China’s oil options in the face of US sanctions on Iran

China’s oil and gas relations Iran


China’s oil and gas relations with Iran have three main strands: importing oil from Iran, investing in oil and gas assets in Iran, and supplying Iran with gasoline.


China, Japan, India and South Korea together account for about 60% of Iran’s crude oil exports. At 20%, China is the largest buyer. China started importing significant quantities of crude oil from Iran in 1995. These imports were arranged by Zhuhai Zhenrong, a company established with the explicit aim of importing oil from Iran on behalf of China’s military so that China could receive payment for the arms it sent to Iran during the Iran-Iraq war. Zhuhai Zhengron has progressively lost its monopoly over crude oil shipments to China as Sinopec’s subsidiary, Unipec, has built its share.


Annual imports of crude oil rose from 900,000 tonnes in 1995 to 10.8 million tonnes in 2001, by which time Iran was China’s top supplier of crude oil and accounted for 18% of the country’s imports. After 2002, Iran was unable to keep pace with China’s surging import requirement and Saudi Arabia soon took over as China’s top supplier of crude oil. By 2005 Iran had slipped into third place behind Angola. Iran managed to boost its supplies to China to 20 million tonnes by 2007 and has kept them at or above this level since then. But its share of China’s imports has slipped to about 10%.


Over the last 7 years the Middle East has accounted for 45-47% of China’s crude oil imports. As Iran’s share has fallen, so Iraq’s share has risen from 1% to 5%. The proportion supplied by Saudi Arabia has also grown, from 15% a few years ago to 18-22%. Last year (2011) saw a substantial boost in the quantity of oil supplied by Iran to China, from 21.3 to 27.6 million tonnes. This represented a disproportionately large share of the China’s incremental imports over the previous year of 14 million tonnes. This surge suggests that China was trying to compensate for reduced Iranian supplies to Europe.


For the last 10 years China’s national oil companies have been trying to gain access to some of Iran’s vast oil and gas reserves, a task made easier by the exclusion of most competitors by sanctions. CNPC, Sinopec and CNOOC all have contracts signed or under negotiation. These include onshore oil and gas fields such as the North Azadegan and the Yadavaran oilfields, as well as stakes in the offshore North and South Pars fields. These last two could supply large quantities of gas to China. Despite the apparently grand scale of these opportunities, little progress has been made on most of these projects due to a mix of technological and administrative challenges, as well as to wariness on the part of China’s NOCs.


The third strand of China involvement in Iran takes the form of gasoline supplies. The output of oil products from Iran’s refineries has been unable to meet domestic demand. To fill this gap, Guangdong Zhenrong Energy, a subsidiary of Zhuhai Zhenrong, has been supplying Iran with gasoline provided by CNPC and Sinopec as well as, in the past, by Russia’s Lukoil.



China’s exposure and options


The extent of China’s exposure to current events in the Gulf and the range of options it faces need to be assessed in a wider political and economic context.


China’s relationship with Iran is not just based on oil and gas. It is a strategic relationship which goes back decades and, most notoriously, involved the shipment of weapons and nuclear technologies in the 1980s and early 1990s. In recent years, links have grown to include infrastructure, mining and consumer goods. As a consequence, China is most unlikely to abandon Iran entirely by acceding fully to the US sanctions Conversely, it is unlikely to ignore pressure from the USA. Instead it will seek a middle way in an attempt to minimise economic and political fall-out.  In this China may be aided by steps it has taken in recent years to enhance its political and economic relations with other oil-producing states in the Gulf, notably Saudi Arabia and Iraq.


China’s exposure to the sanctions imposed on Iran is diverse. First, it has to decide how to react to the embargo on Iranian oil exports. In theory it has three choices: to reduce imports, to maintain them unchanged, or to increase them to make up from falling flows to Europe. It seems that China has chosen the first option, at least in the short-term, for it has reportedly halved the quantity of oil to be supplied in January and February of this year. Japan and South Korea have also reduced their shipments from Iran. As a consequence China has to seek additional imports from other sources. Premier Wen’s visit to Saudi Arabia in mid-January was very timely. Not only is it likely that he will have asked for additional supplies of crude oil, but the economic interdependence between the two nations will have been enhanced by the signing of an agreement for Saudi Aramco and Sinopec to build a new refinery in the Gulf port of Yanbu. Whether China will receive additional supplies from Saudi Arabia in the short-term will depend to a great extent on whether Saudi chooses to use some of its spare oil production capacity.


The Premier also visited Qatar and the UAE. Neither are larger suppliers of oil to China nor do they have significant spare capacity, though Qatar is an increasingly important supplier of LNG. Instead, China will probably have to look to Iraq, Russia, Latin America and West Africa for incremental supplies of oil.


Second, the Chinese companies taking charge of the crude oil imports are facing difficulties making their payments. By the middle of 2011, Iran was complaining about the length of time the companies were taking to pay. There was even talk of making payments through barter. The Chinese companies are using their position of strength to demand longer payment periods and discounted prices. In the same way, the Chinese companies supplying Iran with gasoline may have difficulties being paid. This challenge has probably not been affected by the action of the US State Department to constrain Zhuhai Zhenrong’s financial activities in the USA, as the company has no assets in the USA and can find other routes to receive payment.


Third, the absence of suitable imported technologies is one of many factors delaying some of China’s more ambitious oil and gas field projects in Iran. CNPC and CNOOC will not be too dismayed by these delays as they have many other upstream projects in their portfolios. In contrast, Iranian assets form a significant share of Sinopec’s upstream portfolio.


In the case that oil exports from Iran were stopped completely, China as a country would suffer in the same way that all oil importers would suffer – from a short-term rise in international oil prices. How long this price spike lasted would depend to a great extent to Saudi Arabia’s willingness to use its space capacity to make up for the loss of Iranian supplies. Given that imports account for more than 50% of China’s oil consumption and that China is the second largest importer of oil in the world after the USA, the impact on the economy of such a price rise would be significant. China’s oil companies would also lose, as they would need to find new supplies of crude oil for their refineries back in China. Any discounts they had wrested from Iran would be lost, and their financial losses in the Chinese domestic oil market would rise.  In the unlikely event that the Straits of Hormuz were closed, the price spike and the economic consequences would be even more pronounced. In addition, LNG supplies from Qatar to China would be interrupted.

To conclude, China is most likely to keep its oil imports from Iran well below the levels seen in 2011. It will seek additional supplies from other countries, but only Saudi Arabia has significant spare production capacity. The Chinese oil companies which trade with Iran will find ways to continue their business, albeit it at a reduced level and probably on more favourable terms.

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