Russia's Tighter Ties With Fewer Friends Create Risks

Russia has managed to successfully market its oil volumes that have been shunned by the West. But about 90% of its crude exports in the first quarter of the year went to only three partners — China, India and Turkey — creating a critical dependence for Moscow on those countries. Pressure from the West — on India and Turkey in particular — to rein in those purchases, along with re-exports of Russian products and sales of so-called dual-use goods to Russia, meanwhile looks set to grow. 

• Russia-China trade is booming, but there are limits when it comes to energy, and risks associated with trade in yuan.

Attracted by discounts, China imported some 2 million barrels per day of Russian crude in the first three months of the year out of Russia's total exports of 4.68 million b/d. Imports by China of Russian oil products, coal and gas are at record highs as well. State-controlled PetroChina is the big winner when it comes to oil and gas imports, but China’s independent refiners, or teapots, are also making the most of it, also lapping up Russian fuel oil as their crude quotas are exhausted. But however cheap Russian commodities might be, China will avoid becoming overdependent on them — keeping its supply sources diversified, including shipments from the Mideast Gulf.

The move to payments in national currencies could also pose some risks to Moscow. While convenient in the short term, it presents long-term risk as the yuan is not a freely tradable currency, but instead is tightly managed by Beijing. Total trade between the two countries in the first four months of the year stood at $73.15 billion, on track to exceed the $200 billion trade target for this year. Russia’s dependence on China is rising not only as a major export market for its commodities but also as a provider of goods that Russia cannot procure anywhere else — like cars, smartphones, computers, semiconductor chips — with China’s exports to Russia up by 67.2% over the January-April period compared to a year ago.

But China’s rapidly growing renewables power capacity is another risk for Moscow. Over time, China will import less coal from Russia and be less dependent on gas, too. This could be one reason China is in no rush to sign off on a proposed second Russia-China gas pipeline, the 50 billion cubic meter per year Power of Siberia 2 gas pipeline.

• Friendship with Russia comes with sanctions pressure.

There is also growing concern in the West that China-Russia trade may involve weapons-related goods, raising tensions between Europe and China and prompting China to warn against secondary sanctions targeting its companies. Perhaps because of these tensions, Beijing has moved up a gear on its Russia-Ukraine mediation efforts. Li Hui, China’s recently appointed special representative for Eurasian affairs, has embarked on a European tour to discuss China’s peace proposals, including stops in Kyiv and Moscow. Given China’s vague peace plan — including a cease-fire that would leave Russian troops on Ukrainian territory — success is far from guaranteed. But Li’s tour will give credence to China’s role as a mediator in the conflict.

India is facing similar risks. In preparation for the EU's 11th package of Russian sanctions, the EU's foreign affairs chief Josep Borrell accused India of sanctions circumvention. "If diesel or gasoline is entering Europe  ... coming from India and being produced with Russian oil, that is certainly a circumvention of sanctions and member states have to take measures," Borrell told the Financial Times ahead of meeting with Indian Foreign Minister S Jaishankar in Brussels this week.

But Jaishankar correctly pointed out that processing Russian crude and exporting it as products to Europe does not violate EU regulations, and Washington has indicated it's fine with the practice. A European diplomat reinforced that view: China and India buying discounted oil, refining it and sending it out into the world — this is how the price cap was designed, he said. India's imports of all Russian crude grades averaged 2 million b/d in April, compared to just 50,000 b/d prewar. Of India’s 123 million bbl in total clean product exports over February-May, Europe accounted for 20% compared to 8.7% a year-earlier period, data from analytics firm Kpler show.

• Moscow faces political and currency risks with India.

Indian Prime Minister Narendra Modi could be subjected to further pressure on Russian ties, both during the G7 in Japan this weekend and his Washington visit next month. The narrowing discount for Russian oil could eventually make it less attractive for Indian companies, but likely only if it drops below $5/bbl. According to the Russian finance ministry, the discounts for Urals over Apr. 15-May 14 stood at $23.90/bbl to dated Brent (in Indian ports, they are even lower). Earlier this year, they exceeded $30/bbl.

Moscow is also facing a big trade surplus with India and a rupee bounty Moscow is unable to fully utilize. According to Russian Foreign Minister Sergei Lavrov, billions of rupees have accumulated in Indian bank accounts. The two sides are in discussions, but New Delhi is refusing to allow conversion into yuan or United Arab Emirates dirham.

• A Turkey under new leadership could adjust its energy ties with Russia, but looks set to face new pressures either way.

Turkey has emerged as a crucial trade partner for Moscow, which sees it as a friendly country despite its Nato membership. It has become another important outlet for Russian oil shunned by the West, importing some 430,000 b/d of Russian products over the past three months, double last year's average, with imports of ultra-low-sulfur diesel alone reaching around 250,000 b/d in March.

President Recep Tayyip Erdogan has forged especially close ties with President Vladimir Putin, and energy cooperation has deepened, including in the strategic nuclear power sector, with Rosatom building Turkey’s first power plant. Erdogan’s good showing in the first round of Turkey’s presidential poll last Sunday, against an opponent who has vowed to improve cooperation with the West, will therefore have been welcomed in Russia.

Turkey is not expected to stop buying discounted Russian crude and products if Erdogan's rival, Kemal Kilicdaroglu, pulls off a surprise second-round victory, as Turkey is not bound by the EU embargo and its economy clearly benefits from them. But Turkey’s role as a potential hub for the covert re-export of Russian products to Europe is another matter. US and European pressure on Turkey appears to have succeeded in ending the country’s use of Russia's Mir payment system and largely halting the transit of sanctioned goods to Russia. Now, as the EU increases the pressure on its Asian allies to clamp down on sanctions workarounds and concerns about disguised Russian diesel being shipped to some EU countries rise, the surge in Turkey’s imports of discounted Russian fuel is coming under greater scrutiny.

For more coverage of the Ukraine crisis, visit Ukraine Crisis: Energy Impact >