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Pipelines and Dragons and Bears, Oh My!

Xi Jinping’s first foreign trip as China’s head of state was to Moscow, where he signed a number of energy agreements last Friday. We didn’t make much of it at the time. The two countries have a history of making overtures without following up, and the odds against a true strategic alliance are still long. But the pragmatic benefits of a deal between the world’s largest energy producer and the world’s largest energy consumer may have partially overcome the two countries’ long-running suspicion of one another. If fully implemented (always a big question in Russia-China deals) the agreements will eventually make China the largest importer of Russian gas, and possibly oil as well.

First, the gas. Gazprom expects to finalize a thirty-year supply deal with Beijing by the end of the year. The two countries have been trying to reach a gas deal for years, but price has been a big sticking point. The price hasn’t been agreed upon yet, but both sides seem optimistic that a deal will be reached in the next few months.

Why now, after so many years? From Russia’s point of view, they’re losing customers in Europe, and the customers they retain are renegotiating prices.

China, on the other hand, needs the gas. Its economy keeps growing, and it’s now consuming nearly fifty percent of the world’s coal. Air pollution is wreaking havoc on its environment and its citizens are getting restless. A 2007 World Bank report suggests that pollution costs China 5.8 percent of its annual GDP in material damages, healthcare costs, and premature deaths. Natural gas burns a lot cleaner. Though China is sitting on large reserves of shale gas, it lacks the technical savvy and geological providence that have enabled the American shale revolution. So it has to import.

To ship natural gas over water, it has to be liquefied. That difficult process makes liquefied natural gas (LNG) an expensive resource (just ask Japan). If the gas is shipped overland through pipelines, it’s a lot cheaper. And add one more consideration: the US Navy rules the waves and not even the most ardent nationalists in Beijing expect that to change anytime soon. Gas shipped by sea is hostage to the United States. So Russia is China’s best bet for cheap gas that is relatively secure from American interference.

But hold on—there’s oil in them thar pipelines too! Rosneft, Russia’s state-owned oil company, signed a 25-year agreement that will more than double its exports to China. To sweeten the deal, China’s state development bank will loan Rosneft $2 billion. That’s not a huge chunk of change by international energy standards, but it probably comes with fewer strings attached than European or US financing would. As part of the deal, China’s state-owned oil firm, CNPC, will have access to three offshore oil fields in Russia’s Arctic shelf. These areas have huge potential over the next century as polar ice melts but will still be difficult and costly to tap. Rosneft has partnered with foreign firms to drill in the Arctic before, including Exxon Mobil, but this is the first time China has gotten in the mix.

The China-Russia deal gives both sides something they desperately need. Russia gets to diversify the buyers of its vast reserves of oil and gas. China gets more and cleaner fuel for growth.

“We didn’t come here to waste our time,” Xi Jinping told reporters. Indeed.

[Xi and Putin meeting in China, June 6, 2012, courtesy of Getty Images.]

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