Russia`s Pivot or Pirouette to the East? A reality check Reviewed by Momizat on . [caption id="attachment_5512" align="alignnone" width="615"] As a measure of Russia`s slowness to reorient itself to the Pacific area, consider this: Russia exp [caption id="attachment_5512" align="alignnone" width="615"] As a measure of Russia`s slowness to reorient itself to the Pacific area, consider this: Russia exp Rating: 0

Russia`s Pivot or Pirouette to the East? A reality check

As a measure of Russia`s slowness to reorient itself to the Pacific area, consider this: Russia exports nearly as much to The Netherlands as to the whole of Asia.

As a measure of Russia`s slowness to reorient itself to the Pacific area, consider this: Russia exports nearly as much to The Netherlands as to the whole of Asia.

Much has been written and reported of Russia`s own “pivot to the East” but what of the realities and practicalities of this move by Russia towards China and its search for alternative markets to its past dependence on the West?

A perusal of the 2014 year end financial statements reveal that for the two significant energy companies, Gazprom and Rosneft, the share of their exports that go to Europe are respectively 83 percent and 67 percent. As Europe has historically been the key market, infrastructure in the form of pipelines have been constructed to meet those needs. Obviously, the last twenty years – and in particular, the last decade, has witnessed the rise of China as the world`s centre of “economic” gravity has shifted to the Pacific region.

China has sought to access its energy needs from multiple sources, such as Central Asia, increasingly Africa i.e. Angola, South America i.e. Venezuela and indeed the Middle East. Russia has been somewhat of a bystander on these developments from a narrow business angle although it has watched with a mixture of awe and anxiety from a geopolitical perspective how China has evolved to the world`s second largest economy and China`s growing interest in what it considered its historic sphere of interest, such as Central Asia.

As a measure of Russia`s slowness to reorient itself to the Pacific area, consider this: Russia exports nearly as much to The Netherlands as to the whole of Asia.

From a number of angles, Russia was going to need to engage with China as, to borrow an old expression, because “that is where the money is.” Thus, even proceeding the conflict in Crimea and the Ukraine, in October 2012, Russia`s President Putin had already instructed Gazprom to commence construction of a 4,000 km pipeline from  Eastern Siberia to transport Yakutia’s gas to Primorsky Krai and Far East countries, particularly China.

A key stumbling block was the sales price that Gazprom would be able to charge its Chinese customer given it has been able to dictate to its European customer base – a pricing mechanism which is now the subject of an investigation by the EU competition authorities.  China has been loath to commit to such a long-term pricing formula given its stance on purchasing in the market with flexibility.

But that long-term pricing mechanism is essential to Gazprom since it is the basis on which it can secure long-term project finance from financial institutions, including western banks. Unless of course, the Russian government wished to finance it itself and take the attendant risk. This is has been reluctant to do despite the fact that it ostensibly has the financial resources to do so on its own account – the Reserve Fund.

The annexation of Crimea and the conflict in eastern Ukraine brought the “pivot to the East” policy into the spotlight less as a means of diversification away from the western market coming under pressure from multiple sources although Gazprom still supplies 30 percent of Europe`s needs on average –  but as geopolitical reinsurance for the Russian government as relations with the West deteriorated. Gazprom was not specifically sanctioned – there is no gas embargo by the EU for obvious reasons but there is in terms of financing and future exploration projects. However, the Russians seemed anxious to demonstrate to one and all that they possesses “options” elsewhere even if it was unclear what they might be or the likely costs to be incurred.

Thus, in an event of much fanfare, on 21 May 2014, Russia and China signed a 30-year gas deal which was needed to make the project feasible. But there was scant detail available on the specifics of the deal and the all important pricing. But much was said of the headline: a thirty-year, USD 400 bln deal that will see as much as thirty-eight bln cubic meters (bcm) of Russian gas go to China annually from around 2018 to 2047. This works out at around USD 13 bln per annum. But Gazprom`s sale of gas to Europe was of the order of USD 36 bln in 2014.

A further deal was concluded in November 2014 with China. But times were a-changing. Oil prices have declined sharply since those halcyon days and now stand below USD 50 per barrel – which have had important knock-on effects, albeit with a time lag, on gas prices.

China has had good time to analyse this deal and there is now some temporising on their part. As the Chinese economy itself undergoes a marked slowdown in its growth and seeks to contain the fallout of recent share price falls impacting on the real economy, it is seeking to delay the project.

China is also quite cautious about the extent of its investment in Russia. It has taken note of western investor experiences in the country even if has been comfortable with doing business in countries where western companies are unwilling or unable to get involved in – think of Zimbabwe and Venezuela. Its foreign investment in Russia amounted to just USD 1 bln in 2014, not small but a sign that it remains very cautious about the Russian business environment.

Europe and the USA account for 90 percent of Russia`s foreign direct investment. The EU accounts for 50 percent of Russia`s total trade versus China`s 11 percent.

Indeed China`s real substantive interest is in commodities and natural resources, – areas of vital strategic interest to the Russian government,  which hitherto have been closed to it obtaining a significant controlling interest in.

The gas project has already been delayed beyond 2018 and is likely to be delayed even further. The cost of the project is estimated to be USD 55 bln for Russia (with an additional USD 20 bln to be borne by the Chinese) and is rising both due to domestic inflation and the effects of the depreciation of the ruble. Indeed the project might end up costing between USD 150 bln and USD 200 bln. This is big money for a company whose market capitalisation is about USD 50 bln and which incurred a net loss of about USD 2.7 bln in 2014.

Given Gazprom`s current travails and, as noted elsewhere the significant potential for further to come its way, such a costly project with its future pricing unclear or subject to the leverage of its Chinese customer would unlikely to have been undertaken by any normal commercial entity, state owned or otherwise.

Indeed, it has been recently reported that Gazprom has already cut its planned capital expenditures this year for the first leg of the pipeline by half.

Thus Russia`s pivot to the East is unlikely to constitute the strategic coup that President Putin presented to the audience. In fact, it may well have been more directed at reassuring a domestic audience that Russia has options aside from the west.  If so, Russia`s geopolitics may yet encounter reality in terms of hard economic truths.

Photo courtesy of Anwar saadat/Wikimedia Commons.

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