Economy, Business And Markets

China-Iran Ties After Nuclear Deal

China-Iran Ties After Nuclear DealChina-Iran Ties After Nuclear Deal

The July 14th nuclear deal between Iran and the six world powers looks set to be a mixed blessing for China. China is one of the largest importers of Iranian oil and a major investor in the country’s upstream sector, and the gradual easing of restrictions on investments and trade with Iran should make life easier for Chinese firms doing business there.

However, the Iranian government would also like to attract western investors, in a bid to reduce what is increasingly perceived as a Chinese stranglehold on its economy, according to The Economist Intelligence Unit.

The deal between Iran and the P5+1 powers (the permanent members of the UN Security Council plus Germany), caps a series of talks that have taken place since 2014. Under its terms, Iran has essentially agreed to limit the capacity of its nuclear program. In return, the agreement means that sanctions against Iran will be lifted, delivering a significant boost to its economy from 2016.

  China and Iran: Ties That Bind

Oil flows have become an increasingly important part of Sino-Iranian ties. China, the world’s largest oil importer, has relied on Iran for around 10% of its imported oil, on average, over the past decade. China has also become a key investor in the Iranian upstream oil industry, owing largely to the western sanctions regime that has deterred other countries’ firms from investing.

Indeed, Chinese involvement in Iran’s hydrocarbons sector began shortly after the US introduced the Iran-Libya Sanctions Act in 1996. China’s national oil companies were taking their initial steps onto the global scene at that stage. As a result, they were more willing to accept the Iranian system of “buyback” contracts—an arrangement that is less appealing to most western investors than the production-sharing agreements or service contracts used in most other oil-producing countries.

Over the years, Chinese investors have increased their footprint in Iran. All three of China’s national oil companies —CNPC, Sinopec and CNOOC—have committed to multibillion-dollar investments in Iran’s hydrocarbons sector in prize assets, including the South Pars gas field (one of the world’s largest) and in the Azadegan oilfield.

Commercial relations have also deepened between the two countries, encompassing manufactured goods and electronics. This has propelled China to become Iran’s largest trading partner, with bilateral trade reaching $51.9 billion in 2014, according to Chinese customs authorities, almost one-third of Iran’s total trade volume and a fourfold increase on the 2005 figure.

  Not All Rosy

While Chinese investments and financing have offered the Iranian economy a lifeline throughout the permutations of the sanctions regime, relations have not been entirely rosy. For one, progress on developing oilfields has been slow and contentious. Chinese firms, at least in the earlier days, did not have the know-how to develop Iranian fields without foreign oilfield-service firms, which were barred from operating in the country.

Moreover, as China’s NOCs began expanding their investments in North America, they grew concerned about the impact of US sanctions on their operations there, prompting them to slow progress in developing their Iranian assets.

Diplomatically, the Chinese government wanted to assert its right to ignore US and EU sanctions by maintaining its companies’ foothold in Iran. However, at the same time, it tried to demonstrate restraint by slowing Chinese state-owned firms’ Iranian projects and by curtailing its oil imports. As a result, Chinese oil imports from Iran fell from their height of 565,000 barrels per day in 2011 to 430,000 bpd on average during the following two years. Overall, the share of Iranian oil dropped from 13% of China’s total imported oil in 2007 to 8% in 2014.

China’s balancing act did not go down well in either the US or Iran. In 2012 the US imposed sanctions on a Chinese oil trader, Zhuhai Zhenrong, for selling gasoline to Iran, while slow progress on upstream investments led the Iranian government to cancel CNPC’s $2.5 billion South Azadegan oilfield development project in April 2014.

Meanwhile, restrictions on international banks doing business with Iran, imposed in the context of sanctions, have served to increase Iran’s use of the renminbi, as well as its imports of Chinese goods, as part of efforts to avoid using the global financial system for oil payments. This has increased the flow of Chinese consumer goods to Iran, and, with it, Iranian dissatisfaction about their growing share of the market there.

This has led Iranian leaders to court western oil and gas companies and to seek a more diverse investor base. The country’s leaders have promised to revise the buyback contractual system. For now, these efforts remain tentative: A new contractual framework has yet to be drafted and western oil company executives remain cautious regarding the timeline of Iran’s opening. However, the threat to China’s privileged position is clear.

  Signs of Relief

China’s NOCs fear that Iran wants them to commit now, but will seek to renegotiate their deals at a later date, when western firms are back in play. (Iran certainly plans to encourage foreign investment in its hydrocarbons sector as it tries to get production back above the pre-sanctions level of 3.8m b/d, and looks set to announce new contract terms for international oil companies later in 2015, as part of its effort to stimulate their interest in entering Iran’s energy sector, once it is legally possible to do so.)

The Chinese firms’ caution is exacerbated by the fact that they must reduce investment and focus on their most strategic goals, now that their revenues are falling, along with global oil prices. Moreover, the fallout from domestic anti-corruption investigations has cooled the appetite of Chinese NOC executives for pursuing new ventures.

Sino-Iranian ties will, therefore, need to adapt to new realities. Despite caution on both sides, there is still significant impetus to further deepen Sino-Iranian ties, coming from the highest levels of the Chinese government. This is because the ties that bind China to Iran run deeper than energy.

China’s leaders view Iran as a rising power in the Middle East and a geostrategic hedge against the US. Moreover, Iran is a key part of China’s “One Belt, One Road” initiative, which involves channeling Chinese investment capital to markets from Southeast Asia to Europe, in order to promote economic development and strengthen China’s strategic influence. As a result, Iran will remain high on the Chinese government’s political agenda.