Bloomberg News

China Gets Cheaper Iran Oil as U.S. Pays Tab for Hormuz Patrols

January 23, 2012

Jan. 12 (Bloomberg) -- China stands to be the biggest beneficiary of U.S. and European plans for sanctions on Iran’s oil sales in an effort to pressure the regime to abandon its nuclear program.

As European Union members negotiate an Iranian oil embargo and the U.S. begins work on imposing sanctions to complicate global payments for Iranian oil, Chinese refiners already may be taking advantage of the mounting pressure. China is demanding discounts and better terms on Iranian crude, oil analysts and sanctions advocates said in interviews.

“The sanctions against Iran strengthen the Chinese hand at the negotiating table,” Michael Wittner, head of oil-market research for Societe Generale SA in New York, said in a phone interview. Chinese refiners are likely to win discounts on Iranian crude contracts as buyers from other nations halt or reduce their purchases of Iranian oil to avoid being penalized by U.S. and European sanctions, he said.

At the same time, the U.S. is bearing most of the cost of air and sea patrols and surveillance in the Strait of Hormuz, through which transit 17 million barrels a day of crude, or 20 percent of world supplies. China, the No. 2 importer of oil after the U.S., enjoys protection for the shipping lanes without paying a cent, retired Admiral Dennis Blair, a former U.S. Director of National Intelligence, said in an interview.

U.S. Patrols

“Policing the region imposes a cost on us, and benefits the Chinese,” Blair said in an interview. A few Iranian officials recently have threatened to shut the passage if the U.S. and Europe enforce tough oil sanctions.

The U.S. military is flying 24-hour drone missions every three days in the Strait and the Persian Gulf and 12-hour sorties by Lockheed Martin Corp. manned P-3 surveillance aircraft, according to Chief of Naval Operations Admiral Jonathan Greenert and Navy Captain Jim Hoke.

The U.S. gets 18 percent of its crude and petroleum products from the Persian Gulf, according to the U.S. Energy Information Administration. China imported 5.09 million barrel a day of oil in the first eleven months last year, of which 51 percent came from the Middle East. Imports from Iran rose 5.3 percent in the period from a year earlier to 25.32 million metric tons, accounting for 11 percent of China’s total, according to Chinese customs data.

As the world’s second-largest economy after the U.S., China often gets to be an economic free rider “even absent the current tensions in the Persian Gulf,” said Erica Downs, a China and energy specialist at the Brookings Institution, a research group in Washington.

Iran’s Oil Income

In Afghanistan, China benefited economically from the U.S.- led war to oust the Taliban, Downs said. In 2007, Metallurgical Corp. of China won the right to develop Afghanistan’s largest copper deposit, even as U.S. forces were fighting and dying in the country, she said.

Oil is Iran’s main source of income, yielding the country $73 billion in 2010 and supplying more than 50 percent of the national budget, according to the U.S. Energy Department and the International Monetary Fund. The second-largest producer in the Organization of Petroleum Exporting Countries after Saudi Arabia, Iran exported an average of 2.58 million barrels a day in 2010, according to OPEC.

Oil fell yesterday as U.S. crude and fuel supplies climbed more than analysts estimated. West Texas Intermediate futures for February delivery declined $1.37 to settle at $100.87 on the New York Mercantile Exchange. Prices rebounded as much as 0.6 percent today to $101.49 on concern that a strike in Nigeria will curb petroleum supplies and Japan will cut purchases of Iranian crude. Oil is up 2.6 percent this year.

The U.S. and Europe say they are targeting Iran’s oil earnings to force the regime to abandon a suspected nuclear weapons program. Iran says that its nuclear program is for peaceful civilian energy and medical research.

Four Rounds

While China has voted for four rounds of United Nations sanctions on Iran, China’s leaders have criticized efforts to expand U.S. and European sanctions unilaterally. Chinese Vice Foreign Minister Zhai Jun said a congressional measure signed into law by President Barack Obama on Dec. 31 to penalize Iran’s central bank and block payments for its petroleum exports elevates U.S. law above international norms.

China is the biggest refiner of Iranian crude, buying 22 percent of Iran’s oil exports, according to the U.S. Energy Information Administration.

“Iran is one of China’s biggest petroleum suppliers,” Zhai said at a Jan. 11 briefing in Beijing. “China hopes that petroleum imports won’t be affected, as petroleum is needed for China’s development and for ensuring the needs of its people.”

China is seeking to diversify its Middle East oil sources. Chinese Premier Wen Jiabao embarks Jan. 14 on a six-day trip to the Middle East, including Saudi Arabia, Qatar and the United Arab Emirates.

Hedging Its Bets

During Wen’s visit, China Petroleum & Chemical Corp., known as Sinopec, and Saudi Arabian Oil Co. will sign an agreement for a proposed refinery at Yanbu on Saudi Arabia’s Red Sea coast, the Saudi state-oil company said in an e-mailed statement Jan. 8. Sinopec has agreed to a 37.5 percent stake in Aramco’s planned 400,000 barrel-a-day fuel-processing plant.

Even if it diversifies sources of oil, China is unlikely to sever commercial ties to Iran, said Willy Wo-Lap Lam, an adjunct professor of history at the Chinese University in Hong Kong.

“It has been a long-standing policy of Beijing’s to undermine U.S. influence in the Middle East even as the Obama administration is shifting its diplomatic and military pivot to the Asia-Pacific,” Lam said in an e-mail. “There is no possibility that Beijing will curtail its oil imports from Iran, which is seen by Beijing as a major ally.”

Instead, China’s oil executives are expected to demand lower prices for Iranian crude, said Mark Dubowitz, director of the Iran Energy Project at the Foundation for Defense of Democracies, an advocacy group in Washington.

Reducing Purchases

Dubowitz estimates that if China were the only remaining buyer of Iranian crude, it might command as much as 40 percent discounts. Among the other major refiners of Iranian oil, India has increased orders from Saudi Arabia, and Japanese and South Korean officials say they are gradually reducing their dependence on Iran, Dubowitz said.

The European Union, which is collectively the No. 2 buyer of Iranian crude, taking 18 percent of Iran’s exports, has agreed in principle to an embargo of Iranian oil. The 27 EU foreign ministers are expected to approve the embargo at a Jan. 23 meeting in Brussels.

Discussion of the EU embargo “is already setting off a cascade of oil-market behavior,” as the Chinese try to exploit Iran’s weakness by demanding price cuts, Dubowitz said.

Forcing Discounts

The Chinese “are forcing the Iranians to offer these price discounts to compensate for added political and legal risk,” said Dubowitz, who has been advising Congress and the Obama administration.

Sanctions work in part by leveraging the greed of buyers willing to flout sanctions, he said. Even those buyers will hurt Iran’s bottom line by cutting their oil revenue, Dubowitz said.

Dubowitz agrees with Lam that there’s little evidence that “Beijing and Tehran are breaking up.” Rather, a shrinking circle of refiners will be able to “ruthlessly drive for discounts,” he said.

--with assistance from Pratish Narayanan in Mumbai, Asjylyn Loder in New York, Ramsey Al-Rikabi in Singapore, Frederik Balfour in Hong Kong, Regina Tan in Beijing, Winnie Zhu in Shanghai, Wael Madhi in Cairo and Tony Capaccio in Washington. Editors: John Walcott, Larry Liebert

To contact the reporters on this story: Gopal Ratnam in Washington at gratnam1@bloomberg.net. Indira A.R. Lakshmanan in Washington at ilakshmanan@bloomberg.net

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net


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