Giving China a Piece of Russia..1/07/09

On June 17, President Dmitry Medvedev and Chinese President Hu Jintao signed an agreement in which Russia will sell 300 million tons of oil to China over 20 years for $100 billion. That breaks down to $57 per barrel.

In order for Russia to deliver that oil, a new pipeline must be built to China. This is something that Yukos had originally planned to build by the mid-2000s at a cost of $4 billion.

By March 2008, however, the price for the project had risen to $29 billion. At that cost, oil deliveries through the pipeline would only recoup expenses given oil prices of at least $80 per barrel. But Russia has agreed to a price of just $57 per barrel for its exports to China.

Russia built the Chinese Eastern Railroad in the early years of the 20th century. That railroad was a symbol of the Russian Empire's dominance over the Chinese Empire. The Soviet Union began construction of the Baikal Amur Mainline, or BAM, railroad in the 1970s that essentially served as a line of defense against the Chinese. Now, Medvedev and Prime Minister Vladimir Putin are building a pipeline to China that will turn Russia into a raw materials appendage to its huge neighbor in the east.

The contract Medvedev signed with Hu means that Russia will inevitably lose its Far East. If you want to see how this process has already begun, take a trip to Blagoveshchensk on the Russian-Chinese border. You will see a dilapidated, depressed town on the Russian side, while just a stone's throw away on the Chinese side you will see the skyscrapers of the booming town of Heihe.

One reason for this stark contrast is that the Kremlin is killing off the Far East by prohibiting exports of round timber and hiking import tariffs on used Japanese automobiles. By contrast, the Chinese government has set a national goal of helping its business community to prosper.

It is entirely possible that a serious conflict could break out between Russia and China in the near future. Once the Kremlin realizes that it has tied an oil-and-gas noose around its own neck, it will start its usual backtracking, ending in an intractable argument with Beijing -- much like its recent "gas war" with Ukraine and "milk war" with Belarus. And in so doing, it will only tie that noose even tighter around its neck.

It is not difficult to see that the Kremlin's China strategy is identical to the course pursued by former Yukos CEO Mikhail Khodorkovsky -- with only one significant difference. If you build an oil pipeline for only $4 billion, develop the region's oil deposits and sell that oil to China at market prices, you turn eastern Siberia into an extremely powerful economic zone in which the interests of both countries are fused like Siamese twins. This would make a war between Russia and China far less likely since a conflict would result in unacceptable economic losses to both sides.

But if you build the world's most expensive oil pipeline for $29 billion while signing a contract to export that oil at a loss and if your idea of developing oil deposits in eastern Siberia boils down to dismantling Yukos and appropriating its assets, then the loss of those territories becomes inevitable -- without a single shot being fired.