By Patrick Alexander
Both Russia and China find themselves at the forefront of American national security concerns. Russia’s brutal invasion of Ukraine amasses new victims every day, while shady Chinese financing in the developing world allows them to accrue influence in valuable locations. While the two nations find themselves amidst varying levels of sanctions for these and other actions, collaboration with each other may lessen their own financial damage.
Oil represents Russia’s strongest export sector and best path to prosperity for a country whose GDP has decreased by a quarter over the past ten years. Thus, it was a prime target for Western powers to sanction when Russian troops crossed into Ukraine in February of last year. These sanctions created a decrease of 2.2 million barrels in crude and refined petroleum production initially, but this was short-lived. Other buyers, particularly India and China, pounced on the reduction in demand and increased their purchases to the point where the damage was confined to a 310,000 barrel production dent by July. By September, Russia was exporting half a million more barrels of crude than it was a year prior, albeit at a 20-30% cheaper price. A price cap has recently been imposed by G7 countries, though a set price has yet to be determined. Broader sanctions against Russia will be coming in the near future, including the European Union’s ban on seaborne crude imports, expected to halt roughly 1.9 million barrels per day in December, and the bloc’s February ban on all refined Russian petroleum products. China may prove a willing buyer for these barrels, as they were with the initial round of sanctions. Beijing maintains the largest dependency on foreign oil, with China importing 73.4% of its demand in the first half of 2020. If China’s economy continues to need foreign energy to support growth, and Russia still needs oil sales to maintain its own financial survival, then the two will remain in support of each other in a trade relationship that carries political convenience along with economic prosperity.
Russia has been eager for China to purchase its oil, to the point that Gazprom, the state-run gas giant, transacted sale contracts in Yuan. Not only does this spite the United States, whose dollar has been elevated to global reserve status for its role in energy transactions, but it helps grow demand for the Yuan as well. This move parallels how Russian firms, unable to use the sanctioned American dollar and unwilling to use the devaluing Ruble, are turning to the Yuan to facilitate transnational deals and financing. Russia held the third most SWIFT transactions involving the Yuan in July, when they were not in the top 15 months earlier. This recent increase in demand compliments the Yuan’s presence in Russia due to the Belt and Road Initiative. Chinese state-run firms have been using the Yuan to finance projects such as the Arctic Free Trade Zone and the Eurasian High Speed Rail Project in Russia. While their infrastructure investments are designed to increase Chinese trade with partner nations, they carry the added benefit of increasing the Yuan’s usage in financing.
Fortunately for American national security interests, Russia’s economic health is not as strong as its response to Western sanctions would indicate. Rather, it is as healthy as the global oil market allows it to be. Sanctions have resulted in Russia’s crude and refined oil devaluing while their global equivalents have appreciated, resulting in a price advantage that India and China have exploited to cut costs. While not a perfect solution for Russia, moving more oil at a cheaper price gives it financial viability at a needed time. Removing the price advantage Russia has, specifically by devaluing the global oil market, would force it to compete with other producers and lose its security. While maintaining large reserves of petroleum, Russia’s production process is expensive, especially when compared to Saudi Arabia, Iraq, and other Middle Eastern producers. A lower universal crude price would render the production process non-cost effective for much of Russia’s crude reserves, weakening the country’s overall economy; 21% of Russia’s oil reserves would be subject to that condition if the Brent Crude index reached $60, compared to 8% of Saudi Arabia’s, according to analysis from Rystad energy.
There are several avenues to reduce global oil demand that American policymakers can take. The first is to directly fulfill American imported crude oil needs with domestic sources. By deflating the American market for oil, currently the second largest on earth at 8.47 million b/d, and turning to domestic petroleum or alternative energy sources, Russian long-term economic viability will be weakened with lower global prices. This comes with the many added dividends of American energy independence, such as new employment resulting from greater domestic energy investment. American policy in the Middle East would be decoupled from the need to appease Saudi Arabia, a key exporter, allowing for bolder stances on human rights, the war in Yemen, and regional disputes. This would also present an opportunity for renewable energy to become dominant in American consumption, though an entire replacement of imported crude with renewable sources would require a 60% increase in production, necessitating a transitional period.
Another policy route to devalue Russia’s exports is to introduce new suppliers of petroleum into the global market, specifically Venezuela and Iran. Venezuela constitutes the world’s largest oil reserves, with Iran holding the third most, proving a lucrative opportunity to flood the market with new supply if American and global sanctions are rolled back. With Venezuela possibly resuming oil exports due to closer American ties, and Iranian nuclear negotiations addressing oil concerns, this route does seem like a possibility, if these negotiations buck recent precedent and produce meaningful sanctions rollback with historically anti-American regimes. However, both nations’ membership in OPEC limits their ability to independently control production, creating a barrier between them and their ability to affect the global oil market. Neither reducing demand or inflating supply are perfect or guaranteed solutions on their own, but using them in tandem would produce the best chance at hurting Russia’s long-term trade and development prospects.
Unfortunately, cheaper global oil prices would benefit China, as domestic industrial production would benefit from a cheaper oil price under their current energy usage. China’s overall energy future is murky at best to predict. China is seemingly building its place in a clean energy future through national manufacturing coordination, including producing 78% of the world’s solar cells. President Xi has planned to peak carbon emissions by 2030, spelling bad news for oil consumption; this mirrors a projected height in oil consumption in that same year. Granted, these statements have been taken with some scrutiny in the international community, especially with the recent shattering of energy and coal consumption records in the nation, as well as rising oil demand in the new year; it is reasonable to assume these clear indicators precede a shift in energy targets in the near future, perpetuating the use of petroleum in a more conspicuous way than Xi would have liked. However, ongoing Chinese demand should not stand in the way of American oil price deflation. First, weakening Russia is time-sensitive as the bloody invasion of Ukraine continues. Waiting for the ideal scenario where Chinese gains are minimized would cost lives, territory, and possibly Ukraine’s sovereignty. Furthermore, China’s economic rise faces several structural barriers, such as a real estate credit bubble that permeates every part of Chinese society, state control that costs money and social capital, and ongoing COVID-19 woes for the manufacturing sector. Cheap energy will not fix these problems, and stands unlikely to be China’s escape plan from the middle-income trap.
China and Russia remain America’s largest national security threats. However, their relationship presents a key route to unravel the two nations’ danger to the free world. Lowering global oil demand will threaten Russia’s long-term viability, while not necessarily accelerating China’s economic rise. The overall idea of oil price deflation, regardless of specific policy, could isolate China in the long-term by drastically weakening their largest and most dangerous ally, a chance American policymakers should not pass on as both continue their efforts for dominance.
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