Deal of the century?

“My enemy’s enemy is my friend’ is a pithy phrase but hardly a new one. The concept is thought to have been first expressed in a Sanskrit treatise on statecraft in the fourth century BC. Much later Winston Churchill invoked the sentiment once more in defence of wartime aid to the Soviet Union. In the battle with Germany Britain’s leader said he had put his anti-Communist sympathies aside, declaring: “If Hitler invaded Hell, I would make at least a favourable reference to the Devil in the House of Commons.”

In the contemporary world of power politics, the phrase is again being applied to Russian relations with China. Faced with a hostile reception in Europe and the US, Moscow has looked east to China, a country that has chosen not to condemn Vladimir Putin’s annexation of Crimea. In part China’s Russia policy is an extension of its own deteriorating relations with Washington. Prime among these are its strategic concerns over the US “pivot” to Asia (which China views as an attempt to militarily thwart its own regional ambitions). Relations received another jolt last week when the US Justice Department indicted five Chinese army officers on charges of espionage.

Putin’s visit to Shanghai brought back into sharp relief the idea of ‘my enemy’s enemy’ as he portrayed the bear and the dragon as grand bedfellows in a US-dominated world. In an interview with local media Putin called China “our trusted friend” and claimed that cooperation between the two countries had “reached its highest level ever”. In a remark that seemed squarely aimed at the White House, Putin also said of the new Sino-Russian amity: “Our positions on the main global and regional issues are similar or even identical.”

And the Russian president was keen to provide more concrete evidence of his reorientation from west to east. So even before he arrived it was widely touted he would sign a 30-year deal to pipe vast amounts of gas into China. Doing so would demonstrate the strengthening of ties, analysts thought, as well as allow the Russians more room for maneouvre with some of their international critics.

After years of bickering over the terms, the contract was finally signed last week.

So a deal is signed at last?

Most of the press has reported that there were 15 years of negotiations leading up to last week’s announcement, although Xinhua dates the dialogue back even further to 1994, when the first memorandum of understanding was signed between the two countries on gas exports.

Whatever the starting point, the talks have advanced at a glacial pace. And while eight further agreements have been signed over the last 10 years, there’s been no sign of final terms being reached.

Early last week the Russians turned up in Shanghai showing a much greater sense of urgency.

The deal was “98% ready,” Anatoly Yanovsky, deputy energy minister, told media before the trip, while Putin also claimed that negotiations had reached a “final phase”. Gazprom’s chief executive Aleksey Miller was convinced that the two sides were just “one digit” away from agreement, while another Russian spokesman maintained the positive mood last Monday by promising that a contract would be signed at “absolutely any moment”.

That made it something of a shock when the Financial Times reported that talks had broken down at the end of the second day of the Russian visit. The Chinese were blaming price, it suggested. “We won’t be signing,” an unnamed CNPC official had insisted. “At the moment the import price and domestic price are inverted. We are already losing money on imported gas, and we can’t lose more.”

Perhaps the source was misquoted. More likely his comments were aimed at the Russian negotiators. Talks continued until 4am the following morning and a deal was finally announced a few hours later. Putin and his Chinese counterpart Xi Jinping then toasted one another with shots of moutai at the signing ceremony. “This is the biggest contract in the history of the gas sector of the former USSR,” the Russian president celebrated.

Who got the best of the negotiation?

The implication is that CNPC pushed aggressively for a better deal than the Russians were first offering. “Our Chinese friends are difficult, hard negotiators,” Putin said, in a statement that veered somewhere between exasperation and admiration. The Chinese had already got their way last year on the route for the pipeline after the two sides squabbled over where the gas should arrive in China. The Russians were pushing for the Altai route into Xinjiang in China’s northwest but the Chinese demurred on concerns that this was too far from their main cities. They were also suspicious of Russian intentions, worried that the Altai routing allowed Gazprom to pump gas from fields in western Siberia that also supply the Europeans. Not wanting to be played off against other customers, the Chinese asked for dedicated supply from fields further east. They got their way last September when Moscow agreed to build the Power of Siberia pipeline as an alternative route.

The Russians seem to have held firmer on ownership, however, following reports that CNPC wanted to invest at least $10 billion in joint development of the Siberian fields. There was no mention of equity last Wednesday so Chinese calls for a stake in upstream production seem to have been resisted. This fits with the Kremlin’s unspoken block on Chinese ownership in its energy sector (although CNPC did get approvals last year to buy a fifth of the Yamal LNG project led by Novatek, Russia’s second-biggest natural-gas producer after Gazprom).

How about price?

Price has been the main sticking point for years. Gazprom hasn’t wanted to drop below its European tariff levels, fearing other customers will demand discounts too. But the Chinese counter that they won’t pay more than they do for the gas they buy from Turkmenistan.

Russian Prime Minister Dmitry Medvedev continued to insist on benchmarking against European prices in remarks earlier this month that “in the long run, the price will be fair and totally comparable to the price of European supplies.”

Of course, the reference to “the long run” left Russian negotiators with some wriggle-room. But the final outcome on pricing is largely unknown as Gazprom is insisting that the terms are a “commercial secret”. In the meantime the estimates are being based on the headline numbers (a $400 billion contract for 38 billion cubic metres of gas annually over a 30-year period) and the consensus is that Beijing is going to pay about $350 per thousand cubic metres. That would be pretty similar to the prices from Turkmenistan and less than the $380 average that Gazprom demands from its European customers.

Gazprom has pushed to link contract prices to the cost of oil – an arrangement similar to the one used with customers in Europe – but CNPC hasn’t been keen, saying it sees gas imports as more of an alternative to coal. A basic agreement on indexing was reached last year, although there’s been wrangling over the benchmarks to be used.

But Craig Pirrong, a finance and energy professor at the University of Houston, says that speculating about pricing is pointless without a better understanding of the index arrangements. “Since nobody knows what that formula is, they have no clue on what the real price is,” he insists.

Elsewhere, there are calls for more clarity on how much of the contract will be prepaid (Russia needs the cash to finance its own construction costs, which are estimated at a minimum of $55 billion). Alexander Medvedev, the head of Gazprom’s export unit, has said previously that $25 billion was agreed “in principle,” Reuters has reported.

But Gazprom’s CEO Aleksey Miller then admitted that the two sides were still talking about the final sum. “That little slip by Miller is a huge red flag that this deal isn’t as done as the principals claim,” Pirrong warns. “If that part is still under discussion, the entire thing is still under discussion.”

There was more pressure on Russia to do the deal than China?

The Global Times says that it’s not too bothered if the contract hasn’t been completed. “It’s like two brothers doing business,” it explained. “Even if there is no deal, the trust is still there.”

Yet it was brinkmanship rather than brotherly love that was apparent in Shanghai last week. The Chinese knew that Putin couldn’t leave without a major announcement. Levering up the pressure, they pushed the Russians hard until the early hours of Wednesday, before stepping back and clinking glasses on a contract announcement.

But the celebration doesn’t mean that a final deal has been done. Putin may have saved face but it has cost the Chinese little in negotiating terms. And what seems more likely is that the two countries came to an outline agreement last week but left key items like price and upfront payments for another day.

The bigger picture is that the Chinese have been developing other options to meet their gas needs until 2020. An initial pipeline from Turkmenistan that reaches China through Central Asia opened five years ago and Beijing agreed to fund a fourth spur for the pipeline through Tajikistan and Kyrgyzstan in March.

In a timely reminder to Moscow of China’s choice of options, Xi Jinping also hosted the Turkmen president for a three-day visit two weeks ago.

Last year CNPC started getting gas from a second pipeline that links fields off the Burmese coast with the Yunnan border. Likewise China has been building more terminals for delivery of liquid natural gas (LNG), becoming the third-largest importer globally last year.

These alternatives mean that time is on China’s side in the pipeline negotiations, says Feng Yujun, an expert from the Chinese Institute of Contemporary International Relations. As Beijing broadens its options, Moscow’s position weakens, especially if spot prices drop further in response to the shale gas glut in the United States.

“China should actually sit back,” Feng told 21CN Business Herald. “There is no rush to get this agreement inked as the conditions in the international gas market favour its position.”

For Putin the need for a deal is much more pressing. Partly that reflects the threat of sanctions over the Ukrainian crisis, although Gazprom also needs to lessen its reliance on exports to Europe because the shale revolution has been threatening profits.

This combination of pressures may have weakened Russian resistance during the negotiations, even though Zhang Xin, CNPC’s head of external communications, told Russian agency Interfax that the Chinese weren’t using events in Ukraine to push for cheaper gas.

Asked by reporters in Moscow whether political tensions with Europe were shaping the talks, Yury Ushakov, a presidential aide of Putin’s, took a slightly different view. “Obviously, they do affect them to some extent,” he said.

Comments last week from Chen Weidong, a senior researcher at CNOOC, one of China’s three energy giants, then drew comparisons with a “loan for oil” agreement signed with Russia five years ago.

The oil contract also took a long time – 16 years, Chen told Caixin magazine – to come to fruition. More significantly the breakthrough came when Russian oil firms were under financial pressure from the global credit crunch, Chen believes.

Analysis from Morena Skalamera at Harvard University then offered more comparisons with current events. She says that the major terms for the oil deal were reached in the aftermath of Russia’s invasion of Georgia in 2008, when relations with the West were at their worst point since the Cold War. Here, the similarities with current tensions over the Ukraine look obvious.

Does the gas contract herald a wider shift in international ties?

Some analysts seem to believe that Putin’s trip is signposting a shift in relations similar to China’s rapprochement with the United States after Richard Nixon’s visit in 1972. It’s true that there are forces pushing the two countries closer together.

Russia has commodities to sell but a shortage of people. China’s problem is the opposite. More specifically in gas, Russia needs new markets while China has to find a cleaner source of energy than coal. Gas accounts for just 6% of its energy production currently, far below international averages. Gas imports will be crucial in closing the gap: China’s shale resources aren’t expected to generate a meaningful supply for years.

Yet talk of a deeper transformation in relations on the back of last week’s deal looks premature.

For one thing, the Russians are cautious about becoming too dependent on the Chinese. Reflecting some of those concerns, Andrei Piontkovsky, a political analyst, told the Economist magazine last week that an alliance between Russia and China could be likened to one between “a rabbit and a boa constrictor”.

Australia’s former ambassador to China Geoff Raby told CNBC that current ties between Beijing and Moscow are as “good as it gets”. But he cautioned that “historically, there is a lot of fundamental mistrust in this relationship”.

Similarly, an editorial in the Financial Times noted that Russia is now the junior partner in the pairing, a state of affairs that Putin’s “proud” compatriots might well struggle to come to terms with.

The new pipeline isn’t going to be operational until 2018 at the earliest (and possibly longer, say the pessimists) and even then China won’t come close to replacing the Europeans as Russia’s biggest gas customer.

The headline number for the gas deal is huge but the $400 billion of sales is spread over a 30-year period. The Europeans are already buying four times as much gas from the Russians on a yearly basis than the amounts anticipated in the contract signed in China last week.

China’s wider economic ties with Russia also trail those with Europe and the United States by some distance. Russian politicians have predicted that two-way trade with the Chinese will grow to almost $200 billion by 2020. But that is dwarfed by trade between China and the US, which was already close to $500 billion in 2012. At $540 billion in trade flows, business with the European Union was even higher.

There’s also the question of what happens when the political conditions change and Russia feels less in need of an energised relationship with the Chinese to offset its colder ties with the West.

While Putin’s strongman style has been admired by many Chinese (see WiC229) some netizens have warned against expecting too much from a partnership with Russia too. “Don’t trust the Russians,” one contributor urged. “They have never kept a promise and don’t expect them to do so this time.”

“Putin is the winner again,” declared another. “The deal has secured export contracts for Russian gas and bailed him out from the Ukraine fiasco. But when the pipeline is finished and the [Ukraine] crisis is over, Russia could then export to Japan and Korea.”

Chen Weidong from CNOOC made a similar point about the oil contract with Moscow. Looking back at how the mood changed once the 2008 cash crisis had receded, Chen complains that the Russians reneged on parts of the deal.

“A lesser known fact is that after the pipelines began carrying crude oil, Russia never sent the 15 million tonnes of oil that were supposed to get to China by train,” he warns.

“It seems that China and Russia only complement one another when Russia is in need.”

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