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Thursday, 22 May 2014

China and Russia sign a huge gas deal… Or, there is no such thing as ‘coincidence’ in Russia's exports policy. In spite of this deal, Russia is not home safe yet!

In the midst of the turmoil between Russia, the Ukraine and the European Union about the annexation of the Crimean region and the hostilities in East-Ukraine, there was the news that Russia reached an agreement with China about the delivery of Russian gas.

The Chinese government has signed a contract with Russia, which deals with Russian gas deliveries for the next thirty years. Although Russia’s negotiations with China have allegedly lasted for at least ten years, the news about the successful gas deal seems too favourable for Russia to be simply ‘coincidential’ in the current, tense political situation.

It seems that Vladimir Putin has raised a finger towards the West, as a warning: ‘If you want to fight an economic battle with me, it will be me who has the last laugh!’

The following snippets come from news agency Reuters:

China and Russia signed a long-awaited, $400-billion gas supply deal on Wednesday, securing the world's top energy user a major new source of cleaner fuel and opening a new market for Moscow as Europeans look elsewhere for their energy.

Russian President Vladimir Putin and Chinese counterpart Xi Jinping applauded as they witnessed the deal being signed in Shanghai between state-controlled entities Gazprom and China National Petroleum Corp (CNPC).

The deal is a political triumph for Putin, who is courting new partners in Asia as customers in Europe attempt to reduce their reliance on Russian gas to bolster their bargaining positions with Moscow after its seizure of Crimea from Ukraine.

But from a commercial point of view, much depends on the so far undisclosed price and other terms of the contract, which has been more than a decade in the making.

Industry insiders said China had the upper hand in negotiations as they entered their final phase, aware of Putin's need for new customers as his isolation in Europe intensified.

Industry estimates showed that the price of the agreement may have come in at around $350 per thousand cubic meters. The Western European average is $380.

Another potential sticking point has been whether China would pay a lump sum up front in order to fund considerable infrastructure costs.

Gazprom CEO Alexei Miller said that element of talks remained unresolved, but Putin said China would provide $20 billion for gas development and infrastructure and that the price formula was similar to the European price tied to the market value of oil and oil products.

Analysts said broader, political factors were likely to have been at play around the negotiating table.

"Given the EU sanctions that could potentially hit Russia, I don't think Gazprom is in a position to strike a very high price for its gas," said Gordon Kwan, head of Asian oil research at Nomura.

There is little doubt that this contract with China is extremely good news for Vladimir Putin, in the current political conundrum.

However, in my humble opinion, there should also be little doubt that China has fully benefitted from Russia’s awkward economic situation. According to Russian economist Evgeniy Arsyukhin – in a must-read February 2014 article in the Komsomolskaya Pravda – Russia is at the brink of defaulting.

The economic health of Russia has strongly deteriorated during the last ten years. This is caused by the ubiquitous corruption and the mindboggling waste of government money during the preparations for the 2014 Winter Olympics and other highbrow projects, like the World Championships Football of 2018.

And there is something more: while the contract negotiations between Russia and China have allegedly been finished, the gas supply itself is far from operational yet. It requires vast investments to get such a massive infrastructure of thousands of kilometers of pipelines operational. Money that Russia might not have at hand, at the moment.

This is probably one of the reasons that Vladimir Putin and CEO Alexei Miller of Russian stateowned gas company Gazprom have required (“as in politely asked or begged”) a lump sum payment from China, to cover a large share of the huge, initial expenses.

The following parts of the pipeline infrastructure from Siberia to China must yet be built (see this chart, courtesy of Gazprom):

Map of the future gas infrastructure from Russia
to China. The dotted parts are still under construction
Map courtesy of:
Click to enlarge
This whole operation will probably take at least five years and the future yields of the gas supplies to China should not be overestimated, warns Geert Groot Koerkamp of Het Financieele Dagblad:

Following expections, this operation would take five years. The first Russian gas, coming from the city Blagoveshchensk, will flow into China as early as 2020.

And even when the whole infrastructure will be operational as planned, the deliveries to China will pale in comparison with the current deliveries to Europe. For the time being the contracts with the Chinese amount to 38 billion cubic meter gas per year. However, in 2013 alone, Russia delivered 165 billion cubic meter per year to Europe.
Besides that, the existing contracts between Russia and Europe cannot be finished at will; by none of the parties involved. One of the parties unilaterally ending these gas contracts, will be seen as breach of contract, which could be penalized with billions of dollars in penalties.

To the unformed readers, it might seem that President Vladimir Putin is currently holding all the cards with respect to European gas supplies, after this monstrous gas deal with China. Putin has seemingly a deal in hand, which he can use as leverage during the future negotiations with Europe.

But don’t be mistaken: in spite of this Chinese/Russian gas deal and the continuing gas contracts between Russia and the European countries, the European economic sanctions and its diminishing dependence on Russian gas still could bring the Russian economy slowly to its knees within the next five years.

The ubiquitous corruption in Russia, the megalomaniac infrastructural projects and the gargantuous sports events will surely drain the Russian economy dry from money. And so will the faltering domestic economy, with its poor, underdeveloped manufacturing and commercial service industries, its millions of small civil service jobs and its enormous amount of human labour, where other countries already use machines, computers and robots.

During my many visits to Russia, I was always amazed how many service-oriented jobs had still been maintained there, where similar jobs had been abolished a long time ago in Western Europe: janitors, museum guards, desk clerks in banks and public offices, conductors in trams and busses, ticket sellers, guards in public places. I dare to state that an average Russian company or public service has three times the amount of personnel that a comparable Western company would have.

And when for instance a Russian woman gives birth to a child, she has the right to take maternal leave for a staggering three years, WITH job guarantee. When she will give birth to another child within this three year period, she can stay away from the job for five years or so and still claim her job back after this period. It’s really ridiculous…

This erratic economic situation can only be maintained when the gas and oil money flows in like water. But when it doesn’t anymore…?! I dare to say that when the European gas payments would be reduced within the next five years, Putin can be in for a hard battle at his own turf.

I have no doubts that President Xi Jinping of China is fully aware of this. He has without a doubt tightened the thumbscrews on Vladimir Putin: “You can become our friend and we will never complain about you or your domestic and foreign policy in international bodies, like the UN and the Safety Council. However, our friendship will not come cheaply…”. 

So Russia might have found a new option with its gas, but it is not home safe, yet…

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