China, Iran strike deal on oil

Oil and gas deals between China and Iran are set to change. Last week, several news agencies in the region, including the Iran Daily and Trend News Agency said that Iran and China have agreed that China would pay in cash for the oil and gas it buys from Iran.

China is currently the biggest buyer of Iranian crude oil, purchasing more than 440,000 barrels per day (b/d), but Tehran imports goods instead of receiving cash from these sales. The Iran Daily said that Iran can sell about one million b/d of oil under a preliminary nuclear agreement but the country has to use a maze of routes to receive its money. The two countries reached an agreement on payments partly in cash and the transfer of money to a third country to pay for imports.

“We wanted to transfer part of the export earnings to other countries, such as South Korea and Japan, to pay for imports or receive it in cash. Hence, consultations were made and an agreement was reached in this respect,” said Asadollah Asgaroladi, chairman of the Iran-China Chamber of Commerce. “Under the new agreement with Chinese authorities, it was decided that after a commission rebate, the balance of the oil and gas exports earnings is returned to Iran,” Asgaroladi said.

He added that there is no problem for payment of the oil earnings by the Chinese, without specifying the currency in which the two countries are trading. Crude oil is priced in US dollars, however, China has stated on several occasions that it would like to see the Chinese Yuan, as part of a basket of global currencies, used as the world’s reserve currency to offset a global financial system dominated by the dollar and Western governments. Iran, for its part, has also advocated using a different currency for oil payments, in efforts to distance itself from Washington’s influence.

This disclosure comes as Iran is in prolonged negotiations with the group known as P5+1 (the five permanent UN Security Council members, including the US, plus Germany) over Tehran’s nuclear program ambitions. In early April, the two sides reached a political agreement to eventually lift Western sanctions.

Almost immediately after the preliminary deal was reached Iranian officials traveled to Beijing to meet executives at Sinopec Group, one of China’s largest energy companies. At the time, Andy Lipow of Lipow Oil Associates told CNBC that Iran was laying the groundwork for increased oil sales to China once the sanctions were lifted. In light of recent talks between China and Iran, it appears that Lipow was correct. Iran is also negotiating with several other countries, including South Korea, over post-sanctions cooperation.

However, the April agreement was a preliminary deal. A June 30 deadline for reaching a permanent deal is approaching. In the meantime, the possible increase of Iranian crude oil to an already over supplied global oil market is keeping analysts and energy consultancies busy.

The US Energy Information Administration (EIA) said after the preliminary deal that reintroducing an estimated 700,000 b/d of Iranian oil to the market would counteract production cutbacks elsewhere. The EIA was mostly referring to cut backs at some US shale plays amid plunging oil prices, off around 40 percent in the past year, and slower global oil demand growth, including slower demand from China. If a comprehensive deal with Iran is reached, the EIA report said, 2016 crude oil prices might need to be revised lower by between $5 and $15 per barrel.

New Iranian oil entering the global oil markets would prove problematic for several OPEC members, especially as the cartel tries to stick to its November decision to maintain production levels to protect market share despite the downward pressure that strategy exerts on oil prices. However, for Iran, whose economy took a direct hit from Western sanctions over the past five years (especially its oil sector) and for China, who needs to diversify its oil supply, additional volumes of Iranian oil hitting the market would be welcome news.

CNBC