China's appetite for Russian energy is being hit by diminishing consumption, soaring prices
Since Russia invaded Ukraine, all eyes have been on China - waiting to see whether the world's second-largest economy would provide support to its northern neighbour and "strategic partner", either diplomatic or economic.
Nearly three months on, there has been no trace of direct diplomatic support from the China side, but there also has not been a condemnation of Russian aggression that many Western politicians had hoped for.
On the other hand, the latest trade figures between the two countries seem to suggest that Beijing is defying mounting Western pressure to cut off the economic lifeline to Russia. In April, China's monthly imports from Russia hit a record high of US$8.89 billion, up 56.6 per cent from a year earlier and 13.3 per cent higher than March.
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But the true picture might be muddier. Instead of China stepping up purchases of Russian products, soaring commodity prices may provide an alternative explanation, especially as stringent coronavirus lockdowns hit the richest regions in China in the past two months, strangling the economy and suppressing demand, according to experts.
Chinese officials have claimed that normal trade with Russia would continue despite Western sanctions. But for Chinese importers, a necessary calculation is whether the discounted Russia products shunned by many other countries are cheap enough to compensate for the risks and uncertainties surrounding payments, shipping and the potential for secondary sanctions.
Currently, around 80 per cent of Chinese imports of Russian products are minerals, and crude oil comprises more than 70 per cent of those imported minerals, according to Post calculations based on Chinese customs figures.
This means that any fluctuation of crude prices in the global market would lead to substantial changes in China's total Russian imports.
Post calculations also indicate that the average import price of crude in April was 70.3 per cent higher than the same time in 2021. And that of Russian crude also increased by 50.9 per cent, year on year.
In March, Chinese imports from Russia increased 26.39 per cent compared with the same time last year, in US dollars terms, with crude imports increasing 29.93 per cent, year on year. And in April, the figures were 56.6 and 59.01 per cent, respectively.
China has been widely expected to soak up more Russian crude since the war began in late February, especially as Western sanctions have escalated, with the United States and Britain announcing bans on Russian oil imports, and the European Union announcing this week a plan to end its dependency on Russian fossil fuels over the span of five years.
But the trade figures by volume have told a different story. In March, despite the rising import value, the import volume of Russian crude dropped 14.12 per cent, year on year - on par with the 14 per cent decline of total crude volume that China imported in the same month.
"The sanctions ... aimed at reducing Russian revenues also mean reduced supplies of Russian oil and gas in the global markets, which in turn squeeze the global markets and raise prices," said Michal Meidan, director of the China Energy Programme at the Oxford Institute for Energy Studies.
"But there are contracts and things in place that mean not all buyers can stop taking Russian oil and gas. Even with reduced volumes flowing from Russia, at higher prices, Russian revenues are still high and potentially higher than they were previously."
While the March volumes arriving in China from Russia rose 18 per cent, month on month, they were likely traded long before Russia's invasion, and they reflected expectations for strong domestic activity in China after the Lunar New Year lull and prior to the current coronavirus-related lockdowns, said Yen Ling Song, associate director at S&P Global Market Intelligence.
In April, the amount of Russian crude arriving in China increased by 2.6 per cent, month on month, compared with a 6.6 per cent increase from all sources.
The shrinking Chinese demand, stemming from extended stringent lockdowns in Shanghai and many other places across the nation, is the "single most deterministic factor affecting Chinese oil companies' purchases abroad", said Zha Daojiong, a professor with the School of International Studies at Peking University.
"With Shanghai in a Covid lockdown, the Chinese market's demand for petroleum consumption is weaker than usual," Zha said.
Before the war began, China had been stepping up crude purchases from Russia, and the country is a popular sourcing place for small independent refiners, due to its geographical proximity, which reduces transport costs.
In 2021, 72 per cent of Chinese crude oil was bought from overseas, and about 79.6 million tonnes, or 15.5 per cent of all crude imports, were from Russia - the second-largest supplier after Saudi Arabia.
Most Russian crude oil flowing to China comprises an ESPO Blend from the far east Kozmino port, and last year around 80 per cent of the seaborne ESPO Blend shipments were discharged in Shandong, suggesting that most went to independent refiners, said Song at S&P.
"In recent months, we have seen this fall to 70 per cent or slightly less, and this is partly to do with independent refiners reducing their refinery runs in response to the demand dip as well as other related issues with the Covid-19 measures," she said.
Even though Western sanctions on Russia so far have not been extended to its energy exports with other countries, most buyers in China are acting in a more cautious manner on energy trade or investment with Russia, by stopping or reducing purchases, or trading through a third party, said a researcher and adviser to the Chinese government in the field of energy security, speaking on condition of anonymity.
"Larger companies with business around the globe will be more cautious, fearing that their business in the United States or globally will be affected by sanctions," the source said.
However, Bloomberg reported on Thursday that Beijing was in talks with Moscow to buy additional supplies of oil, to bolster China's strategic crude inventories. White House officials aboard Air Force One reportedly said this would not contravene US sanctions.
Unlike state-owned refiners, which are supposed to be more cautious as representatives of the state, independent traders are more likely to take the opportunity to buy cheaper Russian barrels, Meidan said.
"For [independent refiners], though, it's harder to access financing, for instance," she said.
Song also noted that refiners are finding it more difficult to get financing for cargoes originating from Russia, particularly if they have trading entities in Singapore and are dealing with Asian banks wary of possible sanctions.
Concerned about potentially running afoul of Western sanctions, the offshore units of some major Chinese banks reportedly stopped financing deals involving Russian commodities right after the war began.
"To get around this, there may be requirements to make payments up front for cargoes yet to arrive, but given the high oil prices now, this would tie up a lot of capital for smaller-scale refiners and may deter them from purchasing Russian cargoes," Song said.
With Beijing having doubled down on its zero-Covid policy, with cross-regional transport being restricted since March, it is unclear when the Chinese crude demand will eventually rebound, Meidan said.
"You do get into the kind of question of the quality of crude and what kind of recovery," Meidan said. "Russian crude is quite diesel-heavy, [which will be needed] if there's more mobility and you need more gasoline."
As for natural gas, Russia was China's third-largest supplier, after Australia and Turkmenistan. But since the war began, the import value of pipeline natural gas from Russia has been on the decline, despite soaring global prices.
Russia is unable to redirect pipeline gas destined for Europe to China, due to infrastructure limitations, according to experts. But there will be opportunities to sell additional liquefied natural gas (LNG) to China, said Elizabeth Wishnick, a senior research scientist at CNA, a US-based non-profit research and analysis organisation.
After dropping 19.4 per cent in March, year on year, the import volume of LNG from Russia bounced back in April, increasing 79.63 per cent compared with the same time last year.
But transporting LNG may be another obstacle, as international-flag vessels would face difficulties in doing so, while Russia lacks sufficient ice-class tankers, Wishnick said.
"[Russia] had commissioned South Korean tankers, but South Korea is complying with sanctions and placed export controls on navigation and marine equipment," she said. "Chinese companies had been collaborating with Japan and Finland to build ice-class LNG tankers for use in the Russian Arctic, but both Japan and Finland are complying with sanctions, so it's unclear what impact this will have on these projects."
Compared with oil, steep discounts from Russian coal miners have recently garnered increased interest among Chinese buyers, according to customs and shipment data.
Coal is the second-most-important Russian product that China imports, with its trade value equating to about one-eighth of that of crude oil, according to Post calculations.
China's imports of Russian coal had been on the rise, especially after Beijing unofficially unbanned Australian coal in late 2020 due to political tensions with Canberra. In 2021, it became China's second-largest supplier of coal after Indonesia, delivering 52 million tonnes - including 37.3 million tonnes of thermal coal and 10.7 million tonnes of coking coal - and accounting for 14.4 per cent of China's total imports.
And similar to the oil-trade situation, the volume of Russian coal imports in March fell by 29.7 per cent compared with the same time last year, according to customs figures. That was mainly because Chinese traders refrained from buying as banks suspended the issuing of letters of credit (LCs) on Russian coal cargoes, according to Pranay Shukla, associate director at S&P Global Market Intelligence.
But as some Chinese banks later reported that they had relaxed restrictions on LCs, the demand from Chinese clients surged, Shukla said.
In April, the import volume increased by 22.9 per cent compared with March, customs data shows.
In addition, the removal of import tariffs by the Chinese government on all imported coal - previously only Indonesian coal was exempted - from May 1 will provide additional support to Russian coal cargoes, according to experts.
"In May 2022, seaborne shipments are expected to hit an all-time-high level of 7.5 million to 8.5 million tonnes," Shukla said.
Still, the biggest factor in all types of energy trade with Russia is the level of suppressed Chinese demand under Beijing's zero-Covid policy, analysts say.
For example, the lockdowns of many regions in China to contain coronavirus outbreaks have dampened power consumption while casting a shadow over market demand, Fitch Ratings said in its latest China Power Watch report.
"High coal prices, with imported coal prices substantially higher than those of domestic coal amid tight global supply, are putting pressure on the margins of power-generation companies, especially those with large exposure to seaborne coal."
This article originally appeared in the South China Morning Post (SCMP), the most authoritative voice reporting on China and Asia for more than a century. For more SCMP stories, please explore the SCMP app or visit the SCMP's Facebook and Twitter pages. Copyright © 2022 South China Morning Post Publishers Ltd. All rights reserved.
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