EU Embargo of Russian Oil Spells Trouble for Iran

European Union leaders have agreed on a landmark embargo of Russian oil that will seek to slash imports by 90 percent by the end of the year. The embargo represents a major intensification of European sanctions on Russia following the invasion of Ukraine.

For most oil producers, the embargo will be a boon. While the measures were widely expected and therefore may have been partly priced-in by traders, oil prices jumped on the news. Saudi Arabia, for one, is already planning how it will spend the windfall enabled by high oil prices.

But for Iran, and to a lesser extent Venezuela, the embargo of Russian oil is bad news. For countries whose oil exports are subject to U.S. or EU sanctions, China is the buyer of last resort. For several years, China has been the sole country to continue significant purchases Iranian and Venezuelan crude oil, ignoring the threat of U.S. secondary sanctions. These imports have been an important contributor to Iran’s economic resilience under sanctions. However, this is not because revenues are flowing back to Iran. The revenues accruing in China are being used to sustain Iran’s imports of crucial intermediate goods for the country’s manufacturing base.

Iran has also benefited from increased financial resources in the United Arab Emirates and Malaysia, two countries which are serving to intermediate Chinese imports of Iranian oil. Most Iranian oil arriving in China is declared as an import from the UAE or Malaysia. As it stands, Iran is consistently exporting more than 1 million barrels per day of crude oil to China.

Russia’s rise as a major energy exporter to China corresponds to the period in which Iranian oil was taken off the market due to the impacts of US, EU, and UN sanctions programmes—Iran’s demise as an oil exporter helped open the door for Russian exports.

The new EU embargo on Russian oil will intensify competition between Russia and Iran in China’s oil market. Russian suppliers are already offering buyers a 30 percent discount on benchmark prices, a much steeper discount than Iran has offered Chinese buyers in recent years. Russia and Iran will be competing for the business of the limited number of Chinese refiners willing to process “sanctioned” oil.

Already, some Chinese “teapot” refiners are replacing Iranian oil with Russian oil because of the attractive discounts on offer. So far, customs data does not reflect a dramatic swing away from Iranian imports. But it is early days and the embargo will dramatically change incentives. According to the IEA, around “60 percent of Russia’s oil exports go to OECD Europe, and another 20 percent go to China.” While some customers, such as India, might import the Russian barrels that would have otherwise gone to Europe, political and economic realities will require Russia to push more oil into the Chinese market.

Looking to Chinese customs data for April, Russia’s ability to squeeze Iran becomes clear. It is clearly a more important supplier of crude oil to China. While logistical bottlenecks might prevent an immediate jump in Chinese purchases, all of the Russian barrels already flowing to China are newly subject to discounts—China can insist on lower prices now that the EU embargo is in place. This in turn creates pressure for Iran to match Russian discounts or risk losing market share.

While it is possible that the further pressure on global supply might push oil prices even higher, minimising the loss of revenue for Iran even as Chinese imports fall, in the medium term, Russia has the means to bully Iran due to its lower fiscal breakeven price and lower production costs. At the outset of the COVID-19 pandemic, Vladimir Putin boasted that Russia could withstand oil prices of as low as $25 dollars per barrel for as long as a decade. Iran’s oil sector, already weakened by a decade of sanctions, does not have the same ability to endure low prices. In short, Russia can afford to undercut Iran. 

Plus, for whatever period that Russian oil is not subject to U.S. secondary sanctions, Chinese tankers and refiners may prefer to handle Russian crude, due to the lower risk of enforcement action.

Iran has a couple of options here. First, it could try and negotiate an arrangement with Russia, agreeing not to engage in a race to the bottom when it comes to pricing their sanctioned barrels for China. Iran might even be able to play a role as an intermediary in Russian energy exports to China, importing refined products across the Caspian and exporting crude oil to China as part of a swap arrangement. But this kind of cooperation is highly unlikely given the track record of Russia-Iran relations and the fact that Russia sees Iran as the junior partner in the relationship.  

The second option would be for Iran to try and get itself out of this predicament by taking decisive steps to restore the nuclear deal. Doing so would see the rollback of U.S. secondary sanctions on Iranian oil and enable the resumption of exports to European buyers precisely when those buyers need it most. Earlier this month, EU High Representative Josep Borrell commented on the heightened value of the nuclear deal for Europe in the wake of the Russia crisis. He told the Financial Times that “Europeans will be very much beneficiaries from this deal” as the “the situation has changed now.” He added that “it would be very much interesting for us to have another [crude] supplier.”

Earlier this week, Iranian officials boasted that oil revenues were up 60 percent year-on-year owing to the high oil prices. But the situation has changed now. As the EU moves forward with its historic embargo, Iran’s oil revenues are suddenly in Russian crosshairs.

Photo: Kremlin.ru

China’s Declared Imports of Iranian Oil Hit a (Deceptive) New Low

New data from China’s customs administration show a significant drop in purchases of Iranian oil. The declared value of September imports was just USD 254 million, down 34 percent from August and down 80 percent from the same month last year.

The September data appears to end a period of relative stability for Chinese imports of Iranian oil following the Trump administration’s revocation of a key sanctions waiver in May, since when China has continued to purchase Iranian oil in direct violation of U.S. sanctions.

But the decline in purchases of Iranian oil was not matched by a decline in Chinese purchases of non-oil goods. Non-oil imports from Iran exceeded USD 500 million in September, a level of monthly trade that has remained stable since April of this year and which is consistent with the monthly average observed over the last two years.

This suggests that the fluctuation in oil purchases is not related to a system-wide disruption in China-Iran trade such as the banking difficulties that stymied commerce late last year. Additionally, Chinese exports to Iran did not decline month-on-month in September.

According to data provided by TankerTrackers.com, fewer barrels of oil were observed departing Iran in August than in July. Observed exports amounted to around 670,000 bpd in August, down by about 130,000 bpd from the previous month. This drop in observed exports offers one explanation as to why Chinese declared imports of Iranian oil were lower in September than in August—export levels in a given month tend to appear as declared imports in the following month given the four week journey of tankers at sea.

Notably, any decision to scale back imports of Iranian oil in September would have predated the Trump administration’s move to sanction tanker subsidiaries of Chinese state shipping giant COSCO involved in the transport of Iranian oil. The Chinese government has reportedly asked the Trump administration to remove sanctions on COSCO as part of its ongoing trade negotiations. 

In July, U.S. officials had publicly expressed concern about continued Chinese purchases of Iranian oil, suggesting that China was given prior warning that its tanker fleet could be targeted with sanctions designations. This may have spurred China to reduce the use of its own VLCC tankers in the transport of Iranian oil. The fleet of the National Iranian Tanker Company (NITC) has long been the primary means by which Iranian oil is exported to China, but having fewer Chinese tankers picking up oil from terminals in Iran would nonetheless reduce export capacity, depressing overall imports. 

However, data on observed exports from Iran does not correspond to the drop in declared imports in September’s customs data. The value of the observed exports is considerably higher than the USD 250 million in Chinese purchases declared for September. The market value of Iran’s August exports is over USD 1.2 billion. Syria is the only other customer currently purchasing Iranian oil and imports significantly less than China. So where is the additional oil going?

Some tankers which departed Iran for China in August are still in transit, waiting for ship-to-ship transfers that will take the Iranian crude to its final port destination. Other tankers may have delivered their oil into bonded storage, meaning that the oil has not yet been sold to China and is therefore not captured in the customs data. 

But the most obvious explanation for why declared imports lag observed exports is actually captured in the customs data—just not in the entry for Iran. Reports earlier this summer noted ship-to-ship transfer activity off the coast of Malaysia that appeared to be tied to exports from Iran. Chinese customs data from the last few months illustrates how the drop declared imports from Iran is concurrent with a marked increase in imports from Malaysia.

Since May of this year, Malaysia has exported an average of USD 1.2 billion worth of oil to China each month. The monthly average in the twelve months leading up to May was just USD 1 billion. Re-export of Iranian oil via Malaysia allows China to overcome the capacity problem introduced by the threat of sanctions on major players like COSCO. China can use smaller tankers for the final leg of the journey from Iran, picking up oil from Iranian VLCCs.

Looking ahead, TankerTrackers.com has reported total Iranian exports of around 485,000 bpd in September, a decline of 185,000 bpd when compared to the previous month. With less crude at sea, the value of oil imports declared in China’s October customs data may even fall below the September level. Yet there is little evidence that China is making a strategic decision to further decrease imports of Iranian oil. On the contrary, the strategy to sustain a baseline of imports appears to be growing more sophisticated.

Photo: Depositphoto