined as the withdrawal of customary trade and financial relations for foreign and security policy purposes[7]. With the decline of oil prices Russian economy experienced a significant damage from Western sanctions which caused an overall economic crisis in the country.

Due to political confrontations and different points of view on solving the Ukrainian problem, in March 2014 Western countries imposed sanctions against Russia with the main focus on energy, military, aviaconstruction and financial sectors. In terms of oil and gas industry, it is important to note that the total number of 38 countries joined the sanctions against Russian companies producing oil and gas. All those measures made Russia turn its focus on the Eastern direction that was called “Pivot to Asia” not only because there were no other options but also because it was a great chance to strengthen cooperation with Asian countries and develop Siberian and Far Eastern regions of Russia. Mentioned events led to the $400 billion gas contract between Russia and China in 2014. The Russian side was very optimistic about getting Chinese equipment supplies, technologies and financing. However, technological investment from the Chinese side was limited, as well as the financial part of the contract due to the fact that the “Big Four” Chinese banks had big US assets. It was not only politically caused but also economically as Chinese banks had to choose between high risks on declining Russian markets and stability on huge American and European markets. The only commercial bank that agreed to participate in oil and gas deals with Russia was Bank of China that provided Russian gas producing company Gazprom with a $2 billion dollars’ loan for 5 years which became a largest loan in the history. Eventually, the main financial institutions that have signed the agreements with Russia were China Development Bank (CDB), Export-Import Bank of China and the Silk Road Fund which are not too much dependent on international financial system.

It is also interesting to note that from the political point of view, the desire to achieve the goal of closer cooperation was not only left to oil and gas companies in the period after the introduction of the sanctions and crisis in Ukraine but was also reinforced by the strengthening of state interaction, emphasizing the geostrategic nature of relations with China. When relations with the West deteriorated sharply after the entry of Crimea into Russia in 2014, the number of meetings with China rose dramatically, and Putin’s participation became more important. Indeed, in May 2014, Presidents Xi and Putin met for the seventh time for 14 months in Shanghai, ending with a joint statement confirming the desire to expand cooperation in all areas and coordinate diplomatic efforts to strengthen the China-Russia partnership in the field of strategic cooperation. Clearly, although the commercial drivers of the eastern strategy are important, since Asia provides significant opportunities for generating new revenue, political dynamics are also vital and attract a large amount of time and resources from the Russian government.

However, these additional political efforts have led to some visible results in the energy sector. In May 2014, the long-awaited gas agreement between Gazprom and CNPC was signed, and also a deal on strategic cooperation between CNPC and Rosneft. Rosseti (Russian Grid Company) and SGCC signed a long-term contract for the supply of electricity worth 100 billion kWh for the period until 2036, and RusHydro signed two cooperation agreements with PowerChina and Dongfang Electric. In addition, in October 2014, Russia and China signed a “road map for cooperation in the coal industry,” which goal was to intensify participation of Chinese companies in Russian coal projects. The final and the most important deal, however, was about CNPC that took a 20% stake in Yamal LNG and made a 20-year contract of 3 million tones per year.

Unfortunately, statistics show that in fact the trade turnover between the two countries fell dramatically. After growing by 6,8% in 2014, it declined to almost 30% in 2015 which moved Russia from top ten China’s trading partners to the 16^th place (Table 3). It was caused by the overall negative trends in the world economy, as well as slow negotiations process about the physical implementations of the agreements between Russia and China.

According to the data of the Main Customs Administration of the People’s Republic of China, Russia’s trade with China in 2015 amounted to 68,065.15 million dollars (-28,6%), including Russia’s exports to the PRC – 33,263.76 million dollars (-20,0%), imports from China – 34,801.39 million dollars (-35,2%). Negative trade balance in 2015 decreased by 87,3% to $1,537.63 million (2,26% of total turnover) against $12,070.83 million in 2014[8].

Russia ranked 16th in the rating of 20 major trading partners of China.

The slowdown in the dynamics of mutual trade in 2015 was due to a number of objective factors that emerged in 2014, but the delayed effect of which was fully manifested in 2015.

First, the general geopolitical tension, the complication of the situation in Ukraine, the introduction of economic sanctions against Russia by Western countries, the worsening of the world’s foreign trade conditions, including the reduction in demand in foreign commodity markets, the volatility of the global financial market, and the debt problems of the eurozone and the United States.

Secondly, the slowdown in economic growth rates both in Russia and in China.

Thirdly, the fall in world prices for energy and raw materials, which account for more than 70% of Russian exports to China.

Fourth, the decrease in the purchasing power of Russian consumers of Chinese products due to sharp exchange rate fluctuations of the ruble to major world currencies, including the Chinese yuan.

Fifthly, the increasing pressure of the downward trend that began in 2014 in China’s foreign trade. Thus, according to customs statistics, China’s foreign trade turnover in 2015 decreased by 8,0% to $3,958.64 billion, including exports – by 2,8% to $2,276.57 billion, imports – by 14,1% to $1 682.09 billion. Negative dynamics is noted not only in trade with Russia, but also with China’s main foreign trade partners. In particular, trade with the EU declined by 8,2% to $564.85 billion, with ASEAN – by 1,7% to $472.16 billion, with Japan – by 10,8% to $278.64 Billion. A slight increase (+ 0.6%) was recorded in trade with the US (558.38 billion dollars)[9].

If we take a look at the statistics of Russian export of oil to China in 2016, we can also notice a negative trend.

In 2017, in the trade turnover between Russia and China, a new positive trend has emerged. According to the recently published data by the main customs administration of the People’s Republic of China, this year in January the trade turnover between Russia and China reached 6.55 billion dollars, which is 34% higher compared to the same period last year. Analysts believe that in the context of the global economic recovery, trade turnover reflects the positive development dynamics of the two countries.

This is not only the start of new successes, but also a hint that this situation will be observed throughout the year. In January, the amount of export of Russian products to China reached 3.14 billion dollars, Chinese products to Russia – 3.41 billion. China continues to be a major trade and economic partner for Russia. It is estimated that this year, in the context of rising energy prices, bilateral trade between our countries will also expand.

To sum up, due to the implementation of sanctions and taking into account current trends on the global market of energy, the main goals and interests of Russia in terms of developing its energy sector within the cooperation with China are the following:

1. Diversification of export supplies, due to the reorientation of part of the flow of oil from the stagnant European market to dynamic Asian Pacific markets (primarily China and Korea).
2. Providing direct (bypassing trenchant countries) access to traditional and new markets for oil, oil products and gas.
3. Obtaining long-term guarantees for purchases of oil, oil products and gas at reasonably high prices.
4. Participation in the management (joint operation) of transit, transport and distribution infrastructure of oil, oil products and gas through the territory of the importing countries.
5. Participation in the profits from the sale of oil, oil products and gas on the territory of the importing countries.

At the same time China is increasingly facing serious limitations in terms of the growth of man-caused environmental pressures, which is largely due to the expansion of coal mining and utilization systems. More than 80% of all freight traffic in China is coal. All these factors force China’s leadership to stimulate the development of the oil and gas industry, organize supplies from various regions of the world. In conditions of changing technological level of energy supply, further motorization of the economy and population, transformation of the structure of the fuel and energy balance, the demand for oil and gas will grow most rapidly. The most preferable option for Chinese companies is the option of direct access to oil and gas assets (resources and hydrocarbon reserves, infrastructure facilities) through obtaining licenses for geological exploration, exploration and production of hydrocarbons and participation in the capital of oil and gas companies.

Overall good relationships between Russia and China and its intensified cooperation and sanctions and countersanctions policies have a significant effect on Europe. Both Russia and China are considered to be key strategic partners for Europe. For Russia, Europe has always been the main trading partner. And China is the world’s largest economy that is impossible not to take into account. After the implementation of sanctions, commodity exports from Europe to Russia fell by 28,4% in the period of 2014-2015[10]. So, the question is: can China substitute Europe in terms of trade for the Russian economy?

To answer this question, it is important to take a look at Allen-Hicks model of elasticity that shows the ratio to what degree two goods or services can be substitutes for one another[11]. It is a very useful model to analyze the relations between multiple countries. We can assume that a market can import from three different countries (in our case, it’s Russia, China and European Union taken as one dimension). As a result, comparing to the two-factors model, this might cause a “domino effect” of substitutions for the other factors which will impact the demand for the original two factors. Generally speaking, the price effect on the demand will be in dependence with all of the factors. According to the research made by Alicia Garcia Herrero and Jianwei at Bruegel[12], Europe and Russia complementary on the Chinese market as the calculated coefficient is less than zero or negative. This can be explained by the fact that the main commodity that Russia exports to China is energy resources, like oil and gas. And at the same time Russia’s exports do not cross with European exports to China that mainly provide it with consumer products, so they complement each other while trading with China. However, for the Russian market the elasticity coefficient, which is positive or higher than zero, proves that Europe and China are substitutes so they compete on the Russian market. Moreover, since the elasticity is higher than 1, Europe and China become two major competitors for the Russian market, and a reduction in the price of exports between China and Europe benefits China as it might increase the demand for Chinese imports.

Table 4. Elasticity.

For these calculation they assumed that the elasticity of substitution is symmetrical and used a translog function (Diewert (1979) and Feenstra(2003)):

ln(E_i)=ln(U_i)+α_0i +∑α_j ln(p_ji)+∑∑λ_j ln(p_ji)ln(p_ki)

In this function:

• U_i is the utility of country I;
• p_ji, p_ki – prices from country j and k in country I.

Then, we can take the other function (Freenstra (2003)):

S_mj =α_m+∑λ_kmln(p_kj), where:

s_mj is the market share of country m in country j;

p_kj – price of import from country k in country j;

μ_i– product dummies;

λ_t – year dummies;

Finally, we get:

MarketShare_{EU−Russia,it}=β_0a+β_1aln(p_{EU−Russia,it})+β_2aln(p_{China−Russia,it})+β_3aln(p_{ROW−Russia,it})+μi +λt +εit

MarketShare_{EU −China,it} = β_0b + β_1b ln( p_{EU −China,it} ) + β_2b ln( p_{Russia−China,it} ) + β_3b ln( p_{ROW −China,it} ) + μi + λt + εit

We assume that β_1a and β_1b estimated impacts on European Union exports and get the function where Allen-Hicks’ two-factors elasticity is proportional to β_1a and β_1b:

3.      China as a new potential market for Russian export of energy resources

3.1. Main characteristics of China energy strategy

Generally speaking, Chinese energy strategy can be described by the words of President Hu Jintao, that he mentioned in 2006 at the G8 Summit in Saint Petersburg: “to ensure global energy security, we need to develop and implement a new energy security concept that calls for mutually beneficial cooperation, diversified forms of development and common energy security through coordination”.

The Chinese energy strategy and Chinese-Russian energy cooperation are based on an assessment of the situation of supply and demand for energy in the PRC.

China is the largest country in the world for the production and consumption of energy. In terms of production and consumption, China ranks second in the world. The provision of own energy resources exceeds 90%. In terms of oil production, China rose to the fourth place, following Russia, Saudi Arabia and the United States, however, it takes the second place in terms of oil consumption, importing over 50% of the oil consumed in the country from abroad.

The structure of China’s fuel and energy balance is characterized by a high proportion of coal, a small share of oil and a small amount of natural gas. In 1952 coal in the total volume of energy consumption reached 95%. With the development of industrialization and urbanization, the share of coal gradually decreased: in 2007 this figure was 69.4%, the share of oil – 20.0%, natural gas – 3.4%, hydropower, nuclear and renewable energy – only 7.2%. In the future, despite the fact that the share of coal will decrease, the volume of its consumption will grow. In 2009, the volume of coal consumption was 3.2 billion tons, in 2020 it will increase to 3.8 billion tons, but the share of coal in the total consumption of energy resources will decrease to 57%. Therefore, increasing the share of clean energy in the consumption pattern is an urgent problem for China’s energy security.

China is rich in energy resources, mostly it is coal, and oil and gas reserves are relatively small. In explored reserves of primary energy, the share of coal is 87,4%, oil – 2,8%, natural gas – 0,3%, hydropower – 9,5%. By the end of 2007, China’s share in world oil and natural gas reserves was estimated at only 1,3%. According to the Ministry of Land and Natural Resources of the People’s Republic of China, oil reserves in China at the 2007 level were estimated at 0.82-1 billion tones, with a slight upward trend. According to the Government’s forecast, by the year of 2020, the oil production in China will reach its maximum and will then decline steadily. Prospects for natural gas production due to limited reserves are similar to oil. Despite the significant steps taken in China, the production of oil and gas is unlikely to have much growth. In 2009, natural gas production was 80 billion m³. The extraction of natural gas in China is characterized by a high cost, and its increase is associated with great difficulties.

Most of the largest oil fields in China are located in the north-eastern and northern central regions of the country and are the basis of domestic production. However, these deposits are mature and are prone to cut production. The Daqinq deposit of CNPC, located in the northeast region, is one of the oldest fields in China, accounting for 19% of the total oil production in China. Sinopec’s Shengli oil field near the Bohai Bay is the second larges oil field. And finally, Changqing, China’s third-largest producing oil field is situated at Changqing in the north central Ordos basin.

Due to the rapid development of the economy and the continuous increase in the degree of modernization in all sectors, the demand for energy in China is increasing in a huge pace. Over the past ten years, there has been a significant increase in demand for all types of energy, but the demand for oil and natural gas is growing at the fastest rate. The growth in oil consumption for the period from 2001 to 2009 reached 161 million tones with an annual increase of 20 million tones.

In the period 2016-2020 the growth rate of demand for gas will be at the level of up to 8%, at the same time this indicator for oil will be in the range of 4-5%.

In the long term, the demand for energy resources in China will grow at a rapid pace, but the production of these resources will lag far behind. In the next ten years, oil production can reach 200 million tons, and the gap between supply and demand will be constantly increasing. In the structure of oil consumption, the share of imports in 2020 will exceed 60%, and by 2035 can reach 79%. The share of gas imports from abroad will exceed 50%. Solving the problem of a continuous increase in the gap between supply and demand for energy resources is an important task to improve China’s energy security.

The energy situation in China is characterized by the following main points: the percentage of own energy resources is now quite high, but the structure of the fuel and energy balance is irrational with a high share of coal; reserves and oil and gas production are inadequate, the gap between supply and demand is great, with a trend of continuous growth in the future.

In accordance with this provision, China has developed its energy strategy, the main direction of which is to change the irrational structure of the fuel and energy balance in the direction of increasing oil and gas production in order to ensure a continuous increase in demand for these types of resources. The Chinese energy strategy includes two parts: internal and external. The main argument of the strategy: the use of two resources and two markets involves the use of own and imported fuel and energy resources, the development of domestic and foreign markets, and contributes to improving the energy security of the state.

The Chinese internal energy strategy includes, mainly, the following:

1. The increase in investments in the exploration, development and processing of oil and gas creates conditions for a reliable system of supplying consumers with these resources.
2. The implementation of measures to save energy and increase the efficiency of using fuel and energy will reduce the tension in energy supply.
3. The intensive development of the use of renewable and secondary energy resources, including hydro, wind, solar energy, bioresources, and nuclear energy, will make it possible to improve the structure of energy consumption, reduce environmental pollution, and, thus, – change the climate.
4. The development of clean coal technologies will increase the efficiency of energy production and significantly improve the environmental situation in the country.
5. The creation of a strategic oil reserves will prevent risks in the oil supply of consumers in China.

In 2012, coal accounted for the majority (about 66%) of total energy consumption in China. The second largest source is oil and other liquids, which account for almost 20% of the total energy consumption in the country. Despite the fact that China made efforts to diversify energy supplies, the share of hydroelectric power stations (8%), natural gas (5%), nuclear power (about 1%) and other renewable energy sources (more than 1%) accounted for a relatively small share of China’s consumption of energy. The Chinese government plans to limit coal consumption to 62% of total primary energy consumption by 2020 in an effort to reduce the intense air pollution that has swept through parts of the country in recent years. China’s national energy agency claims that coal consumption fell to 64.2% of energy consumption in 2014. The Chinese government set a goal to increase energy consumption not related to fossil fuels to 15% of overall energy consumption by 2020 and up to 20% by 2030 in order to ease the country’s dependence on coal. In addition, China is currently increasing the use of natural gas to replace some coal and oil as cleaner fossil fuels and plans to use natural gas for 10% of its energy consumption by 2020. Although absolute coal consumption is expected to increase in the long term, as well as total energy consumption, energy efficiency and China’s efforts are aimed at improving environmental sustainability and reducing the share of coal.

As a result of high consumption of coal, China is also the world’s leading emitter of CO2. The Chinese government plans to reduce its total CO2 emissions by at least 40% between 2005 and 2020. The current climate change plan, issued in late 2014, has strengthened China’s commitment to reducing carbon emissions mainly in energy-intensive industries and construction by 2020. Recently, China predicts that its carbon emissions will grow by more than one-third of current levels and reach the peak in 2030. These goals suggest that China can reduce its dependence on coal and become a more energy-efficient economy in the long term.

In recent years, China has made great strides in this area. Thus, China takes the first place in the world in investment in the development of the use of renewable and secondary energy resources. In terms of the development of wind energy, China also occupies the first place in the world.

The goal of China’s external energy strategy is to create a reliable energy supply system that can fill the ever-widening gap between demand and supply and ensure the energy security of the state. Import of energy resources from abroad must meet the requirements: “stability, economy, cleanliness and safety”. “Stability” means long-term stable supply of energy resources, which is sufficient to meet growing internal needs. “Savings” means that the price of resources should be rational. “Cleanliness” means engaging as much of the energy as possible, such as oil, gas, etc., in the balance sheet; The introduction of measures to improve energy efficiency, the development of renewable and nuclear energy. “Safety” means ensuring the safe and uninterrupted transportation of energy resources.

Summarizing, the most important points of the Chinese foreign strategy are the following:

• expansion of imports of oil and gas to meet domestic demand through purchase or participation in shares;
• development of a pipeline network of oil and gas in order to improve the security of transport of energy resources;
• development of multilateral scientific and technological cooperation in terms of increasing the efficiency of use of energy resources.

3.2. Oil negotiations and deals

The Sino-Russian negotiations in the energy sector have been going on for more than 15 years and have been rather difficult. Only recently, progress has been made in this area. This is due mainly to the existing long-term factors between the two countries and also to changes in the international political and economic situation. What are these long term factors?

First of all, good political relations between China and Russia. China and Russia agreed on the relationship of the partnership for strategy and cooperation in 1996, and since then the relations between the two countries have been continuously deepening. Both sides concluded a “Sino-Russian agreement on good neighborly relations and cooperation”, finally solved the historically abandoned question of borders, and political mutual trust between the two countries is continuously improving. In such fundamental issues as state sovereignty, territory, etc., the countries are mutually consistent, and mutually coordinated in broad international issues. Sino-Russian relations are at a historically best time, representing political support for the development of energy cooperation between China and Russia.

Secondly, China and Russia have quite a strong complementarity. Russia is rich in energy resources. Demand for energy resources in China is continuously growing, and China has the world’s most stable oil and gas, as well as coal and electricity market, with the most evolving potential. China and Russia are close neighbors. The mutual complementarity of the Chinese and Russian energy industries is the material basis for the development of cooperation in this field.

Finally, the development of the Russian Far East and Eastern Siberia will require the development of China-Russia cooperation. Russia developed a plan for the development on a large scale of the Far East and Eastern Siberia, in which oil and natural gas occupy an important place. In accordance with this plan, the “Russian Energy Strategy for the period until 2030” determines that the policy of exporting oil and natural gas is directed to the east. Oil production in Russia in 2030 will reach its maximum value, and after that it will start to decline. Oil exports to Europe will decrease, and the share of exports to the east will increase to 22-25% in 2030. The share of exports of natural gas to the east will rise to 19-20% in 2030.

In 2016, the level of daily oil consumption in China was 10.46 million barrels per day, while production in August 2016 was fixed at 3.9 million barrels per day[13]. In recent years, there has been an increase in demand for oil and petroleum products in China, which is due to extensive economic development and population growth.

In 2016 China became the second largest importer of Russian oil after Netherlands. Even export of oil in value terms to China has a tendency to decrease, the share of Russian exports of oil going to China is continuously increasing, from 9,5% in 2014 to 13% in 2016.

Russian oil resources are geographically close to China, therefore China in the long term is interested in expanding cooperation with Russia in the energy sector. Today, as never before, it is obvious that the prospects for this cooperation are considerable.

The negotiation process on deliveries of Russian oil and gas is actively going on. In June 2013, Rosneft and the Chinese National Oil and Gas Corporation (CNPC) signed a long-term contract for the delivery of Russian oil with a volume of 365 million tones for the 25-year period. The estimated volume of the deal was 270 billion dollars. The contract provided the supply of 325 million tones of oil with the East Siberia – Pacific Ocean (ESPO) oil pipeline Skovorodino – Mohe. In addition, the same route will deliver 35 million tons of oil to the Tianjin refinery.

In 2014, due to the economic sanctions of the European Union, the Russian Federation began to pursue more actively the eastern gas policy. In May 2014 in Shanghai, the Chairman of Gazprom Miller and President of the Chinese National Oil and Gas Corporation Zhou Jiping in the presence of Russian President V.V. Putin and President Xi Jinping of China signed a contract for the supply of Russian pipeline gas to China along the “eastern” route.

The contract for a period of 30 years provides for the export of 38 billion cubic meters of Russian gas per year to China on mutually beneficial terms, with reference to the oil basket and the “take or pay” condition. This is the largest gas supply contract for the entire history of Gazprom, for which more than 1 trillion m³ will be shipped during the validity of the agreement. Specially for this project, the “Siberia Power” gas pipeline is being built, which was started in September 2014, and the launch is planned in 2018-2020.

Later in 2014 in Beijing, the Russian and Chinese sides concluded a number of agreements in the fuel and energy sector, including a memorandum between Gazprom and CNPC on the supply of 30 billion cubic meters of gas on the western route “Altai” for 30 years. The document reflects the time and amount of fuel transportation, the point of its transfer at the border and the “take or pay” condition. The document determines the conditions for transportation of fuel from the fields of Western Siberia. The contract can be signed already this year, and gas exports to China, it is possible, will exceed the volume of its sales to Europe [27]. Supplies via the “Altai” gas pipeline will be carried out from the same fields, the resources of which are used for raw materials sales to European countries and, possibly, will exceed the current export to Europe in the future.

Among other documents, there is a Memorandum of Understanding between Gazprom and CNOOC (confidential) signed in 2014, as well as framework agreements between Rosneft and CNOOC on Chinese purchases of more than 10% in Vankorneft. In addition, in November 2014, Russia and the PRC agreed on an additional oil supply of 5 million tons.

Russia is increasing the volume of supplies on the Russian-Chinese oil pipeline, the implementation of the project for the construction of the Tianjin oil refinery and the “Siberia Power” gas pipeline, which should be fully operational in 2020, continues. In addition, the parties are working to agree on the terms of supply of Russian gas to the PRC along the western route. China has increased its participation in the largest in Russia project for the production of liquefied natural gas Yamal LNG.

In 2016 Rosneft entered into a new annual oil supply contract with China National Chemical Corporation and an agreement that provides for ChemChina to invest 40% in the capital of the Eastern Petrochemical Company (BHPK) with proportional participation in financing. The deal on entering ChemChina in VNKhK will be closed as soon as possible Months. The project worth 1.313 trillion rubles provides for the construction of three lines with a total processing capacity of 24 million tons of oil and 6.8 million tons of petrochemical raw materials per year. The construction of the third stage is planned to be completed in 2028.

With Sinopec, Rosneft concluded a framework agreement on the preparation of a feasibility study for the construction and operation of a gas processing and petrochemical complex in Eastern Siberia. In the future, it is planned to create three oil and gas chemical complexes in Western Siberia and in the Novokuibyshevsk area.

In addition, the Russian company sold 20% in Verkhnechonskneftegaz to China’s Beijing Gas, the deal is also expected to close in the near future.

The large oil and gas agreements signed between Russia and China in recent years are beneficial for Russian companies participating in them, as they provide them with opportunities for growth and access to new sources of financing with the prospect of expanding these relations. At the same time, the agency’s analysts point to certain problems related to the turn of Russia to the east: the possible increase in pressure on prices from China, as well as the scale of necessary investments may negatively affect the profitability of the Russian oil and gas sector in the future.

Considering oil and gas contracts with Russia through the prism of China’s economic development, it can be argued that the supply of Russian oil and gas will create the necessary conditions for:

• strengthening the infrastructure of the PRC for the storage and transportation of energy resources;
• integrated energy development in urban and rural areas;
• increasing the pace of construction of infrastructure projects in the oil and gas sector;
• successful development of China’s pipeline transport;

These agreements will also reduce Russia’s dependence on European energy markets, threatening sanctions and competitive risks.

3.3. Russian oil or OPEC’s oil for China: comparative analysis

Since the nineteenth century, four main stages of the development of the oil market can be distinguished.

The first stage (until 1973) is usually called the stage of leadership of oil companies, which are called the “Seven Sisters.” The world oil industry at the first stage of its existence developed under conditions of monopolization and monopoly prices. This stage is characterized by the dependence of oil prices on the seven largest international oil companies – oil producers (American Exsop, Gulf, Mobil, Royal Dutch / Shell, Texaco, British Petroleum, Standard Oil of California. The monopolization of these companies made it possible to keep oil prices at a stable level, regardless of the growth in oil consumption – this, in turn, provided low but stable profits to all exporters. Moreover, since oil prices were kept at a rather low level – at about $3, oil production was considered cost-effective only in countries with production costs, as well as subsequent transportation below this level, that is, most often in the countries of the Arab region (73%). Nevertheless, the main consumers were developed countries (72%) which obviously were dependent on oil imports. Moreover, analyzing this period, it can be seen that the exporters’ incomes from oil sales were not significant, which ultimately led to discontent about the existing order of income distribution and the formation in 1960 of OPEC that included 13 developing countries – the main exporters of oil.

The second stage (from 1973 to 1986) is characterized by a sharp increase in the influence of OPEC on the world oil market. Developing countries organized OPEC in order to defend their own interests and in 1973 nationalized oil production on their territories, which led to a huge “oil crisis”. As a result, oil prices soared in the next two years more than 5 times, which coincided (and to some extent was the cause) with the general raw material and monetary and financial crises that affected the whole world economy during this period. In addition, developed industrial countries could not immediately reduce oil consumption, and this contributed to a price increase until the beginning of the 1980s ($35 per barrel).

Analyzing the above, it is possible to distinguish the feature of the second stage of development of the world oil market. It consists in the establishment of a specifically new, higher, level of world oil prices. It also manifests itself in the transition of the leading position to the 13 developing oil producing countries – OPEC members (Saudi Arabia, Iran, Iraq, Kuwait, Qatar, United Arab Emirates, Libya, Algeria, Nigeria, Ecuador, Gabon, Indonesia, Venezuela).

Another feature is the change in the nature of competition in the oil market. Vertical competition between the national (mostly state-owned) companies of the OPEC countries and independent companies from the industrialized countries operating in the sphere of processing and marketing of oil began to dominate.

High oil demand allowed specific countries with a higher cost of oil (for example, Great Britain, Mexico, Russia) to significantly increase production levels and start their own oil exports, which was impossible in the first period. That led to decrease of the share of OPEC countries in the supply of oil to the world markets and the transition to the third period.

The third period (from 1986 to 2001) is characterized by the following:

1. Exchange pricing for crude oil (prices are formed at specialized trading platforms – oil exchanges, the main exchange players – oil “hedgers” that have a major impact on price behavior).
2. Formation of the global market of “paper oil” and its institutions, similar to financial markets.
3. Gradual dominance of the paper oil market.
4. Unstable and relatively low level of oil prices and the intensive nature of their changes due to the transition to the market of paper oil.
5. Underinvestment of the world oil industry and creation of material prerequisites for the subsequent growth of costs and prices for oil.
6. Key pricing factors – mainly the expectations of financial players.

It should be noted that by the end of the 1980s, a global system of exchange trade in oil and oil products was formed, serviced mainly by 3 centers (New York – NYMEX, London – IPE, Singapore – SIMEX) and operating in a 24-hour mode. The existence of 3 geographical trade exchange centers, together with the massive development of computerization, telecommunications and information technologies, provided real globalization of the world oil market, its functioning in the present-day regime, interdependence and subordination of oil prices in various regions of the globe.

The fourth stage (from 2001 to the present) should be called a period of acceleration of the liberalization of the world oil market. In this stage, two main circumstances are highlighted. Firstly, the oil flows are changing for the implementation of stable supplies, which is connected with the diversification of oil supplies by the largest exporters. Secondly, the role of exchange trade increases and the turnover of “paper” oil increases. At the same time, hedging and speculative transactions begin to have a big impact on the price dynamics.

International analysts today increasingly say that the West is required to reduce its importance from oil supplies from the Middle East as much as possible, and vice versa, to increase Russian supplies and African countries. Nowadays, we can see the same tendency in China where it is noticeable that the government is decreasing oil imports from Saudi Arabia and increasing imports from Russia.

China’s petroleum industry consists of three main companies: CNPC (China National Petroleum Corporation), Sinopec (Chine Petroleum and Chemical Corporation) and CNOOC (China National Offshore Oil Corporation). CNPC was originally aimed at making its business independent by putting its production, marketing and exploration into PetroChina with only 10% of shares belonging to the parent company. The main area of interests of CNPC is the country’s onshore upstream assets. On the other hand, Sinopec was created as a joint stock entity with 80% of state-owned shares divided between the China Petrochemical Corporation Group and Bank of China (53% and 27% respectively) with the responsibilities focused on refining, distribution and petrochemicals. And finally, the last major oil company, CNOOC, which was formed in 2001, received special rights in overseas transaction from the Chinese State Council and got to do business with foreign partners in exploration and development sectors.

As China expands its economic influence by steadily increasing its foreign direct foreign investment, the government recognizes the need to create a powerful diplomatic relationships that would effectively implement its foreign policy and ultimately pursue the interests of the state. NOCs are increasingly expanding abroad through mergers and acquisitions, loan agreements and joint project cooperation not only with other oil companies, but also with resource-rich countries directly. Along with this, the Chinese government has updated and refurbished its diplomatic body to establish closer relations with oil-rich countries, such as Russia and Saudi Arabia. Stability, security and security of supply of China’s energy resources are the main objectives of China’s energy diplomacy. This government support of the NOCs through diplomatic channels is called “oil diplomacy”.

Since 2008, NOCs have acquired assets in the Middle East, North America, Latin America, Africa and Asia and invested about $ 73 billion in foreign oil and gas assets between 2011 and 2013, according to the International Energy Agency (IEA). The Middle East (mainly Saudi Arabia) has always been China’s largest source of oil, followed by some African countries, especially oil-rich Angola. Historically, Iran was China’s third largest oil trade partner, however after US and European sanction caused by Iran nuclear program, China changed its focus on the US and Europe. Similar situation happened to such countries as Sudan and South Sudan which became significant oil exporters to China until production was shut in at the beginning of 2012, following political conflicts between the two African nations over their oil resources.  

As a result, China had to replace the share of oil lost from Iran, Sudan and South Sudan, and Libya with imports from other Middle Eastern countries (United Arab Emirates, Oman and Iraq), Angola, Venezuela and Russia. China and Russia signed agreements on the supply of China to Russia up to 800 thousand barrels per day by 2018, mainly through a pipeline. At present, Russia sends oil to China via pipelines, ships and railways, mainly from Russian fields in Eastern Siberia.

China also dramatically increased imports from Iraq, although future import growth will probably depend much on infrastructure and the political situation in Iraq.

As China is in urgent need of oil suppliers since its oil consumption grows in a high pace every year, it is also important to diversify its oil imports and rely on different options. Russia as a strategic partner of China seems to be a better perspective for the Chinese oil market.

In 2016, Russia became the largest oil supplier to China, for the first time bypassing Saudi Arabia, according to the data by the Main Customs Administration of China.

Deliveries of Russian oil to China in 2016 increased by an annualized rate of almost 25 percent to about 1.05 million barrels per day. The growth of imports ensured the demand from independent private refineries that considered Russia to be the most acceptable supplier. Those private refineries were the first to receive an oil import license at the end of 2015, are easier to process Russian raw materials due to smaller volumes and proximity of ports.

Saudi Arabia became the second largest exporter of oil to China. China increased oil imports from Saudi Arabia in annual comparison by 0.9 percent to 1.02 million barrels per day in 2016.

In December 2016, fuel supplies from Russia reached 1.19 million barrels per day, which is 4.8% more than in December 2015. At the same time, Saudi Arabia’s oil supplies fell by almost 20%, to 841,820 barrels a day.

The third place among oil exporters in China was occupied by Angola, which increased shipments by 13%, and the fourth place – Iraq, which showed about the same growth.

In addition, China increased imports from South America: supplies from Brazil increased by 37.6%, from Venezuela – by 26%. Simultaneously, imports from Iran increased exports to China by almost 18% last year, to a record 624,260 barrels per day[14].

Russia can maintain the status of China’s largest oil supplier and in 2017, thanks to the growth of supplies via the ESPO pipeline against the background of the planned reduction in oil production in Saudi Arabia. The reduction in production of OPEC means that oil producers from the Gulf countries will lose some of their shares in the market, although the majority of their supplies will fall to Europe and the US. Russia is planning to expand the ESPO, as well as supply to China through the territory of Kazakhstan. According to the CEO of Rosneft Igor Sechin, the company’s intention is to increase oil supplies to China to 31 million tons in 2017.

After 2015, oil refineries in China obtained the right to use imported oil. Russia has become a supplier of raw materials for refineries, since imported oil from the eastern ports of Russia is much easier to handle, the size of the vessels is small, and the distance is much closer. However, Saudi Arabia very much appreciates the arrangements for long-term oil supplies with such a precious client as China.

After many years, Russia hopes to become a reliable supplier of oil, especially after sanctions imposed on it. China and Russia are expanding their calculations in national currencies, avoiding the dollar, and are also implementing billion-dollar projects, Chinese companies are getting shares in Russia’s largest oilfields. Beijing, by increasing purchases of Russian oil, wants to be sure that the Russian economy will not deteriorate and will not threaten stability on the borders of China. In addition, buying more oil from Russia, China reduces dependence on offshore oil supplies from countries in the Middle East that are prone to weather interruptions. The situation of Saudi Arabia is now becoming unclear, as the US, the geopolitical partner of the Saudi Arabia, has reduced dependence on oil imports through the shale boom in the country. However, Saudi Arabia still has the Asian market, which gets about 70% of Saudi oil.

SWOT-analysis of Russian oil industry shows that there are many more advantages of using Russian oil instead of Saudi Arabian oil. Despite of some serious threats and weaknesses which are in many ways are similar to Saudi Arabian ones, the overall analysis shows that Russia has significant benefits over the OPEC country, especially due to trade in local currencies, common border and close distance, as well as friendly good economic and political relationships and similar views on the world order and strategy.

Besides, Saudi Arabia and Russia have a lot of political misunderstandings regarding Syria and Iran, which make the relationship between the two countries quite tense, even though they call them “strategic”. Thus, on September 5^th in 2016 during G20 Summit in Hangzhou, Russia and Saudi Arabia have agreed to maintain stability in the oil market and ensure a sustainable level of investment in the long term.

The long-term challenges for supplying countries in the world oil market, including a significant reduction in the world’s capital expenditure on oil production, in particular, in geological exploration; mass cancellation and postponement of investment projects, which in general has already led to a more volatile and, therefore, unstable situation in the oil market in the long run for both producers and consumers. Russia and Saudi Arabia have also agreed that they will develop cooperation in the oil and gas industry to introduce new technologies and will create a joint database of promising technologies in the energy sector. After this agreement, in mid-December, oil prices rose sharply ($58/barrel), which was a new record for the previous 18 months.

In its oil strategy, China is not going to choose one particular oil supplier as the Chinese government realizes that it is important to diversify oil imports and rely on different sources of oil – from Russia, Central Asia, Africa and OPEC countries.

4.      Russia and its challenges in the global market of energy

4.1. Energy resources as an economic center of gravity

By the beginning of the 20th century, Russia accounted for 30% of the world’s oil. After the revolution in 1917 and the subsequent nationalization of deposits, oil production in the country fell. But foreign capital did not leave Russia. Companies such as Vacuum and Standard Oil, to which the Rothschilds sold their assets, cooperated with the Soviet government. As a result, since 1923 the level of exports has returned to its previous values.

Before the Second World War, most of the oil was extracted in the Caspian region and in the North Caucasus. Therefore, control over those most valuable raw materials areas was one of the main tasks of Germany during the war. After the war, oil production in the Caspian Sea began to grow again, but it was decided to actively develop the search and development of deposits in the Volga-Ural region, where in 1975 the output reached a peak of 4.5 million barrels per day.

The USSR made large-scale investments in oil-producing complexes, and this contributed to the rapid growth of oil production in the region. Open fields were not difficult to develop. In addition, they were located near the transport arteries, which was another major factor contributing to the development of the industry. In the 1950s, the Volga-Ural deposits accounted for about 45% of all oil produced in the USSR. As oil production increased, oil exports continued to grow. In the 1960s, the volume of hydrocarbons produced by the USSR was the second largest in the world, which caused a drop in prices for Middle Eastern oil and served as one of the reasons for the creation of OPEC.

In the early 1960s, the discovery of the first large deposits of Western Siberia was announced. This happened when the question arose in the country: how to keep a high level of production after the spoil of prey on the deposits of the Volga-Ural. The opening gave a powerful incentive for the development of the region – thousands of people moved to the harsh land, cities and towns of oil workers grew quickly. The West Siberian Basin became the largest oil and oil producing region in the USSR. Despite the difficult climatic conditions, oil production grew at a record pace. An important feature of the region’s raw materials base was a high concentration of explored reserves in large and large deposits. In 1965, a giant Samotlor field was discovered, containing 14 billion barrels of available oil.

Owing to the development of the oil industry in Western Siberia, the USSR quickly increased production: from 7.6 million barrels per day in 1971 to 9.9 million barrels per day in 1975. And to this day the region remains Russia’s main “oil trump card”: in the Khanty-Mansiysk Autonomous Okrug, about 60% of the annual oil production in our country is mined.

After this tremendous success in the industry, a decline gradually began, caused by the desire to get as much as possible without worrying about the long term. The lack of investments in exploration was compensated by intensive drilling. In 1988, the Soviet Union reached a record – 11.4 million barrels per day, with the largest part being in the fields of Western Siberia. But from that moment technological flaws made themselves felt – it was impossible to restrain the drop in volumes for a long time.

The collapse of the Soviet Union had a major impact on the crisis in the industry. Domestic demand fell, there was not enough export capacity. Due to financial difficulties, drilling was reduced, wells were not properly serviced, no repairs were made. The fall in oil production ceased only in 1997.

Demonopolization and privatization of the industry led to the creation of large vertically integrated oil companies, each of which is engaged in a full cycle of oil production and processing – from exploration of deposits to the sale of petroleum products to the end consumer. These companies today determine the face of the industry, which plays a crucial role in the country’s economy. According to the results of 2007, the largest of them are Rosneft, Lukoil and TNK-BP.

Today in Russia, oil companies are often forced to work in very difficult conditions: they have to extract oil from deposits that were barbarously exploited in Soviet times, from flooded layers, from difficult fields to develop. Therefore, the development of new technologies is one of the priority areas of the industry.

In 2007, before world economic crisis, Russia produced 492 million tons of oil and condensate. It is oil that accounts for about 30% of the total volume of Russian exports. At the current rate of extraction of proven reserves, this liquid hydrocarbon should be sufficient for 50 years. However, many experts believe that the future is due to the development of new technologies that will allow producing oil where it was previously impossible.

To evaluate the current situation in the Russian economy in general and its challenges on the global market of energy particularly, it’s important to take a look at the overall economic growth of the country and the factors that made it happen. It goes without saying that the Russian economy showed an impressive growth in the first decade of the 21^st century including the pre sanctions period 2011-2013. Especially impressive were periods between two financial crises in 1998 and 2009. According to the statistics, between 2000 and 2008, GDP was increased by 83% with the productivity growth of 70%. By 2008 per capita GDP (PPP) had grown to $21600 comparing to only $9300 in the end of 1999, and the country’s share in the world economy increased from from 0,6% to 2,7%. At the same time, there was an impressive upsurge in terms of the welfare of the population showing the growth in real wages (by 3,4 times) and real pensions (by 2,8 times). In fact, in the period from 2000 to 2008, average annual GDP growth was 6,9%, which dramatically declined after the crisis to only 1,0%.

What were the reasons of that significant growth during that period? Analysis showed that the main factors that drove Russian economy before the crisis of 2008 became the following:

1. Investment and consumer domestic demand growth rate was higher that GDP rate.
2. The growth rate of exports was almost the same as GDP rate.
3. Huge oil and gas revenues due to high world prices.
4. Increase in exports.
5. Reforms in taxation system for oil and gas sectors (2002) which made the federal budget receive 70% of the natural rent.
6. The growth in all government expenditures and public investments.

Concluding, all GDP components showed an increase and as a result contributed into the overall GDP growth. Consumer demand became a result of government expenditures and the growth in wages in the public sector, while government procurements pushed forward the demand for industrial products.

As was mentioned above, one of the main factors of GDP growth in Russia were high prices for oil and gas and as a result their revenues. However, after reaching its maximum in oil prices in 2011, the world oil prices became to continuously decline due to shale oil production in the United States and overall economic decrease in developed and developing countries. This is a situation where the whole world is experiencing an economic crisis (following the peak) which, as predicted by some economists, might last for 15 years and which is one of the steps of normal economic cycle. Declining oil prices, western sanctions and the capital outflow prove that it is going to be a long period of recession for the Russian economy.

With the overall stagnation of the economy, exports of oil in value terms fell dramatically for the last two years, moreover it fell to the lows of the last five years due to the devaluation of the ruble, the reduction in production and the current food embargo. The graph below shows that comparing to 2013, export of oil fell more than 2 times by the end of 2016, from 304,8 billion dollars to only 132 billion dollars respectively.

Graph 9. Export of oil in value terms, billion dollars. Source: Russian Federation Federal State Statistics Service.

The devaluation of the ruble played a decisive role in reducing the indices, which followed the strongest fall in oil prices in early 2016. In January 2016, quotes for Brent crude oil fell below $30 per barrel due to excess supply in the market, as well as a reduction in demand from China.

The rate of the dollar to the ruble at the same time skyrocketed to 78 rubles. This coincided with a seasonal decline in business activity in January, which is observed in Russia annually, as well as with a reduction in production in many manufacturing industries. As a result, January volumes of trade became record low – exports fell by one third, and imports – by 20%.

However, since February, volumes of trade, together with the ruble exchange rate, have begun to recover. The largest oil exporting countries – Venezuela, Canada, Nigeria, Libya, for political and economic reasons, were forced to reduce the production and supply of black gold. As a result, excess production decreased, and prices began to return to normal. In the autumn, quotations continued to grow, and together with them the ruble exchange rate. Despite the pessimistic forecasts, after several years of negotiations, the OPEC member countries finally agreed on a reduction in oil production. In addition, the election of Donald Trump as president of the US has provided additional support to the ruble – many expect a change in policy and the possibility of lifting sanctions for Russia.

Graph 10. Export of Russian oil in 2015, billion dollars. Source: Russian Federation Federal State Statistics Service.

It is interesting to note that in terms of the quantity, Russian exports of oil increased which is connected to the overall Energy strategy of Russia and the growth of oil production.

Graph 11. Export of oil in weight terms, thousand tones. Source: Russian Federation Federal State Statistics Service.

The difficult situation in foreign policy forces Russia to direct all its forces to regulate the economy, which is excessively dependent on oil prices; Implement the import substitution plan; Promote the development of other industries and at the same time expand economic cooperation in the Asia-Pacific region. Now China is busy raising and re-profiling production, and with it, the trade of the two countries is developing.

4.2. Pipeline politics for the Chinese energy market

As Russia and China are working close together to intensify their mutually beneficial oil trade, it is necessary to take an important step towards building an infrastructure that would help reach all the goals, including pipelines – the main mean of oil transportation.

Oil transportation in Russia uses three different ways:

• Pipeline transportation – 90%
• Rail transport – 6%
• Road transport – 4%

By the number of pipelines, Russia ranks second after the United States. But, unlike the American ones, the pipelines in Russia are more extensive, and the diameter of pipes used in Russia is more than in the USA. Experts also say that the length of the welded seam of Russian oil pipelines is 30% higher than in the rest of the world. At present, in Russia the length of the main gas pipelines is 161.7 thousand km, and the oil pipelines – 70 thousand kilometers.

The popularity of oil pipelines is explained by its efficiency (it can serve a long time at a one-time cost of construction), as well as cheap transportation.

Today, Russia’s oil transportation system has to solve two global problems of the 21st century. And both of them are about diversification. This is an acquisition of alternative routes that allow to reduce dependence on the Belarusian section of the “Druzhba” (Friendship) oil pipeline and (more importantly) the most unstable Ukrainian sector.

Export of oil from Russia is carried out in three main directions. First of all, this is Europe. There, Russia exports oil to several routes. Two of them, transit ones, have already been mentioned – these are directions through Belarus and Ukraine.

Also, oil is exported through seaports: Tuapse and Novorossiysk in the Black Sea and Primorsk and Ust-Luga in the Baltic Sea. The last direction to Ust-Luga is only now being mastered, for this purpose the Baltic Pipeline System II (BPS-2) is being built. It is the BTS-2 that will make it possible to bypass Ukraine and reduce the load on the Belarusian section.

The second direction, now becoming increasingly important, is Asia. In this direction, oil is exported through Kazakhstan.

Recently, a third direction was opened. Perhaps, for today – the most promising: the eastern direction. The first stage of the East Siberia-Pacific Ocean oil pipeline allows oil to be exported to China, as well as to supply to the markets of the Asia-Pacific Region.

Concluding, the main pipelines of the Russian Federation are:

1) The Baltic Pipeline System (BPS). For transportation of oil from Western Siberia, the Timan-Pechora region, the Ural-Volga region to the Western Europe.

2) The East Siberia – Pacific Ocean oil pipeline (ESPO). For oil delivery to the Far East of Russia and to the countries of the Asia-Pacific region, including China.

3) International oil pipeline “Tengiz – Novorossiysk” (CPC oil pipeline). For the transportation of Kazakh oil through the territory of Russia.

4) The “Friendship” pipeline. To deliver oil from Russia to Eastern Europe.

Pipeline system “Eastern Siberia – Pacific Ocean” has no analogues in the world in its length. The distance from the starting point (Taishet) to the final point (Kozmino) is 4,166 km. Thus, the ESPO pipeline broke the Guinness book record – the North American oil pipeline Edmonton – Chicago – Montreal with a length of 3787.2 km.

The Eastern Siberia-Pacific Ocean pipeline system (ESPO) is built to transport oil to the Russian Far East and the markets of the Asia-Pacific region. The system is technologically connected to the existing trunk pipelines of Transneft and is included in a unified network that ensures the operational distribution of oil flows across Russia in the western and eastern directions.

Supplies of Russian oil to the People’s Republic of China via the Skovorodino – Mohe oil pipeline began in 2011 after agreements have been reached between Rosneft, Transneft and CNPC.

In 2013, the parties agreed to increase oil supplies and bring them to the peak to 30 million tons. According to the intergovernmental agreement of March 22, 2013, for the period 2015-2017, the increase in supplies for the diversion from the ESPO Skovorodino – Mohe should be 5 million tons per year. Due to the technical unpreparedness of the pipeline system in China, oil supplies for 2015-2017 can be carried out in other areas, including through the port of Kozmino. At present, 16.5 million tons of oil from Russia are being delivered to China.

CNPC is building an extension of the diversion from the ESPO oil pipeline with a length of 940 km, with a capacity of 15 million tons of oil per year. The work is planned to be completed by October 2017, commissioning is scheduled for January 1, 2018.

It is planned that in 2018, China should take 30 million tons of oil for the withdrawal of Skovorodino-Mohe from the ESPO system.

Table 11. Potential ESPO capacity.

Source: Transneft.

5.      Conclusion

To sum up, at present, the importance of energy in the world is growing. Energy resources play a significant role for the development of each country. The growing dynamics of energy consumption in the world creates colossal opportunities for countries, the largest exporters of raw materials, to supply resources to the markets of foreign countries, to implement large-scale projects in order to strengthen their positions not only on the national territory, but also beyond.

Today, Russia occupies strong positions in the world arena. The current energy policy of the country, the further development of the oil, gas, coal industry and the electric power industry contributes to the further strengthening of Russia’s positions in the energy markets of foreign countries, as well as the strengthening of Russia’s role as a global energy partner.

Recently, Russia has shown an increased interest in the Asia-Pacific region. The export of traditional energy sources to the region grows annually, the largest oil companies of Russia are carrying out a number of projects to support this region. For Russia, cooperation with China promotes the sale of energy resources in a region with a high potential for growth and development. In the last decade, Russia is implementing measures to raise the regions of Western Siberia and the Far East. China, from this point of view is seen as a key investment partner.

China, as a strategic partner of Russia, needs to diversify its energy resources and suppliers of oil and gas. There is a new vector of the development of oil supplies to the country – the priority of pipeline transport over the sea. For a long time, the oil was supplied to China by tankers, but this route will be vulnerable in case of any conflict between China and the US, due to the overwhelming advantage of the American fleet in this region. Singapore, which does not have warm feelings for China, with the help of the US military threatens to clog the bottle neck of the already insecure Malacca Strait, connecting the Pacific Ocean with the Indian (through which about 80% of China’s imported oil is delivered).

Energy cooperation between Russia and China is mainly based on the development of their gas and oil sectors. Oil industry is becoming a very important direction of trade between the two countries which can be explained by many factors, including western sanctions against Russia that made Russia change its foreign politics and turn to China, overall good Sino-Russian relationships, China’s need to diversify its energy resources and suppliers, common border and similar strategic interests. China and Russia are the largest consumer and exporter of raw materials and energy. The countries are neighbors, which makes the delivery of products quick and economically beneficial. Russia became the first country the Chinese leader Xi Jinping visited after the election in March 2013. This fact confirms the special nature of the strategic partnership between Russia and China.

China and Russia share common interests in many areas. Both sides are actively striving to maintain stability, they object to the creation of a unipolar world, adhere to the principle of “non-interference in the internal affairs of other countries”. China is one of the world’s largest consumers and importers of oil, has large reserves and developed oil industry.

Russia and China have made great progress in bilateral cooperation, which is particularly conducive to their strategic partnership. The supply of oil, natural gas, coal, cooperation in nuclear energy, and many other areas are developing. The long-term partnership between our countries in the fuel and energy complex is comprehensive and is constantly enriched with new constructive content. At the current stage of cooperation between Russia and China, energy cooperation on such components as energy efficiency and renewable energy sources is significantly strengthened.

China is currently in the decisive stage of urbanization and industrialization. In the future, it will maintain a high level of demand in traditional energy sources. The export of oil, gas and the development of energy in general are important elements for Russia for the modernization and development of the state.

Russia has been fighting for the Chinese market with Saudi Arabia for more than one year, but only in 2016 it managed to come out on top for the first time. High demand for oil in China is considered a key condition in the gradual recovery of prices for oil. In 2016, China was buying oil at the fastest pace in the last six years, after 2010.

Russia has an extensive border with China, one of the world’s largest regions of oil consumption. Now the center of demand in Eurasia is rapidly shifting to the east. In Europe, the demand for oil is declining, while in Asia it is growing,

However, new eastern supplies, despite their profitability, hardly occupy a significant share in Russia’s oil exports. According to the Ministry of Energy of the Russian Federation, 203 million tons of oil were exported to Europe last year and 51 million tons to China. Raw materials are supplied via three routes: East Siberia-Pacific Ocean (ESPO) pipe to Chinese Mohe (15 million tons), through the sea port of Kozmino (30 million tons) and transit through Kazakhstan (7 million tons). But the supplies will constantly grow, and by 2040, the share of Chinese oil in the Russian export portfolio may be the same or even higher than the European one. Deliveries to the EU, which is logical, will decline due to falling demand.

As China is one of the fastest growing energy markets in Asia, the total pumping capacity will be increased to 99.5 million tons by 2030 and to 120 million tons by 2040, requiring the construction of new pipelines. The current capacity of the ESPO pipeline, as well as the port through which oil enters China, will not be enough to increase exports after 2030. At this point, Russia will have to increase its pipeline’s capacity to meet the needs of the growing Chinese market.

To sum up, nowadays oil is an important energy source that still cannot be replaced by other types of energy.

In the next decade, oil will remain the leading energy source, providing about 40% of energy consumption. It is followed by natural gas (28%), coal (20%), renewable sources (7%) and nuclear energy (5%). The shares of natural gas and oil will grow, while the share of coal and nuclear energy will decline. It is possible that by the end of the decade the level of nuclear energy consumption will stabilize and the scope of alternative sources will expand, but this will not affect the basic trends for at least the next 15-25 years.

In the longer term (until 2067), the structure of the world energy balance is likely to seek transformation mainly in two scenarios.

The first involves a gradual transition from oil to gas, about the same way that oil replaced coal back in time. Then a shift to renewable sources and, obviously, to atomic energy is expected. At the same time, oil will retain its position as an important source of energy in any case until the middle of the 21st century.

According to the second scenario scenario, if in the next decade progress is made in the field of hydrogen technologies that help to quickly displace gasoline engines, then the reduction in oil consumption will begin much earlier – by about 2025. But this is still unlikely.

The energy intensity of the world economy (mainly at the expense of the developed countries) will gradually decrease, but a linear relationship between GDP growth and increased energy consumption will remain. The continuing rise of the global economy will continue to drag the demand for energy for a while. However, consumption is slowing and lags more and more behind GDP. This means that world economies begin to adapt to high prices through a reduction in energy intensity and resort to the use of alternative and renewable energy sources.

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[2] New York Times, 18 Dec 1992, “Yeltsin starting 3-day China visit”

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[5] Постановление от 30 июня 2012 г. N 664 О МИНИСТЕРСТВЕ РОССИЙСКОЙ ФЕДЕРАЦИИ ПО РАЗВИТИЮ ДАЛЬНЕГО ВОСТОКА. http://minvostokrazvitia.ru/images/downloaded/pprf664.pdf

[6] The Federal Customs Service. http://www.ved.gov.ru/_tes_rus_chi_2010_2011/

[7] Jonathan Masters / Council on Foreign Relations / cfr.com

[8] The Federal Customs Service. http://www.ved.gov.ru/exportcountries/cn/cn_ru_relations/cn_ru_trade/

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[10] European Union, trade in goods with Russia. http://trade.ec.europa.eu/doclib/docs/2006/september/tradoc_113440.pdf

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[14] http://www.forbes.ru/biznes/337759-rossiya-vpervye-stala-krupneyshim-postavshchikom-nefti-v-kitay