The Kremlin’s Dilemma

By Nikola Mikovic

Bow to China, or Seek Reconciliation With the West?

Despite its ambitious goals of achieving energy self-sufficiency by 2060, China is looking to expand its gas arrangements with Russia in the near term. The problem for Moscow is that such cooperation will likely be on Beijing’s terms.

When Chinese President Xi Jinping said in 2020 that the People’s Republic aims to have CO2 (carbon dioxide) emissions peak before 2030 and achieve carbon neutrality before 2060, very few had expected the world’s largest consumer of primary energy to quickly begin the energy transition process. In 2024, China has emerged as the global leader in this shift, and it continues to make significant gains in implementing the green agenda.

Last year, China made historic increases in installations of solar, wind, and other renewable energy. As a result, renewables are expected to overtake coal in the country’s electricity production capacity for the first time in 2024.

But despite that, Beijing remains dependent on fossil fuel imports. According to American reports, China imported record amounts of crude oil in 2023, with the largest volumetric increase coming from Russia. Also, the world’s second-largest economy has bought large amounts of liquefied natural gas (LNG) from Russia, as well as from producers such as Australia and Qatar.

In May 2024, China bought coal from Russia for a record amount in almost two years. Coal business with Moscow helps Beijing diversify its energy mix, particularly as it transitions away from more polluting sources domestically. However, it is natural gas that remains the major component of the Russian-Chinese energy cooperation. Russian exports of natural gas to China in 2023 increased by 61.7 percent year-on-year, reaching $6.4 billion. The Kremlin hopes to sign a contract with Beijing on the construction of the Power of Siberia-2 gas pipeline – running from Russia’s Western Siberia Altai region, via Mongolia, to North-Eastern China – “in the near future”. China, however, seems to have slightly different plans.

Russian-Chinese cooperation involves a complex interplay of geopolitics, economics, and energy security. Although the two countries have declared a “no limits” partnership in February 2022, Moscow seems to play the role of Beijing’s junior partner. And that is something that certain very influential oligarchic circles in the Kremlin can unlikely approve.

Energy Markets Post-Ukraine War

Before the Russian invasion of Ukraine in 2022, Europe was Russia’s major energy market. In 2021, Russia’s gas exports via pipelines to European customers peaked at 155 billion cubic meters. Now that the European Union has significantly diversified its natural gas imports, Moscow is desperately looking for new markets. In this strategy, China has a special place.

Back in 2014, at the very beginning of the Ukraine crisis, Russia and China signed a $400-billion gas supply agreement. As a result of the deal, over the past decade, Beijing has been purchasing Russian gas at a discounted rate. This year, the export price of Russian gas for China is $257 per 1,000 cubic meters, while Europe and Turkey will have to pay $320.30. The People’s Republic, therefore, benefits from the EU’s “energy divorce” from Russia, as it gets relatively cheap Russian gas.

The problem for Moscow is that the Chinese market cannot make up for the shortfall from Europe. In 2023, the total Russian gas exports amounted to 22.7 billion cubic meters, while the state-owned Russian gas giant Gazprom plunged to a net loss of 6.9 billion. Even if the Power of Siberia 2 pipeline is successfully implemented, it will not be sufficient to fully offset the decline in European demand. With its 50 billion cubic meters per year design capacity, the pipeline could offset nearly half of the decline in Russian gas exports to the EU.

Despite that, Gazprom CEO Alexei Miller claims that Russia will soon become China’s largest gas supplier. But even if that happens, Gazprom will continue to account for losses. Another problem is that Beijing does not seem to be satisfied with the current price it pays for Russian natural gas.

Reports indicate that Beijing expects to pay rates close to Russia’s heavily subsidized domestic prices, roughly $84 per 1,000 cubic meters. This alleged request could be part of China’s broader strategy to manage its energy costs effectively, especially as it seeks to transition to more sustainable energy sources in the long term. Also, China reportedly needs to purchase only a fraction of the Power of Siberia 2’s planned annual capacity of 50 billion cubic meters of natural gas. The reason for that could be the recent discovery of a large gas field in the South China Sea, which is estimated to contain more than 100 billion cubic meters of natural gas. China’s successful energy transition also appears to play a role, which means that the Kremlin might eventually be forced to make concessions to further reduce gas prices to Beijing.

A Hard Choice

Alternatively, Moscow will have to find a way to end the war in Ukraine as soon as possible, hoping that such a move will allow Gazprom to return to the European market. During its unprecedented cross-border raid into Russia’s Kursk region, Ukrainian forces captured the Sudzha gas metering station, which is a crucial part of the last remaining Russian pipeline still sending gas to Europe through the former Soviet republic. Ukraine is now in a position to completely cut off Russian gas supplies to Europe, a move that could have a serious impact on Gazprom.

The Kremlin undoubtedly values its energy exports as a major revenue source. On the other hand, Russia’s strategic interest is to preserve strong economic ties with China. At this point, however, the Russian Federation remains reluctant to agree to gas prices that would undermine Moscow’s economic interests, or set a precedent that could affect other energy deals. But the situation on the battlefield in Ukraine – as well as in parts of western Russian regions seized by Ukrainian forces in early August – is likely to have an impact on the Kremlin’s strategic decision regarding energy flows.

Quite aware that Beijing has the upper hand over Russia when it comes to gas arrangements, Russian billionaire oligarch Oleg Deripaska recently described the war in Ukraine as “mad” and called for a ceasefire without pre-conditions. Could his statement be interpreted as a message to Russian President Vladimir Putin that the time has come for Moscow to seriously reconsider its approach regarding Ukraine?

Given that energy remains the major driver of Russia’s foreign policy, strategic planners in the Kremlin seem to have a tough choice to make – to accept Chinese terms and provide Beijing with natural gas at a very low rate, or to attempt to reach a deal with Ukraine and the West aiming to eventually renew gas sales to Europe. From the Russian perspective, both options seem to be equally bad. Selling relatively low volumes of natural gas to China at extremely low prices will have a strong impact on the Russian economy. Accepting Deripaska’s proposal and ending the war in Ukraine “without pre-conditions” will represent Moscow’s de facto capitulation to Ukraine and its Western backers.

Whatever decision the Kremlin makes, it risks exacerbating Russia’s economic difficulties and reshaping its geopolitical vector. Ultimately, the choice may be between being a Western vassal state or a client of China.