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

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. While there are no confirmed numbers, 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 under 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. (LMT) 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 barrels of oil a day in the first eleven months last year, of which 51 percent came from the Middle East.

China’s imports of Iranian oil rose 29 percent to 25.3 million metric tons for the 11 months ended November 2011, compared with the same period in 2010, according to Chinese customs data. The value of the imports increased 80 percent to $19.7 billion, according to the data.

Free Ride

As the world’s second-largest economy after the U.S., China often gets an economic free-ride “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.

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 Prices

Oil climbed to the highest level in a week on concern that an oil-workers’ strike in Nigeria will curb supplies. Crude for February delivery fell $1.81, or 1.8 percent, to $99.06 a barrel at 2:30 p.m. on the New York Mercantile Exchange after touching $102.98 earlier in the day.

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.

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.

Biggest Refiner

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.”

The U.S. today announced sanctions against China’s Zhuhai Zhenrong Company, the country’s largest supplier of refined petroleum to Iran. The U.S. has determined that Zhenrong brokered delivery of $500 million of gasoline to Iran between July 2010 and July 2011, the U.S. State Department said in a statement. Energy trading firms Kuo Oil Pte. Ltd., of Singapore and FAL Oil Company Ltd of United Arab Emirates also were sanctioned, according to the statement.

Sanctions Imposed

All three companies had transactions with Iran with individual deals exceeding $1 million and total value in excess of $5 million. The firms face penalties under the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 that will prohibit them from receiving U.S. export licenses or loans exceeding $10 million from U.S. banks, according to the statement.

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.

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.

Undermining U.S.

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.

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.

EU Ministers

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.

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.

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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