Petroleum is very important for Russia and its place in the world. Of course, there is a lot to Russia other than Oil. Russia was the country that beat back Hitler’s armies in the second world war. It is also the first country to send a man to space. And it is still the country with the largest nuclear arsenal in the world. That said, it is impossible to understand Russia’s relationships in today’s world unless we understand its position in the energy world. In this post, I will look at Russia’s relationship with Saudi Arabia, Europe and China. Let us begin with understanding the Russian Hydrocarbon sector.
Russia’s Energy Might
Russia is the third largest producer of crude oil, just behind Saudi Arabia and not too far from the US. It is also the second largest producer and exporter of Natural Gas behind the United States. Interestingly, most of Russia’s gas exports are by pipeline. This is important because pipelines reduce the cost of transport significantly.
Russia has long been a significant producer of Hydrocarbons. However, the production in the country suffered when the USSR disintegrated. It recovered but then the world wide demand fell due to the Asian financial crisis. In this century, the crude oil production in the country has increased steadily until the demand fall caused by the Coronavirus crisis. The first decade of the Twentieth century was very good for prices. On the back of increased production and prices, the oil exports increased from $ 36 Billion to $ 284 Billion between 2000 and 2012. The gas exports increased from $ 17 Billion to $ 67 Billion.
This money has been critical for the country and has strengthened it militarily, economically and socially. As Daniel Yergin says in The New Map,
“As the oil and gas revenues mounted, Russia went from economic weakness to strength, paying off international debt, raising wages and living standards, increasing pensions, saving money in stabilization funds, spending more on defense and financing its restoration as a great power.”
The increase in Russian exports together with the US production boom due to the Shale Revolution has changed the energy world. In Yergin’s words, the world moved from an OPEC /non Opec paradigm to a Big Three paradigm with Saudi Arabia being the third.
This has changed how Russia and Saudi Arabia relate to each other.
Russia and Saudi Arabia — Frenemies
Russia and Saudi are the two biggest exporters in the Hydrocarbon world and hence competitors. The erstwhile Soviet Union had a big role to play in the formation of the Organisation of Petroleum Exporting Countries (OPEC) where Saudi Arabia is a leader. The surging volumes of Soviet oil caused the oil prices to fall. Enraged at a reduction in their revenues, Saudi Arabia and Venezuela led other exporting countries to form OPEC. In the past, OPEC countries have agreed to production cuts multiple times to stabilize or increase oil prices. However, now with Russia’s position in the Big Three, no price fixing can happen unless both it and Saudi Arabia are on board. Hence, they have to cooperate at times of low oil prices and this has happened twice in recent years.
In 2014 crude prices started falling after being more than $100 per barrel for many years. Price fall is a concern for oil producing countries because their economies and government finances depend a lot on oil revenues. Saudi Arabia realized that it was no longer possible for OPEC to stabilize prices by cutting production. If they cut production, the volumes would shift to non OPEC producers. An attempt was made by Saudi Arabia, Russia and Mexico to arrive at a deal, but it did not work out. The prices kept falling.
In September 2016, President Putin of Russia and the then deputy crown prince Mohammad Bin Salman of Saudi Arabia had a meeting. They agreed that no stable oil policy can be followed without the involvement of Russia and Saudi Arabia. Later in the year, OPEC and some non OPEC countries agreed to a production cut of 1.2 million barrels per day. The arrangement has been called OPEC-Plus or the Vienna Alliance.
In 2020 Coronavirus hit all economies of the world and oil prices fell sharply. There was an attempt to reach a deal to cut production but the attempt failed. Miffed, the Saudis announced that they would increase their production from 9.7 to 12.3 million barrels per day. Over a period of time, the prices reached $14 per barrel. The US, under President Donald Trump, got all OPEC-plus producers to agree to a steep production cut of 9.7 million barrels. Russia and Saudi Arabia would contribute 2.5 million barrels each to this cut.
Russia has carved a significant role for itself in the wider Middle East and the oil revenues help. For example, Russian assistance was a big reason that the Syrian President Bashar Al-Assad could crush all his opposition. Russia is also one of the few powers that can talk to almost anyone in the Middle East. However, a detailed discussion of Russian actions in the Middle East is beyond the scope of this post.
Let us look at the Russian European relationship next.
Russia and Europe: Can’t live with you or without you
The last many decades of relative peace have caused some of us to forget the bloody history of Europe. The great powers on the continent have fought ferocious wars for centuries and suffered immense death and destruction. In recent decades, the continent has hoped that increased commerce between great powers would reduce the risk of war. However, increased dependence, especially for something as vital as energy also means that you can become very vulnerable when conflict does happen. This is the backdrop of the relationship between Russia and Europe.
In 2021, Europe imported more than 90% of its crude and petroleum product requirements. The biggest imports were from Russia.
Russia also supplied 35% of the Natural Gas requirements of Europe. This supply was through a set of pipelines. The cost of transportation by pipes is much lower than the alternate method of liquifying the gas, transportation by tankers and then re-gassifying it. This cheaper pipeline gas was attractive for both industries and households. The pipelines have also been the cause of disputes for a few years now.
In 2005, more than 85% of gas sold by Russia to Europe were through pipelines that passed through Ukraine. Ukraine got gas for its own use from this pipeline and also charged transit fees. This arrangement worked when both Russia and Ukraine were part of the Soviet Union. However, bickering started when Ukraine became independent. According to Russia, the price paid by Ukraine for its own use gas was way below market price. Furthermore, Ukraine did not regularly pay its bills even at these concessional rates. When Russia tried to cut supplies in retaliation, Ukraine simply took the gas it needed from the pipeline. This meant that Russia’s other European customers faced shortfalls.
Russia and Ukraine settled their gas related disputes in December 2019. Russia guaranteed five years of volumes to Europe, which would have guaranteed transit revenues to Ukraine. The Russians also agreed to settle a $ 3 Billion arbitration claim of Ukraine. Unfortunately, disputes about Natural Gas were only a part of the problem between the two countries. As we know, war broke out between the two countries in 2022.
Russia has made other pipelines to Europe. Yamal-Europe through Poland and Blue Stream that runs under the Black Sea to Turkey. However, from a Russian point of view, both pipelines have the same problem — they pass through third party countries that can raise their transit charges and cut into Russian profits. The Nord Stream pipelines were supposed to remove this vulnerability for Russia. The Nord Stream pipelines are a pair of pipelines that run under the Baltic Sea directly from Russia to Germany.
The US has long opposed these pipelines. The US felt Germany especially was becoming too dependent on Russia. President Trump went as far as to say, “Germany is a captive of Russia.” The US imposed sanctions that made it difficult for the second pipeline to come up. Germany wanted to go ahead with the pipelines, tempted perhaps by assured gas supply at competitive rates. The Germans also hoped that commercial ties between Russia and Europe would increase the incentives for peace. All this has not worked out well. The Russian-Ukraine war has pitted Europe (and US) against Russia. Russia throttled the supply of gas to Germany many times. It claimed that it was for maintenance. In September 2022, both the pipelines were destroyed. Both Russia and the US have been accused of destroying the pipelines.
Not all Europeans have been enthusiastic about their dependence on Russia. Eastern Europeans especially were wary. Lithuania opened a LNG regasification terminal in 2014. The terminal is called ‘independence’. Poland opened a much bigger terminal a year later.
Incidentally, the risks of European dependence on Russian gas have been discussed for decades. As far back as in early 1980s, Americans feared the influence of Soviet Gas on the European US alliance. As Yergin says,
‘Washington also feared the dependence on Russian gas, especially in Germany, could help Moscow generate fissures in NATO and provide a major pressure point if East-West tensions worsened.’
Since the war began in Ukraine, energy prices in Europe have risen sharply. Europe is relying more on LNG. Volumes for Russia have been replaced for both crude oil and Natural Gas. Seaborne Russian crude oil is banned from entering the EU. China and India have increased their imports of Russian crude. EU imports from the US and the Middle east have increased. This rerouting would increase the global costs of transporting Hydrocarbons. The higher energy prices have impacted industries. It has also taken the energy bills of households up although in many cases they have been subsidized by the country governments.
It is worth noting that the US and Europe have not attempted to totally shut down the exports of Russian Oil and Gas. At least to me, it seems that all they have achieved is some rerouting. Europe knows that they and the world cannot live without Russian Hydrocarbons even as they see thousands of people die in a war on their doorstep.
Europe is wary of Russia. On the other side of Russia is China and the relationship between the two has none of this wariness. Hydrocarbons are one very strong pillar of their relationship.
China and Russia — BFFs
China’s growth has been astonishing for the last few decades. This growth has required fuel. While China gets most of its energy from domestic coal, it has had to import petroleum and natural gas. It has imported these from all over the world.
For a long time, China has worried about what it calls its ‘Malacca dilemma’. A very large portion of China’s imports come from the Persian gulf, and the sea route through the Strait of Malacca is the shortest route for this cargo. China has long believed that this cargo is vulnerable to blockade by the powerful US navy. Imports from Russia and Central Asian Republics either by the Atlantic route or by pipelines reduces this vulnerability.
The Russian-Chinese collaboration in Hydrocarbons was significant even before the current Russia-Ukraine war and one impetus came in 2014. The two countries had negotiated a gas deal for nearly a decade til 2013. The sticking point was price. The Russians wanted the price linked to oil prices as was the case in their contracts with Europe. Beijing wanted prices to be competitive with coal. China has strived to keep the cost of its manufacturing low and energy costs are important for the country.
In 2014 Russia annexed Crimea and was subsequently slapped with sanctions and the negotiations became urgent. Russia and China announced a $400 Billion USD thirty year deal. The Chinese also promised to provide a $45 Billion financing for a thirteen hundred Mile “Power of Serbia” pipeline. This is not the only major Chinese investment in the Russian Hydrocarbon sector.
The Yamal peninsula is just 300 miles from the North Pole. The conditions there are so harsh that it was believed that it was not possible to extract Hydrocarbons from the region. An independent Russian company, Novatek, did not share this belief. It went ahead with a plan that required a very large amount of investments. 30 Billion Dollars were required to develop the new city of Sabetta. 15 new ice breaking tankers were required, each costing $320 million. The challenges for the project increased sharply when Ukraine related sanctions hit Russia in 2014. Till then Russia had been reluctant to take Chinese investments in their upstream assets but after the sanctions they had no choice. The project took a $12 billion loan from Chinese lenders. The Yamal LNG terminal is now an important supply source for China as the shipments from Yamal do not have to go through the Malacca strait.
A lot of China’s Hydrocarbon imports are from Central Asian Republics. Turkmenistan, Kazakhstan and Uzbekistan are all major Chinese Hydrocarbon suppliers. They are also pipeline partners. China not only buys from these countries but also invests in them. It has had to deal with these countries with the utmost sensitivity. Russia considers them under its own sphere of influence and has been very prickly about what it considers interference from other powers.
In the 1990s, the US pushed hard to build infrastructure to evacuate Hydrocarbons from the Central Asian Republicans. Many in Russia believed that the US was doing this to weaken Russia. The US believed that oil revenues would help build the newly independent countries. It would also reduce the risk of supplies from the Middle East. This is what the Vice President Al Gore, who was leading the US effort, had to say.
“The security of the world’s oil and natural gas resources continues to be the highest interest of the United States and its allies. Today, the boundaries of the region over which U.S. interests are concentrated expanded to the Caucasus, Kazakhstan, and Siberia.
Russia was unable to prevent the building of the pipelines and resented it. China has been sensitive to this resentment. It is to the credit of the leadership of China as well as the central Asian republics that as of now they have been able to manage the Russian sensitivities.
The Chinese-Russian relationship has many elements. However, there is no doubt that Hydrocarbons are at least one reason why in 2018, President Xi said, “President Putin is the leader of a great country who is influential around the world. He is my best, most intimate friend.” This was when he gave Mr. Putin a “friendship medal” which looks like a large gold necklace.
Russia is one of the Big Three of the Petroleum world. This position is crucial to understanding its relationships in the world. The Hydrocarbon revenues help it become strong militarily and economically. Hydrocarbons are also central to these three key relationships.
- Russia and Saudi Arabia compete as the two biggest suppliers in the Hydrocarbon world. They also cooperate in tough economic times when oil prices fall too much.
- Russia is the closest Hydrocarbon supplier for Europe. However, Europe and Russia have a complex history and Europe is wary of depending too much on Russia. Europe is also unable to stop Russia from being a supplier to the rest of the world.
- Russia’s other big neighbor is China and the energy thirsty country has an excellent relationship with Russia. China gets Hydrocarbons not only from Russia, but also from Central Asian Republics, which Russia considers in its sphere of influence.
Edddit: The price of icebreakers corrected. 320 million and not 320 billion. Thanks Praneet for the alert.
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