C-R Bilateral Trade and the Energy Transition

Russian fuel exports are rising but face long-term risks

Russia-China bilateral trade will likely continue to grow in the medium-term, but the energy transition could fundamentally alter the two countries’ economic and financial relationship. Russian exports to China will likely rise through the mid-2020s on higher volumes and favorable prices for crude oil and other fuel exports, such as natural gas and coal. China’s exports, meanwhile, will likely trend upwards but face downside risks from anemic Russian macroeconomic growth. Over the long term, China’s at-scale employment of Green Hydrogen or electric vehicles (EVs) could curtail or even eliminate Russian hydrocarbon exports, fundamentally reshaping the bilateral economic relationship.

Bilateral Trade Caveats  

Let’s caveat and contextualize before diving into trade data. First, trade data is often directionally accurate but imprecise: honest statistical collection issues, political influence, and importer/exporter underreporting can distort flows. Second, currency fluctuations complicate analysis, particularly when trade is measured in a third currency (such as USD). Importantly, both Moscow and Beijing are seeking to de-dollarize bilateral trade: only 10% of Russian 4Q 2020 exports to China were denominated in dollars as both sides moved to trade in Euros. According to the Chinese Ambassador to Russia, Zhang Hanhui, the renminbi’s share of China-Russia bilateral trade totaled 17.5% in 2020, up from 3.1% in 2014. Finally, this analysis only examines trade in goods. Bilateral trade in services and bilateral investment flows/stocks are difficult to measure even in more transparent systems.

Despite those caveats, examining bilateral goods trade data is useful for understanding the economic relationship. Both sides are incentivized to report goods trade flows as accurately as possible for tax purposes, and intentionally misrepresenting trade figures would seem to pose significant domestic political risks for few geopolitical benefits. Additionally, currency fluctuations can be minimized by comparing volumes rather than prices for some specific commodities (such as oil) and by measuring exports as a % of GDP (this last measure is admittedly a highly imperfect workaround from the author, who is assuredly not an international economics expert). Finally, while data on bilateral services trade and investment is shaky, physical goods trade accounts for the preponderance of bilateral economic interactions.

A Brief History of Modern Bilateral Trade

Russia-China bilateral goods trade has risen sharply since the Great Financial Crisis. Annual total trade has increased by a nominal (before-inflation) rate of ~9.7% since 2009; it exceeded $100 billion USD for each of the past three years. Bilateral trade flows show some resiliency, as the two sides maintained $100 billion of trade in 2020 despite COVID and the crash in oil prices. Finally, reported trade totals show relatively balanced bilateral trade, with Russia enjoying a $6.6 billion USD surplus in 2020.

The trading relationship is not equally important to both sides. Exports to China constitute a significant and growing share of Russian GDP (about 3.9%); Chinese exports to Russia contribute a non-trivial but relatively minor share of Chinese national output (about 0.35%). Note that the figure below also “normalizes” currency fluctuations, as Russia’s GDP in dollar terms fell sharply in dollar terms in 2014, after the West imposed sanctions in response to Putin’s annexation of Crimea.

The European Union remains Russia’s largest goods export market, although that may change within the next decade. EU imports of Russian goods exports fell considerably after oil prices peaked in 2012 and the bloc levied sanctions after Putin’s annexation of Crimea; the ruble’s devaluation also suppressed exports in dollar terms. Exports to China, on the other hand, have risen sharply on the development of new oil and gas infrastructure, such as the East Siberia-Pacific Ocean crude oil pipeline system (ESPO 1 & ESPO 2) and the Power of Siberia (PoS) natural gas pipeline.

Oil’s Centrality to the Bilateral Trade Relationship

Russian exports to China are highly dependent on commodities, particularly crude oil. Indeed, fuel exports (crude oil, natural gas, coal, etc) accounted for over 60% of the value of Russian exports to China in 2020.

Russia’s 2020 exports to China remained above $50 billion USD, in large part, because of rising crude oil export volumes. Russian export volumes to China grew by ~7.6% in 2020, partially counteracting soft crude oil prices. Russian crude export volumes to China have more than quadrupled since 2010. While the ESPO pipeline’s physical capacity increases are largely responsible for rising export volumes, geopolitical convergence likely accelerated the trend.

The Near and Medium-Term Trade Outlook

With Russia-to-China energy trade likely witnessing stable or growing prices and higher volumes, bilateral trade flows will likely rise significantly in 2021, and possibly for a half-decade or longer. Commodity prices are potentially entering a new “supercycle” of higher prices (or may be at least rebounding to something approximating pre-pandemic levels). Russia-to-China oil, natural gas, and coal volumes, meanwhile, will likely grow significantly. ESPO expansions could incrementally lift crude volumes, natural gas send-outs from the Power of Siberia pipeline and Russian LNG are set to rise, and if the Australia-China trade spat continues Russian coal producers will benefit.

If current trends continue, Russian exports will continue their upward trajectory – and could conceivably exceed $100 billion by the mid-2020s (even 2024) if commodity prices are cooperative and COVID variants remain in check. Chinese exports to Russia will also likely continue to grow, but will likely remain constrained by anemic Russian macroeconomic growth. While both sides will most likely not meet their goal of reaching $200 billion USD of bilateral trade by 2024, they may reach that level later in the decade.

It is very unlikely that the two sides will agree to a substantive trade pact or otherwise dramatically change the character of their trade, at least in the medium-term. Future bilateral trade agreements (or “exclusive trade deals”) are intriguing, and both sides may be seeking to expand bilateral trade and investment ties. Still, Russia has traditionally been one of the world’s most autarkic countries and has maintained this legacy even in the post-Soviet era. Importantly, the EAEU-China trade agreement did not lower tariffs, seemingly on Moscow’s fears that Chinese exports could flood Eurasia if given the opportunity. Finally, can Russia even export non-commodities to China? In 2020, Russia’s top 10 exports to China (by value) were all primary products, with the exception of plastics (which are derived from hydrocarbons) and Iron & Steel. Russia could diversify its exports over time, of course, but that would almost certainly require major economic, legal, and perhaps even political restructuring – nonstarters for Putin and much of the elite.

Future Trade: the Energy Transition

Long-term bilateral trade will be determined by the energy transition. China, the world’s largest hydrocarbon importer, seeks lower energy prices; it would prefer to wean itself off hydrocarbon imports entirely. Russia, the world’s second largest crude oil exporter, seeks prices that maximize its long-term export earnings. The contradiction between the two powers’ energy interests will likely sharpen in the latter half of this decade on changing technological and market drivers. The energy transition is the greatest long-term threat to Russia’s export earnings and, perhaps, its economic and political relationship with China.

Green Hydrogen is not only the most important element shaping the energy transition, as the emerging technology could potentially replace most or even all hydrocarbon uses, it also could define China-Russia economic and political relations. If Green Hydrogen technology becomes economically competitive at-scale it could send oil, gas, and coal demand dramatically lower – perhaps even to zero. China is the world’s largest energy importer, explicitly seeks to lower its dependence on international markets through the “dual-circulation strategy,” and is one of the world’s two leading financial and technological superpowers. It possesses the means and motive to self-develop domestic and Mongolian Green Hydrogen as rapidly as possible. In a worst case scenario for Moscow, China’s adoption of Green Hydrogen would eliminate more than 60% of Russia’s exports to the PRC.

Green Hydrogen’s potential benefits are so overwhelming that China will be sorely tempted to devote resources to its development and run risks in its relationship with Russia – probably regardless of the character and composition of the government in Moscow. While Green Hydrogen’s development is certainly not assured (it could become a permanent “fuel of the future” or face years or even decades of delays) China will almost certainly continue its rapid uptake of electric vehicles (EV).

Chinese EV uptake poses significant risks for Russian crude oil export volumes and earnings. IHS Markit estimates that EVs will displace between 1.1 - 1.5 Million Barrels per day (MMBPD) of world crude oil demand by 2025; the IEA projects that EVs will displace 2.5 – 4.2 MMBPD by 2030 (for reference, 2021 world oil demand stood at ~ 96 MMBPD). While the scale, pace, and consequences of future demand displacement from EVs are unknown it could prove highly significant for Russian exports to China.

EV adoption could sharply reduce Russia’s crude oil exports to China and the rest of the world. World oil prices are highly sensitive to demand (and supply) changes; EV uptake will likely be highest in Europe and China, Russia’s most important export markets; Russia could be forced to build (expensive) marine crude export terminal capacity to supplement or even replace its pipeline export networks, which target Europe and China; and higher maritime transportation costs to markets in South and Southeast Asia would reduce margins for Russian crude producers.

While some highly capable energy experts argue that Russia is well-positioned to benefit from the energy transition due to the attrition of less competitive suppliers, China’s EV adoption will, et ceteris paribus, reduce its need for Russian crude oil imports. EVs likely pose significant risks for Russia’s exports to China.

Russian Exports to China: Rising, but at Risk

The past decade of bilateral trade has been characterized by rapidly growing Chinese economic and energy demand, providing enormous opportunities for Russian commodity producers, particularly in the oil and gas sector. Although both sides will likely fail to reach their goal of $200 billion in annual trade by 2024, the trend of growing economic interchange will likely continue over the medium-term. In the long-term, however, the current bilateral trade arrangement will likely be characterized by change, not continuity. While the energy transition will be complicated and unpredictable, the preponderance of evidence suggests that Russian fuel exports to China will be threatened by electric vehicle uptake and especially Green Hydrogen. Bilateral trade has expanded dramatically but could be approaching a permanent inflection point.

Until next time,

Joe Webster

The China-Russia Report is an independent, nonpartisan newsletter covering political, economic, and security affairs within and between China and Russia. All articles, comments, op-eds, etc represent only the personal opinion of the author(s) and do not necessarily represent the position(s) of The China-Russia Report.