Tehran pins its hopes on trade with China

19 December 2010

As international oil majors abandon projects amid toughened sanctions, the way is open for China to play a greater role in Iran’s energy sector. But Beijing’s oil firms are showing caution

Iran in numbers

$21bn a year: Value of bilateral trade between Iran and China

300,000: Barrels a day of oil production capacity Iran needs to replace each year

Source: MEED

As Western oil majors exit Iran, Tehran is hoping China will be willing to take on an increasingly large share of the country’s oil and gas development. Since 2005, China and Iran have signed eight preliminary and binding upstream agreements, involving all three of China’s leading state-owned energy companies: China National Petroleum Corporation (CNPC), Sinopec and China National Offshore Oil Corporation.

[Chinese policy] approach to Iran has been based on an understanding of shared economic interests

“Sinopec and CNPC are major stakeholders in the Chinese state. Their top executives are all senior politburo members. Loyalty is not just to the company, but to the state. Will the Chinese government pull out of Iran? I doubt it,” says Fariborz Ghadar, director of the US-based Centre for Global Business Studies.

Chinese caution

The energy companies’ proximity to policymakers in Beijing enables them to operate with less red tape and to access project financing rates that other international oil companies cannot match.

For its part, Tehran has offered attractive terms in buyback agreements, with shorter than usual payback periods and higher rates of return than previous contracts.

But in the current political climate, even Chinese oil companies, traditionally less risk averse than their Western counterparts, are wary of pushing ahead in Iran.

Before being thrown off the Persian liquefied natural gas project, the UK/Dutch Shell Group and Spain’s Repsol held talks with Sinopec – China’s second largest state-owned energy firm – over the scheme. “But these [talks] have not proceeded,” says a Tehran-based source.

It could simply be that they have eyed a less controversial prize next door in Iraq. Chinese state-owned energy companies are involved in several fields in the region, with an estimated 24 billion barrels in reserves, and Beijing may have had its fill of Middle East risk.

Even where China has solid commitments, developments have proved achingly slow. Most of the upstream projects that Chinese national oil companies are involved in face delays, not because of reservoir challenges, but due to difficulties in securing the relevant equipment and technology to undertake the vast projects.

After agreeing to develop the Yadavaran oil field in the Khouzestan province in 2004, Sinopec’s progress has been lethargic. The project, which aims to increase production to 185,000 barrels a day (b/d) over two phases, is already running more than a year late and the scheduled completion date of 2016 looks doubtful. The delays are a result of “difficulties with sanctions associated with the major packages and Chinese inefficiencies,” says the source in Tehran.

Many industry observers in Iran are now concerned Sinopec is looking to exit the project. The project management consultancy and engineering, procurement and construction (EPC) contracts for the early production facilities were due to be awarded in June, but bidders are still waiting for news from Sinopec, which has yet to drill its first well at the field.

Sinopec tendered eight EPC contracts in early 2009, along with a project management consultancy deal. Bids were submitted in July after Sinopec and the state-owned National Iranian Oil Company (NIOC) extended the EPC period and asked bidding firms to include extra facilities, such as offices and staff accommodation. The bids were expected to be opened the same month. Bidding firms maintain they are still in contact with the Chinese firm.

According to some sources in Iran, Sinopec – which has a 51 per cent stake in the $2bn development – has sought financial compensation from NIOC over the delays. 

The field contains 18.3 billion barrels of crude oil, of which 3.2 billion barrels are recoverable. The first phase of development is expected to produce up to 85,000 b/d by 2016.

“Memorandums of understanding have been signed, but China cannot deliver as quickly as they or the Iranians had hoped, but that does not mean that they will walk away,” says Ghadar.

Diplomatic pressure on China from US

Progress on other Chinese projects in Iran has also been slow. It appears Chinese firms have adopted a ‘wait-and-see’ policy and analysts put this down to US diplomatic pressure.

In September, a US delegation to Beijing, led by Robert Einhorn, the State Department’s special advisor for non-proliferation and arms control, handed their Chinese hosts a list of companies it considers to be violating UN sanctions by cooperating with Iran in developing its energy sector. The Chinese Foreign Ministry responded that it was observing UN sanctions, although the distinction with the US’ unilateral sanctions should be made.

The US has to conduct a delicate balancing act when seeking to apply pressure on China. After all, Iran is not the only topic on Beijing’s agenda, and the US must work with it on a number of issues, not least growing instability on the Korean peninsula. For China, there is also the question of US arms sales to Taiwan.

Restricting investment in Iran’s energy sector

Nevertheless, Washington has gained some form of international consensus on Iran. China and Russia supported the enhanced UN sanctions in June, although these were watered down significantly to obtain their support, lessening the impact on Iran’s energy sector. However, the mere fact that China and Russia finally acquiesced is perhaps an indicator of where their compasses now point.

China crude oil demand (Millions of barrels a day)
e=Estimate.; f=Forecast. Source: Facts Global Energy

The enhanced sanctions from the US and EU among others, which passed their own laws restricting investment in Iran’s energy sector, have had a far greater impact.

The Italian government decided in March not to extend any more export credit guarantees for firms investing in Iran. At the end of April, Italy’s Eni ended its 43-year involvement in Iran, telling its shareholders it was opting out of a third phase of the Darquain oil field development. The firm has a 60 per cent interest in the 3.6-billion-barrel field and is handing over operations to local partner Naftiran Oil Company.

Japan’s Inpex Corporation announced in October it was pulling out of Iran. The firm held a 10 per cent stake in the 6-billion-barrel Azadegan oil field project. Iran’s Naft Iran Intertrade Company (Nico) held the remaining 90 per cent stake, but agreed to transfer 70 per cent of its share to CNPC before the Inpex pullout.

The two companies differ on their expectations from the field, which contains some 33 billion barrels of reserves, with 6 billion barrels recoverable. Nico hoped to reach 150,000 b/d with phase one in 2008 and 260,000 b/d in phase two by 2012, but progress has been slow. The detailed development plan for the northern part of the field by a CNPC subsidiary is now reported to have come to a standstill.

According to London-based IHS Global Insight, the Chinese energy firm hopes to reach a 75,000-b/d production rate by 2013 and 150,000-b/d output by late 2015 from the North Azadegan project, although the first-phase timeframe is already starting to look tight.

Diplomatic ties between China and Iran were only established in 1971, but since the 1979 Islamic Revolution, Beijing has provided much-needed trade and investment with Tehran. As Iran’s international isolation has increased, the People’s Republic has gradually become the dominant external player in the Islamic Republic’s economy, taking over from the EU in 2009 as Iran’s leading trade partner. Bilateral trade is worth more than $21bn a year.

A hallmark of Chinese policy has been its pragmatism. Its approach to Iran has been based on an understanding of shared economic interests. Iran is China’s third largest supplier of crude oil, exporting 430,000 b/d, just behind Saudi Arabia and Angola, according to Singapore-based consultants, Facts Global Energy.

China’s appetite for energy is enormous, but it shares an asymmetric relationship with Iran. Tehran is attempting to trade access to its abundant oil and natural gas reserves for diplomatic support on its uranium enrichment programme. But it also needs Chinese investment and expertise to prevent its economy from falling apart.

Iran’s oil minister Masoud Mirkazemi may deny that growing isolation and sanctions are affecting the country’s oil business. But he has given his employers a stark warning. The fourth largest oil producer in the world risks becoming a net oil importer if output rates continue to fall. Analysts estimate Iran needs to replace at least 300,000 b/d of oil production capacity every year as its fields mature. The sector will require investment of $150-200bn over the next five to six years to arrest declining production rates. It will be impossible to raise these funds internally.

Iran maintaining output

So far, Tehran has managed to arrest the decline, maintaining average production capacity above 3.5 million b/d for much of the past decade and more than 4 million b/d since 2003. Output capacity is far lower than 30 years ago. The country produced more than 5 million b/d on the eve of the Islamic Revolution. Since then, production has declined due to war and sanctions.

As much as Chinese firms may be eager to get a foot in Iran’s door, for now they appear to be in no rush to inject large sums of cash into energy projects until sanctions are eased and the geopolitical risks are reduced.

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