China-Iran energy relations after UN sanctions

China Iran pipeline

China-Iran energy relations after the lifting of UN sanctions

Whilst Xi Jinping’s trip to Iran in January 2016 had great diplomatic significance, the primary objective was economic, and energy will have featured prominently among the many deals signed. This should pave the way for more inward investment by Chinese energy companies and more energy exports from Iran to China

China’s formal diplomatic relations with Iran date back to 1971 and survived the fall of the Shah. The importance of this relationship to China arises from Iran’s geostrategic and position its geopolitical stance, as well its energy wealth. As a consequence, China has been more deeply engaged than any other major power with the current regime. In addition to providing political support for Iran at the U.N. Security Council, China has also been one of the few countries undertaking trade and investment in the country during sanctions. In recognition of the foreign exchange constraints, China has permitted Iran to pay for imports using Renminbi. Iran has also joined the Shanghai Cooperation Organization and occupies a key position on China’s “Silk Road Economic Belt”

Energy is the economic sector of greatest interest to China in Iran, as the country holds 18% of the world’s proven reserves of natural gas and 9% of the oil reserves. China has sought involvement both upstream and downstream, but the pace and scale of investment and trade has been constrained by sanctions. The end of UN sanctions provides the opportunity for China to increase its oil imports from Iran and for the NOCs to enhance their involvement in Iran’s oil and gas sector, both upstream and downstream.

The Middle East has consistently provided 45-55% of China’s total crude oil imports since 1995 as they have risen from 350 thousand barrels per day at that time to more than 6 million barrels per day (mmbpd) in 2015. For many years, Iran was the largest supplier in the Middle East and its relative contribution to China’s crude oil imports reached a peak of 18% (200,000 barrels per day (bpd)) in 2001. Thereafter, Saudi Arabia took over as the region’s major supplier to China as sanctions progressively constrained Iran’s ability to raise production. In recent years, Iran’s supply to China has fluctuated between 400,000 and 550,000 bpd, depending on the tightness of the sanctions regime.

The year 2014 saw a bounce back to 550,000 bpd, but this only accounted for 8.9% of China’s total crude oil imports. That same year, the quantity of oil supplied by Saudi Arabia to China fell for the first time for several years, whilst Iraq and Oman both saw an increase, as well as Iran. These trends suggest that China is trying to balance the sources of supply from different Middle East countries. Much of the oil trade between Iran and China has been conducted by the state-owned company Zhuhai Zhenrong, which has also been supplying oil products to Iran as well as exporting gas condensate to China. The level of oil exports from Iran to China will likely continue to rise, and those from Saudi Arabia may decline further.

China’s national oil companies (NOCs) embarked on the acquisition of overseas oil and gas fields in the mid-1990s, soon after the country became a net oil importer. The surge in economic growth in early 2000s saw these imports rise sharply, by more than 30% a year in 2003 and 2004. This triggered a new round of overseas deals by the NOCs, with a focus on the Middle East and North Africa, including Iran.

Both CNPC and Sinopec had been involved in Iran since the year 2000 in oil exploration and development. But the big deals came in 2007 when Sinopec committed to develop the Yadavaran oil field and in 2009 when CNPC signed contracts for the North and South Azadegan oil fields. Progress on all three projects was constrained by sanctions. Nevertheless, Phase 1 of Yadavaran reportedly came into production in October 2015 at 85,000 bpd or more, as did North Azadegan with 75,000 bpd.

The real prize in Iran is natural gas. Thus CNOOC signed an agreement in 2006 to develop the North Pars gas field, and CNPC followed suit in 2010, replacing the French company, Total in Phase 11 of South Pars. Both these arrangements were terminated on account of lack of progress under sanctions, was CNPC’s South Azadegan contract. The end of sanctions may allow the Chinese NOCs to revitalise these lost interests as well as to embark on Phase II of the Yadavaran and North Azadegan fields.

Those Chinese NOCs with existing oil fields in Iran will try to raise production levels, thereby assisting the growth of exports. Iran’s government may give China’s NOCs the opportunity to return to projects that had been suspended, but this may not be to the exclusion of the international oil companies.

Western sanctions have also crippled Iran’s oil refineries. China has helped by supplying oil products and by upgrading refineries. The end of sanctions will allow Sinopec to boost the scale of this involvement, notably with the large refineries at Abadan and Isfahan. An inflow of new technology will also raise the quality of the fuels produced, helping to ease the level of air pollution from road vehicles. In addition, Iran and China have shown interest in building a refinery in Kazakhstan that would supply oil products to northern Iran. In return, Iranian crude oil would be exported from southern Iran as a swap.

The involvement of China’s companies will also grow in other parts of the energy industry such as oil refining, pipeline and power grid construction, and nuclear power. China has committed to finance the Pakistan stretch of the Iran-Pakistan gas pipeline the context of the China-Pakistan economic corridor agreed in 2015. This gas pipeline could eventually be extended to China. As part of an agreement relating to nuclear energy development and research, China also agreed to work with Iran to build two 1 GW plants in south of Iran as well as a number 100 MW plants.

Iran is likely to require foreign energy companies to deploy the best available technology, a policy that might constrain the range of opportunities available to Chinese companies, especially in relation to the giant gas fields. Further, it is probable that all projects will encounter a range of administrative hurdles as the government puts in place systems to manage the new inflow of investment.  



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