For several years, China and Russia have been building an alternative world order to that offered by the U.S. and its allies, as analysed in full in my new book on the global oil markets. This was expedited by the unilateral withdrawal of the U.S. in May 2018 from the Joint Comprehensive Plan of Action (JCPOA) with Iran, its withdrawal from Afghanistan in August 2021, and its ‘end of combat mission’ in Iraq in December 2021, among other factors. China’s strategy to achieve this new world order is one based on incremental advances of power, based around money flowing from its ‘One Belt One Road’ (OBOR) program. However, Russian Foreign Minister, Sergei Lavrov’s comments before his meeting last week with Chinese counterpart, Wang Yi, that Moscow and Beijing are paving the way “towards a multi-polar, just, democratic world order” are too much too soon as far as China is concerned. The widely-publicised remarks have left Beijing needing to be even more careful in how its dealings with Russia are interpreted by the U.S., especially in the energy sector in which high oil prices pose direct economic and political threats to Washington. China stated two weeks before Russia invaded Ukraine that “there is ‘no limit’ to how far Russian and Chinese friendship may go” and signed a swathe of huge oil and gas deals shortly thereafter that provided an additional layer of insulation to both from any U.S. sanctions in the future. However, signalling perhaps that Beijing did not believe that Russia would necessarily launch a full-scale invasion of Ukraine before it did so, only a day after the military conflict spread to Ukraine’s major cities, Chinese President Xi Jinping held urgent talks with Russian President Vladimir Putin and advocated peaceful negotiations between Russia and Ukraine. “China was signifying its discomfort over Russia’s military actions, [and] has reiterated that it respects the ‘sovereignty and territorial integrity of all countries’,” Eugenia Fabon Victorino, head of Asia Strategy for SEB, in Singapore, told OilPrice.com last week.
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At the same time, though, she added, Beijing has refrained from calling Russia’s actions an ‘invasion’, and abstained to vote on a UN Security Council resolution that would have deplored Russia’s aggression against Ukraine. “In addition, so far, China has not indicated an intention to take direct action against Moscow, and has kept trading links with Russia open,” she said. A key reason for this, over and above any ideological aspirations of a new world order is that although Russia accounts for only 2.9 percent of China’s total imports, Moscow did resolutely step up to the plate in 2021 when China faced an energy crunch. “As a result, Russia now accounts for 20.1 percent of China’s total coal imports, and its share of China’s imported crude oil has steadily risen to 15.6 percent by end-2021 from 11 percent in 2014,” highlighted Victorino. Russia’s vital strategic importance to China was bolstered again with the 30-year contract for Russia to supply gas to China through its new Far Eastern pipeline – following the earlier installation of the Power of Siberia-1 pipeline which began pumping supplies in 2019 – as highlighted by OilPrice.com.
“Despite stronger ties between Beijing and Moscow in recent years, there are limits to China’s friendship,” Victorino underlined. “While Russia is an increasingly important source of energy, its total trade with China pales in comparison with China’s trade links with the United States and the European Union [EU],” she said. According to the latest figures, among China’s top trading partners, the EU accounts for 15.3 percent of China’s total trade, followed by the U.S. with 12.5 percent. “As sanctions against Russia mount, there are reports that some of China’s largest state-owned banks are already limiting financing for transactions of Russian commodities,” she told OilPrice.com. “Although sanctions have so far stopped short of Russia’s energy trading, Chinese banks may have already stopped issuing US$-denominated letters of credit related to Russian commodities,” she added. Having said this, she underlined, Chinese yuan-denominated financing for Russian commodities may still be available, albeit with a higher level of scrutiny. “Large Chinese banks would be reluctant to lose access to dollar transactions, in our view, and in the past, China’s big four banks have complied with U.S. sanctions against Iran and North Korea in a bid to maintain access to the dollar clearing system,” she concluded.
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The precariousness of the position into which Russia has put China is further evidenced by the fact that increasing fears of U.S. retaliatory measures against Beijing added fuel to the sell-off in Chinese equities in the aftermath of the invasion on the 24th of February. “China will need to make a stronger gesture of neutrality if Beijing wishes to lower the risk of second order political and economic spillovers from the Russian invasion of Ukraine,” Rory Green, head of China and Asia research at TS Lombard, in London, told OilPrice.com last week. “Our view remains that China will comply with the existing sanctions regime and is prioritising three objectives in the current geopolitical turmoil: first, maintaining normal ties with Russia but avoiding aiding the war effort; second, non-alienation of the EU; and, third, avoiding secondary sanctions and economic damage.”
The relative importance of the first objective is now much lower, he said, as Beijing has made efforts to moderate its stance and move closer to European and Western positions. “Following intelligence leaks and U.S. accusations, Chinese officials have sought to clarify Beijing’s stance, with the Chinese Ambassador to the U.S., Qin Gang, writing a Washington Post editorial that underscored Ukraine’s sovereignty and played up China’s neutral position,” he told OilPrice.com. “Also, in a bilateral call, President Xi called on [U.S.] President [Joe] Biden and their respective countries to ‘work for world peace and tranquillity’,” Green underlined, “Additionally, earlier in the week, Xi described the conflict as a ‘war’ for the first time, and Chinese state media have also begun to report less favourably on Russia including coverage of civilian deaths,” he said. “Overall, despite the shared values and Beijing’s reluctance to succumb to Western pressure, we think strategic rationality will dominate,” highlighted Green. “China has indicated a strong preference for avoiding the economic consequences of Russia’s actions and, given the rising growth and market concerns in Beijing, we expect economics to dominate ideology,” he concluded.
Although being seen to comply with U.S. strictures on Russia is important to China, it remains the case that there are several legal and quasi-legal ways for it to continue to import Russian energy in significant volumes, so adding to the overall global supply and affecting oil prices. As analysed in depth by OilPrice.com recently, China has a long history of being able to work around sanctions – ranging across the gamut of legality and beyond – with basic factors working in its favour regarding Russia being the lack of exposure of China’s firms to the U.S. financial infrastructure and to the US dollar, and the direct oil and gas infrastructure between the two countries. It is apposite to note that around the same time as the two huge new oil and gas deals were signed between Russia and China, there were discussions between Gazprom and China National Petroleum Corporation that the contract would be settled in euros to diversify the payment from the U.S. currency.
“As the U.S. dollar becomes more weaponised, there is an incentive to convert more FX reserves into yuan,” underlined SEB’s Victorino. “In the case of Russia, earlier restrictions imposed following the annexation of Crimea in 2014 led to the significant diversification of Russia’s foreign reserves away from U.S. dollars: of the US$643 billion reserves, the share of U.S. dollars has fallen to 16.4 percent as of Q2 2021 from 44.4 percent in 2014, whilst over the same period Russia made cumulative purchases of almost US$78 billion worth of Chinese yuan, meaning that the yuan’s current share is at 13.1 percent,” she said.
By Simon Watkins for Oilprice.com
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