$400 Billion Gas Deal Shows Russia Looking To China To Replace Western Money

Forbes

Chris Wright, Contributor

The news that China and Russia have signed a $400 billion deal through which Gazprom will supply China National Petroleum Corp with 30 years of natural gas is the clearest illustration yet that Russia will be looking east, not west, for international funding.

Last week, in Will China Save Russia With Investment?, I reported a series of new Russia-China deals were about to be launched by the two countries’ sovereign wealth funds, the Russian Direct Investment Fund and China Investment Corporation. Those deals have since been announced: they involve Vcanland, a developer of tourism infrastructure and senior living communities; the first ever railway bridge over the Amur River on the Russia-China border; and logistics services investment.In dollar terms, they may have involved as much as $1 billion of investment, but while the number itself is insignificant compared to the outflows Russia is experiencing, the trend is very important – and is underlined by the new gas deal.

Russia’s central bank says that $63.7 billion of money left Russia in capital outflows in the first quarter of this year; the IMF is forecasting $100 billion of outflows for the full year. Others think those numbers conservative. Russian access to the international capital markets has dried up, and with vast infrastructure needs – just think of the FIFA World Cup, coming up in 2018 – that is a problem. So what to do? It can’t get those sorts of portfolio flows anywhere else, but it can bolster its foreign direct investment, or other forms of international trade. And China, which does not share the west’s sense of outrage about Russia’s behaviour in Ukraine, is the perfect candidate.

The new gas deal, under which Gazprom will supply up to 38 billion cubic metres of gas a year from 2018, supposedly follows 10 years of negotiations, but it couldn’t have come at a better time for Russia. It makes a statement: that Russia isn’t reliant on western capital. Sean Glodek, Director of the Russian Direct Investment Fund, made exactly that point to me in my article last week, pointing out that the RDIF’s $10 billion of assets come almost entirely from the Middle East and Asia. “Russia is not as reliant on western Europe as some investing in public markets would expect,” he says. And actually, although the scale of yesterday’s deal is unprecedented, the principle is nothing new: last year a similar supply deal was struck between Rosneft and CNPC which, among other things, involved a $70 billion upfront payment to Russia. RDIF says that China has promised to put $20 billion of investment into domestic projects in Russia, particularly around infrastructure, and that China is aiming to increase investment in Russia four-fold by 2020.

Don’t be surprised if China does start to contribute to those portfolio flows too. Today, it just doesn’t have the institutional investor base to replace the money that western fund managers have pulled from the market, but don’t forget two things: China wants the renminbi to become a truly international currency, and needs foreign centres for this to happen; and CIC has previously bought a stake in Moscow’s stock exchange. The RMB is already used to settle cross-border trade transactions between the two countries, and has been serving that purpose since 2010. If Russia becomes an instrument through which RMB internationalization can happen, then a mutually beneficial arrangement may be struck: a more international Chinese currency, and a diversity of foreign exchange sources for China.

Along the way, the Russia story from an investor perspective is increasingly becoming all about energy – and energy with Asian buyers. Bank of America BAC +0.55% Merrill Lynch says Russian energy exports to China could double by 2020 and triple by 2030. This appears to be the future.

Additional: As this article was filed, RDIF also announced a $700 million investment in a liquified petroleum gas and light oil products transshipment terminal, owned by the Russian petrochemical holding SIBUR, in the sea port of Ust-Luga. The investment involves not just RDIF but Gazprombank and “a group of foreign investors”.

Their nationality is not named, but it is worth noting that last week RDIF told me to expect four new deals to be announced with Chinese involvement; to date there had only been three, so it may well be that this is another Russian project based partly on Chinese money.