Two key questions logically arise from last week’s announcement from Iran’s Petroleum Ministry that it has awarded a US$1.3 billion development deal to more than double oil production at the supergiant South Azadegan oilfield, the second such oil project signed this month, the other being a US$300 million development contract for Yaran. The first question is, given the fact that Iran is technically bankrupt, how can it afford such projects? The second is, given the swingeing U.S. sanctions still in place – including against the main tanker fleets of the National Iranian Tanker Company and the Islamic Republic of Iran Shipping Line – where is any of this increased oil supply meant to go? The answer to both questions is the same – China – and precisely what is going on is analysed below. Firstly, Iran’s finances are arguably the worst they have ever been, due to the U.S.’s re-imposition of sanctions in 2018, following its unilateral withdrawal from the Joint Comprehensive Plan of Action in May of that year. Using a comparison benchmark of November 2019, as of a week ago, Iran’s GDP growth is minus 22 percent, unemployment is around 37 per cent, inflation is over 65 per cent, and the rial has depreciated at least 65 percent to date over that period against a basket of core global currencies. Iran is also currently running a budget deficit of 80 per cent, and a trade balance of negative US$6.5 billion.
With little prospect of the U.S. lifting its sanctions against Iran any time soon, and any country that uses the U.S. dollar significantly in the trade transactions of itself or its corporations having little choice but to abide by these sanctions, it can well be argued that Iran had little choice but to go with where the money is, which is China. Consequently, as uncovered by OilPrice.com, Iran last year signed a 25-year deal with China that publically just reiterated the key elements of a very vague co-operation deal that was agreed in 2016 but privately included a collection of highly-specific deals across many business sectors, most notably including oil and gas.
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Aside from the new military element added in recently – also uncovered by OilPrice.com - the oil and gas industry part of the 25-year deal means that in exchange for at least US$400 billion from China, Chinese companies will be given the first option to bid on any new – or uncompleted – oil, gas, and petrochemicals projects in Iran. China will also be able to buy any and all oil, gas, and petchems products at a minimum guaranteed discount of 12 per cent to the six-month rolling mean average price of comparable benchmark products, plus another 6 to 8 percent of that metric for risk-adjusted compensation. Additionally, China will be able to pay in soft currencies accrued from doing business in Africa and Former Soviet Union states. Given the exchange rates involved, China is looking at another 8 to 12 percent discount, which means a total discount of around 32 per cent for China on all oil, gas, and petchems purchases.
With this deal now exposed, the two countries are constrained in being able to just roll-out the pieces of deal with impunity. Aside from the public reaction on the ground in Iran, Tehran is concerned about an even harsher backlash from the U.S., either more sanctions, or less tangential measures. China, meanwhile, is not only in the midst of the ongoing Trade War with the U.S. but is also having to deal with the fallout of a range of corollary issues now springing up from Washington. Most recently these include the U.S.’s sanctioning of China over its alleged human rights violations against Muslim minorities in Xinjiang and the extension of U.S. sanctions against China’s flagship technology company, Huawei, over cyber-espionage and technology theft concerns.
“It’s one thing for China to ignore all sanctions that the U.S. has imposed on importing Iranian oil and gas, but it’s quite another thing for it to blatantly put its major state companies on the ground in Iran right now, when tensions are so high,” a senior oil and gas industry source who works closely with Iran’s Petroleum Ministry told OilPrice.com last week. “The working template for such deals to go ahead with Chinese companies without attracting too much attention from either the Iranian public or the U.S. State Department is for Iran to begin by making a field development award to a plausible-sounding Iranian development firm [in South Azadegan’s case the US$1.3 billion contract was awarded to Iran’s Petropars, and in Yaran’s case the US$300 million contract was given to Iran’s Persia Oil and Gas Industry Development Co.],” the source said.
“Then the Iranian firm quietly awards a series of very dull-sounding ‘contract-only’ projects to a number of firms virtually no one has heard of – but all controlled by the big Chinese firms - and China is back in business as the de facto developer,” he added. “Exactly the same method has been used by China recently to expand into Iraq’s Majnoon field and into its West Qurna-1 field,” he underlined. In precisely this context, China National Petroleum Corporation (CNPC) subsidiary, China Petroleum Engineering & Construction Corp (CPECC), was awarded a US$121 million engineering contract late last year for West-Qurna-1. Just before that, China’s Hilong Oil Service & Engineering Company was awarded a US$54 million to drill 80 wells in Majnoon (although China also financed the US$255 million contract awarded to the Iraq Drilling Company at the same time). Crucially, Majnoon is Iraq’s side of the reservoir it shares with Iran, where it is called Azadegan (South and North).
In line with this strategy, then, various Chinese companies have been awarded 11 ‘contract-only’ projects in a number of operational areas of Iran’s South Azadegan oil field development, the Iran source exclusively told OilPrice.com. These include contracts for drilling-only, field maintenance-only, engineering-only, construction-only, and technology-only, among others. A further pointer to what is really going on with South Azadegan is that Petropars was also the partner to CNPC in the stalled Phase 11 project of the supergiant South Pars non-associated natural gas field.
“When [France’s] Total dropped out of Phase 11, CNPC was persuaded to add Total’s stake [50.1 percent] to its own stake [30 percent] by Iran’s additional promise that it [CNPC or another Chinese firm] would also get the first rights to take the major foreign rights to develop the South Azadegan field,” he said. “In Phase 11’s case, Petropars was the main Iranian representative company, with a 19.9 per cent stake and in South Azadegan it is now supposedly the principal developer,” he added. “In reality, it doesn’t make any difference what name is on the publicly-available contract, China is just going ahead with what has already been agreed,” he underlined.
With an estimated 27 billion barrels of oil in place in South Azadegan, the new deal is designed to increase its production from the current 140,000 barrels per day (bpd) to 320,000 bpd over 30 months, according to the Petroleum Ministry. As part of the 25-year deal, any and all part of this output can be required by Beijing to go to China, although the understanding is that Iran can take sufficient output from its oil and gas fields for its own power needs (and to maintain the energy supply deal to Iraq until such time as the U.S. ends the waiver for that). To do this, Iran and China have a very long-established number of methods to not make it too obvious to the U.S.
By far the most effective method remains the ‘rebranding’ of Iranian to Iraqi oil simply by switching the stickers on the sides of the tanker trucks moving oil across the extremely long and porous border between the two countries, and then sending it on to any destination that Iraq oil can go (which is anywhere in the world). Another is disabling (literally just flicking a switch) on the ‘automatic identification system’ on ships that are carrying Iranian oil, as is just lying about destinations in shipping documentation, changing the names of tankers whilst at sea, changing the country of a ship’s registration, and doing ship-to-ship transfers nearer to China (just outside Malaysia is a favourite).
As Iran’s Foreign Minister, Mohammad Zarif, highlighted (in December 2018 at the Doha Forum): “If there is an art that we have perfected in Iran, [that] we can teach it to others for a price, it is the art of evading sanctions.” In this vein, incidentally, despite widespread reports of how hard Iran’s oil production and exports have been hit by U.S. sanctions – that were targeted to reduce them to zero – the Islamic Republic is right now producing at least 2.2 million bpd and exporting 0.5-1 million bpd of that (albeit at dramatically reduced prices), according to Iranian oil and gas industry sources.
By Simon Watkins for Oilprice.com
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