Xi’s Costly Obsession With Security
How a Quest for Control Threatens China’s Economic Growth
When the United States and the European Union decided, in March 2014, to impose sanctions against Russia in the wake of the Ukraine crisis, they attempted to target a key proxy of Russian geopolitical influence: its energy sector. Part of the sanctions’ sting came from complicating Russian energy project finance deals and increasing the level of risk attached to Russian debt. In response, the Kremlin attempted to build new energy-financing channels and export markets. Its first inclination was to turn to the fast-growing energy consumers in Asia, with a particular focus on China. In addition to negotiating a May 2014 deal for Russia’s Gazprom company to supply up to 38 billion cubic meters of gas to China National Petroleum Corporation for 30 years, China became a source of loans for oil and liquefied natural gas (LNG) projects aimed at its market.
Progress on Russia’s eastern gas strategy since then has been sluggish, however, mainly because of China’s slowing growth and its ability to exploit its strong bargaining position relative to Russia, whose eastern hydrocarbon assets are stranded owing to a lack of readily available markets. As a result, the Kremlin has turned its foreign policy strategy back to an old Soviet source of geopolitical influence—the Middle East. The United States’ decision to abandon its role as regional underwriter in chief over the course of Barack Obama’s second presidential term, as evidenced by a series of U-turns on Syria and the decision to indirectly support a regional rebalancing of power between Saudi Arabia and Iran following the lifting of nuclear sanctions in 2016, has allowed the Kremlin to claim a stake in the Middle East’s conflict hot spots, as well as to insert its energy sector at the heart of the region’s oil and gas markets.
The May 2017 rollover of an agreement between OPEC and non-OPEC countries to restrain production in an attempt to bolster oil prices has brought Russia, as the largest non-OPEC producer, together with Saudi Arabia, as the dominant OPEC oil exporter. Both countries need the price of oil to rise above $50 per barrel, with Russia keen to sustain its budget ahead of a presidential election in March 2018 and Saudi Arabia desperate to finance an expensive war in Yemen, maintain social provisions to avoid domestic unrest, and support the planned initial public offering of its most important company, Saudi Aramco. (Indeed, the difficulties facing Saudi Aramco in overcoming the hurdles surrounding its partial privatization could be a key future target for Russia’s companies.)
The world’s two largest oil exporters have become especially close since November 2016, when Russia decided to cut production by 300,000 barrels per day—effectively half the total non-OPEC supply reduction. Saudi Arabia has stated its desire to institutionalize Russia’s relationship with OPEC. And in June 2017, Deputy Crown Prince Mohammed bin Salman and Energy Minister Khalid al-Falih made an official visit to St. Petersburg. Their meetings with Russian President Vladimir Putin and Energy Minister Alexander Novak saw much mutual congratulation over the perceived success of their combined oil market strategy, as well as talk of bilateral cooperation and joint projects across the oil industry.
Russia, however, is not allying itself just with Saudi Arabia. Moscow’s attempts to spread itself across the Middle East can be seen in the corporate deals that have been signed over the past two years in multiple countries. The Russian company Lukoil, for example, has operated oil production at the West Qurna field in Iraq since 2009 but is in negotiations to expand output there and to start production at the newly discovered Eridu field. And Lukoil CEO Vagit Alekperov recently met with Iranian Oil Minister Bijan Zangeneh to discuss investment in two onshore fields. Gazprom Neft, Gazprom’s oil subsidiary, has taken three exploration blocks that permit it to drill for hydrocarbons in Kurdistan while also operating the Badra field in southern Iraq. Rosneft, another Russian oil company, has signed cooperation agreements in Kurdistan and Libya and has bought a 30 percent stake in Egypt’s giant Zohr offshore gas field. Its new subsidiary, Bashneft, has begun drilling on Block 12 in Iraq. Additionally, four Russian oil companies have begun negotiating for opportunities in Syria, a venture driven as much by politics as by commercial interest—although the likelihood of finding large new oil fields is relatively low, the investments have a clear symbolic significance.
In Iran, Gazprom has been negotiating with authorities to invest in the North Pars field (a potential LNG development) and in the Farzad B offshore gas field, with the stated intention, however far-fetched, of providing gas exports to Pakistan and India, which would offer another possible diplomatic negotiating tool for Russia. Furthermore, Gazprom Neft has signed a memorandum of understanding with the National Iranian Oil Company for two potential oil field developments, while the Zarubezhneft and Tatneft companies have also inked two oil deals each with Tehran. At a government level, the Russian Ministry of Energy has signed an oil-for-goods deal that should see it purchase 100,000 barrels per day of Iranian crude via its trading company Promsirieimport.
All this activity makes it clear that Russia is using energy diplomacy and its energy companies to play the role of negotiator between various parties, most importantly between Iran and Saudi Arabia. To be sure, the process had a rough start, with the failed April 2016 OPEC meeting in Doha being at least partially blamed on Russia’s inability to bring Iran to the negotiating table. Since then, however, the Kremlin has been rather successful in managing to maintain a balance in its relations with both parties. Although it has certainly not brought about any rapprochement, it has nevertheless shown a relative evenhandedness. That has allowed it to negotiate commercial agreements in both countries while also providing support for cooperation within OPEC that might otherwise not have been possible, given Iran’s initial unwillingness to comply with any production agreement until its own oil output had reached pre-sanctions levels. As a result, it has managed to gain credibility with both sides and to enhance its position in the region.
The benefits of an expanded Middle East presence for Russia are not just political. The most important effects of U.S. and EU sanctions on the country have been financial. In blocking access to international capital markets for specific Russian companies, they have made servicing short-term debt more difficult. In response, Russia has looked for alternative sources of funds, and one obvious route has been via energy-trading companies such as Glencore, Vitol, and Trafigura, all of which were prepared to offer oil prepurchase arrangements, whereby the trading houses provide a lump sum in return for crude oil deliveries. Given the importance of the region to the oil market, these traders naturally have strong links to the Middle East, and as a result they provide another conduit to increased Russian involvement. Russian companies have been involved in the trading of Kurdish crude oil (taking advantage of its below market prices), with Rosneft, for instance, prepaying for oil for its European refineries. More important, the oil traders have also been able to introduce Russian companies to new sources of capital.
The most obvious example of this is the investment by Glencore and the Qatar Investment Authority in the sale of 19.5 percent of Rosneft in December 2016, which further cemented Russian energy links with the Middle East by underscoring that direct investment from investors in the region into Russian assets is welcome. Inadvertently, this deal may also position the Kremlin at the center of another regional diplomatic triangle, given the recent move by Saudi Arabia and three other Gulf countries to sever links with Qatar. It will clearly be a challenge for the Russian authorities to maintain friendly relations on all fronts.
Despite Russia’s successful inroads in the past two years, it is uncertain how long Moscow can maintain its triangulating role.
Despite Russia’s successful inroads in the past two years, it is uncertain how long Moscow can maintain its triangulating role. Both it and Riyadh appear keen to create a long-term partnership, with talk of formalizing relations and furthering bilateral cooperation. Furthermore, Rosneft CEO Igor Sechin’s visit to Riyadh has raised suggestions within oil industry circles that Russia and Saudi Arabia may be preparing to undertake oil swaps and even to divide the Asian market in order to avoid excessive competition. This positive momentum, however, seems to be built on relatively uncertain foundations. The two countries’ incentives around the OPEC agreement will change as the new rollover agreement expires in March 2018. By then, Putin will likely have been reelected, reducing the pressure on Russia to maintain a higher oil price and continue any further production restraint, which would then be more of a necessity for Saudi Arabia.
If there is a change of Russian attitude toward an OPEC agreement, then other political tensions between Iran, Qatar, and Syria could emerge, perhaps exacerbated by the possible return of U.S. influence in the region, given U.S. President Donald Trump’s recent attempts to rekindle a strong relationship with Saudi Arabia (which have been helped by his anti-Iran stance). Russia’s strategy of creating triangles of diplomacy would then be sorely tested, and the corporate deals that have taken place across the region could become an even more important linchpin in Kremlin strategy.
U.S. Intervention or Not, the Sea is Already Boiling