Russia's Pact with China: Will Others Follow Suit?

WSJ is reporting China and Russia have signed a $25bn 20 year pact. Russia will supply 300,000 barrels per day in exchange for this $25bn. This is similar to what I wrote yesterday, when I suggested Kazakhstan should go to China and sell stakes in some oil field. Now that big bro Russia has shown the way, other Eastern European countries will follow suit.

300K barrels per day = 109mn barrels a year. At a 9% discount rate - remember China is investing in 3% treasuries today - this would suggest a $25 oil price assumption. At a 15% discount rate - to put Russia geopolitical risk etc etc - we get $37 oil price assumption. Clearly Russia is reconciled to the new reality.

Russia in 2008 is different from Russia in 1998. It still has tons of forex reserves to buy time till the end of this year, where it could do deals like this to shore its forex. The Rouble has been a one way bet in the last two months, but Russia is far from collapsing compared to other East European countries. What Putin needs to do is to convince Russians not to convert their roubles into dollars en masse, because then we get a self fulfilling prophecy.

Comments

[Conan the B...:]

Russia used to have more than $500 Billion, it now has a little over $300 Billion having spent the rest trying to support the Ruble. It Owes foreigners about $400 Billion. This helps with their credit.

Feb 19 04:12 AM

[avd:]

Sorry, what is this oil price you are calculating? $25bn is a credit not the price paid for 20 years of oil supply. The credit will be returned unless Russia goes bankrupt, and the price of oil will be market price at the time of delivery.

Feb 19 04:33 AM

[the_lazy_ob...:]

avd is right. the entire agreement does NOT specify the price that will paid for the oil itself. the $25 billion is a loan, and not a payment for the entire 20-year supply.

Feb 19 08:20 AM

[Ferdinand E...:]

To comment on the above, $37/b cannot possibly be the assumed oil price for Russia over the coming 25 years. This is precisely the kind of so-balled reality that Russia would NEVER accept, because when dealing with the Chinese they do not need to accept it..

Feb 19 09:28 AM

[HaavBline:]

Authors seem to get the georgraphy mixed up too.

Kazakhstan is a Central Asian country, not an East European country.

Eastern European countries has few natural resources that are attractive to China, and they are way too far from China, seperated by the entire east-west span of Russia.

Central Asian states however, are right next door and are already well ahead of Russia in trade with China. Oil & Gas pipeline from Kazakstan are already completed and in use and being extended to Turkmenistan. Chinese energy companies already joinly own and operate oil fields and transport propereties with Kazak energy companies. And these all happened partly because Russia let this Siberian pipeline & oil deal dragged on for more than a decade.

Feb 19 10:12 AM

[iyamwutiam:]

Actually I see more of these 'credits' coming down the pike. It makes perfect sense to synergize raw materials and manufacturing (Russia and China). This could be done in an mutually beneficial way (with more benefit for China).

Russia -staves off the effects of capital flight from Western countries via China excess dollars. China gets to invest in it's infra-structure while commodities are low and bring another option other than investing in a declining dollar. The deals wil eventually be converted into local currencies -and remove the effects of dollar hegemony from attacking these countries-allowing them both to develop.

If India was smart -they would do the same thing and exchange their service sector achievements as well as management for raw materials. In the short run -they get a jump start on investing in much needed infra-structure in a deflationary environment. Russia gets to re-nationalize their core resources usurped by corrupt oligarchs.

If Russia would allow immigration freely -with in twenty years they would be the new US. Where immigrant labor and services exchanged for raw materials would lead to a vastly improved infra-structure that Russian businesses would leverage to competitive advantage. Just as US corporations did with the highways, airports and telecommunications infra-structure created by government funds.

Feb 19 01:23 PM

[HaavBline:]

Makes perfect economic and business sense. But it won't happen until Russians manage to muster enough confidence about themselves. They have deep rooted fears about China's rise.

Free immigration won't happen any time soon either. Russia do allow some of their Slavic bretherns in Eastern Europe to immigrate. But few Asians are wellcome.


On Feb 19 01:23 PM iyamwutiam wrote:

> Actually I see more of these 'credits' coming down the pike. It makes
> perfect sense to synergize raw materials and manufacturing (Russia
> and China). This could be done in an mutually beneficial way (with
> more benefit for China).
>
> Russia -staves off the effects of capital flight from Western countries
> via China excess dollars. China gets to invest in it's infra-structure
> while commodities are low and bring another option other than investing
> in a declining dollar. The deals wil eventually be converted into
> local currencies -and remove the effects of dollar hegemony from
> attacking these countries-allowing them both to develop.
>
> If India was smart -they would do the same thing and exchange their
> service sector achievements as well as management for raw materials.
> In the short run -they get a jump start on investing in much needed
> infra-structure in a deflationary environment. Russia gets to re-nationalize
> their core resources usurped by corrupt oligarchs.
>
> If Russia would allow immigration freely -with in twenty years they
> would be the new US. Where immigrant labor and services exchanged
> for raw materials would lead to a vastly improved infra-structure
> that Russian businesses would leverage to competitive advantage.
> Just as US corporations did with the highways, airports and telecommunications
> infra-structure created by government funds.

Feb 19 03:11 PM

[Mr. Michael:]

I assume the oil would be paid for (at leat partially) by the interest payments. As China isn't making much of of our T-bonds, it doesn't sound like a bad deal. It would be interesting to find the CAGR of the interest. We would still need to know the details of the contract, which I assume will be hammered out between the respective companies. One thing that isn't clear is whether this is just an extension of the previous oil-by-rail supply contract or if it suggests the new spur to China will be built.

Feb 19 03:20 PM

[James Lewis:]

I think Haavbline understands the dynamics here. Russia knows that the USA would never even think about trying to annex the region to utilise its natural resources. Where as Russia is very scared about China's rise. Now the reality is that China would never try and annex Russia. Russia could position its war heads all along the border and cause substantial damage to China. Also Europe and the USA and their allies would come to the rescue of Russia for the obvious reason of trying to keep China's power in Asia. Europe and USA coming to Russia's rescue bet I get a few tick downs for saying that. But anyone that understands the dynamics of pseudo-wars would be able to connect with the scenario in 10-15 years. Countries are driven by self interest in war scenarios and making friends with the enemy to defeat a another enemy is all too apparent. This is of course is one of the negative self-fulfilling prophecies of war and the reason the world is the way it is.

Saying this Russia is very paranoid and China is very ambitious so this is always at the back of Putin's mind and probably at the side of the mind of a future leader.

Of course it is my belief that China is very smart and understands occupying large nations is impossible. Having looked at the problems the USA has faced trying to occupy small Iraq and its own knowledge of the problems it has had occupying Tibet (which is tiny and the people do not have arms or any weaponary). Therefore to China it make sense that they instead slowly but surely Buy Russia's oil/mineral infrastucture and resources using its business acumen. Its no secret Russia is absolutly useless at doing anything but selling its resources. By the looks of their surplus now maybe they are even bad at doing this. So I am sure the Chinese know they will ample opportunity to buy. And when China wants to buy things it needs, diplomacy rules over everything.

Of course Putin knows this and also knows he is had badly positioned his country. But what can he do. Well if he is smart, he will realise that he needs to decide between continuing his slightly cold war with Europe/USA or position his country incorrectly by fighting this pseudo war that Russia can not win. A luke warm relationship with the West is far better that a great freindship on the outside that can only bring the very thing Putin wants to stop and thats Russia's oil resources being taken.

He should be happy that the USA/Europe are fully aware Russia has the ability to kill 20% of the world in a few days with his nuclear arsenal. The USA/Europe is hardly going to push Russia to the point it needs to fight back with weapons is it?!

Instead he should focus on trying to building relations with the west and the east.

Of course the USA/Europe need to also give Russia some incentives to do this and forfeit some of it power in the short term to build its relations with Russia in the long term.

Obama is open to doing deals with Russia. Obama is very tough but will compimise for the good of building a future that the USA is not at war with everyone in the world to keep it super power status.

Feb 19 04:27 PM

[searcher:]

Tartars and the Golden Horde are very much alive in the Russian psyche, but that won't deter the priority of necessity.

Feb 19 04:41 PM

[coreopsis:]

Unfortunately except for searcher's comment, none of these postings reflects a very deep understanding of either the current or historical dynamics. Obviously, no one here has spent time in either China or Russia in recent years -- these two countries have a long history of mutual interdependence (as well as distrust of course) -- but the fact that both Putin and Wen spoke in Davos is indicative of a larger cooperative spirit. This results from many, many factors well-enumerated in other articles, but suffice it to say -- both countries are deeply distrustful of the western capitalist model as promulgated by the US/UK/Europe. It has wrought tatters to those areas, but also the larger global periphery. Inside talk is that Putin and Wen consulted with each other before committing to go to Davos, and made sure their speeches were delivered in tandem the first day.

So the speculative blather above is very superficial. Don't discard the old concept of 'Weltpolitik' -- it's alive and well, except for the hypocritical western economies that lecture emerging economies on the necessity for open markets...and then in crisis, rely on protectionism (US, France, Germany, UK etc).

Feb 20 12:25 PM

[Roscat:]

As said above, the Russia-China relationship is deeper than many understand.

The oil deal is just the beginning of the dollar fall. China will pay in roubles and thus will support the Russian currency by selling the dollar. China will further buy Eastern European currencies against the dollars they have in order to diversify.

This will support the EE countries, China's diversification and the US dollar needs of more capital.

But, it needs to happen faster and China only likes things incremental.

Regards.

Feb 20 05:16 PM