Russia cannot be rescued by China

China, it is evident, does not have the capacity to substitute in the short or medium term all the trade lost by Russia with the European Union. It cannot, either, offer a solid alternative to financial sanctions. And, in the technological field, China is far from supplying the necessary semiconductors that the Russian military industry currently needs.

China knows that it does not represent a realistic alternative, at this time, to the bloc made up of the US and the European Union. For this reason, Beijing opposes Western sanctions against Russia, the effects of which could destroy its economy. Both the European Union and China have been Russia’s main trading partners. In terms of exports, adding the United Kingdom, the European Union represents 40% of Russian sales abroad (China is only 14.7%).

natural gas and oil

Russia, in 2021, exported 16.5 billion cubic meters of gas to China. Currently, it is only 5% of the gas consumed by China, but Moscow hopes to increase its supply fivefold in the coming years. On the one hand, the Power of Siberia-1 gas pipeline will supply China with 38 billion cubic meters in 2025. And a second gas pipeline, Power of Siberia-2, could reach 50 billion cubic meters of gas supplied to China. However, the European Union has announced that it expects to reduce its gas imports from Russia by two thirds this year, some 100,000 million cubic meters. And, in the medium term, the EU plans to stop importing Russian gas (at least 155,000 cubic meters per year). China, for its part, could import some 88,000 million cubic meters of Russian gas in the medium-long term. Perhaps a little more, if future extractions of liquefied natural gas from the arctic are included, but Russian exports are also close to losing everything currently exported to the EU. The losses for Russia, in this simple scenario, would not fall below 60 billion cubic meters of gas per year.

In relation to oil, the EU is Russia’s first client, with 65% in 2019. China, however, remains a quarter. If Europe stopped buying oil from Moscow, Russia would lose between 40 and 80 billion dollars, which it would be difficult to compensate with China. In other words, to offset the losses of the oil it stopped selling to Europe, Russia would have to increase its oil exports to China between two and three times. China, naturally, will not increase its oil demand by those amounts. And the Russians would also lose out, significantly, from an abrupt halt to oil imports from the EU.

Loss of industrial inputs

Almost half of Russian imports during 2020 were manufactures in the form of machinery and transport equipment from the EU. Specifically, almost 35 billion euros, a relevant figure considering that Russia’s main trading partner is the EU. China, despite being Russia’s second largest trading partner after the EU, barely represents 20% of total Russian trade. And, as is the case with some raw materials such as natural gas or oil, the industrial inputs imported from China do not seem to be enough to offset the losses from trade with the EU. Investments, in addition to trade, are essential for the industrialization of any country. Without this, efficient integration in value chains can hardly take place, which is key to stimulating economic growth through exports. And, within the long term, to widen the potential growth of the economy thanks to the technological factor. Therefore, the economic future of Russia is now in doubt, mainly due to the harsh sanctions of the United States and the EU.

Semiconductor dependency

Semiconductors are essential to any industry. From transportation to military uses, passing through quantum computing and artificial intelligence, everything requires chips. The sector, throughout the value chain, is dominated by the United States and Taiwan. China has no presence in developing embedded devices or equipment. And it lacks the capacity to produce semiconductors smaller than twenty nanometers. China has been trying to recruit talent in Taiwan for years (an activity that, according to the laws of the island, carries high prison sentences). And both the United States and the EU are limiting Chinese investment in order to preserve their technological superiority within the sector. Russia, therefore, could also suffer from an isolation of key technologies without supply alternatives from China.

Impossible to compete with the dollar

In an environment of tough financial sanctions, Russia has long been increasing the volume of Chinese currency in its foreign exchange reserves, known as the yuan or renminbi. However, the yuan or renminbi does not operate as a fully convertible currency, so it would only serve to be used in the context of commercial relations with China. The Chinese CIPS payment system is still dependent on SWIFT. And international transactions in yuan or renminbi, although they have experienced notable growth in recent years, only add 3%. In other words, as an alternative to Western sanctions, Russia has only one way out: to substantially increase its economic and financial dependence on China. Another option would be that China could cooperate with Russia by supplying foreign currency to try to circumvent sanctions. But such a risky move could open up a new conflict between China and the United States and the EU.

long-term cooperation

China’s energy alliance with Russia is not just limited to gas. Both nations also want to collaborate to exploit limitless energy in space. Specifically, China aims to build a lunar station, together with Russia, in 2035. Ten years earlier, in 2025, both countries plan to send a robot to explore the lunar surface. And, in 2035, they hope to have a permanent structure operational on the lunar surface. Its main objective is to develop space mining, that is, to obtain energy resources from space to be able to use them on our planet. Of particular interest is helium-3. This isotope, abundant on the moon, is needed to generate nuclear fusion power. And its estimated reserves on the moon would be enough to power the entire world for at least a hundred centuries. China will therefore not support Russia politically or militarily in this war with Ukraine. But, seeking a strategic balance, Beijing will not confront Russia either by taking sides with the United States and the EU.

War will put pressure on supplies

Russia and Ukraine barely account for 2% of world trade. But some specific goods, located in Ukraine and Russia, represent a notable proportion. Exports of neon gas, basic for the manufacture of semiconductors, add up to 70% of the world total. Palladium, an important input in the automotive sector, represents 37%. And grains, or nickel, add up to about 10%. Nickel is also a fundamental component for the manufacture of lithium batteries.

The war is going to cause a supply shock that will translate into shortages and inflation. The dreaded stagflation, a sum of economic stagnation and inflation, is one of the scenarios that are handled during this war. Agricultural prices around the world are going to suffer. Energy prices are forecast to remain high. And many industrial goods, due to the increase in the price of semiconductors, in addition to maritime transport, are also going to increase in price.

The United States will undoubtedly benefit from selling more gas to the EU. South Africa, the world’s leading producer of palladium, should be able to take on part of Russian exports. Indonesia, in the Chinese sphere of influence, has almost 40% of the world’s nickel reserves. But the United States and the European Union together do not have the sum of the grain produced by Russia and Ukraine. In any case, the configuration of the world in blocks can negatively affect technology transfers, with the implementation of different standards in sectors such as semiconductors. And trade wars may also end up having negative effects on trade and investment between global value chains as of this year 2022.

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