Sanctions gap allows China to import Iranian oil

A Chinese oil tanker

A gap in U.S. law has allowed China to import nearly $500 million of additional oil products from Iran this year while avoiding U.S. sanctions, demonstrating Washington’s challenge in designing effective measures to target Tehran.

The Chinese imports pose a delicate issue for the U.S., which is trying to curb Iran’s nuclear ambitions through sanctions without harming relations with fast-growing Asian countries that depend on Iranian oil.

U.S. sanctions law is designed to punish any country that imports Iranian oil, but it gives the State Department broad flexibility to exempt countries that are reducing their purchases of crude oil. State has repeatedly given exemptions to China on the grounds that Beijing is buying less crude oil from Iran.

The latest twist stems from a gap in the sanctions law: When discussing exemptions, it mentions only crude oil, not fuel oil, a byproduct of refining crude into more expensive products such as diesel and gasoline. While fuel oil is significantly less valuable than other refined fuels, some Chinese refineries can process it into more valuable fuels.

China imported 5.4 million barrels of Iranian fuel oil valued at $495 million in the first seven months of 2013, according to Chinese customs data, up from less than $1 million in all of 2012. China has purchased more Iranian fuel oil this year than in the past four years combined, according to the data.

By increasing fuel-oil imports, China has offset some of Iran’s lost revenue from lower crude exports. China imported 3.3 million fewer barrels of Iranian crude in the first seven months of 2013 compared with the same period a year earlier, according to customs data. This year’s crude imports were valued at $9.5 billion, down $850 million from a year earlier as a result of both lower volumes and weaker oil prices.

“This is widely recognized as a loophole that you can drive an Iranian oil tanker through,” said Mark Dubowitz, executive director at the Foundation for Defense of Democracies, a Washington think tank that has pushed for more sanctions against Iran.

The U.S. sanctions target financial institutions that conduct oil trades with Iran’s central bank by banning them from doing business in the U.S. Congress passed the law in late 2011 in response to Western charges that Tehran is seeking to develop nuclear weapons. Iran says its nuclear program is for peaceful purposes.

In 2012, oil exports generated up to 60% of Iran’s government revenue, according to the U.S. Energy Information Administration. However, U.S. sanctions have pinched Tehran. Iran’s crude-oil exports are at a 26-year low because of pressure from the sanctions, according to the EIA. It estimates Iran net oil-export revenue fell to $69 billion last year from $95 billion in 2011.

Some U.S. lawmakers have accused China of taking advantage of unintended gaps in the law to boost fuel imports from Iran. The U.S. House of Representatives passed a bill in July that would require countries to reduce imports of fuel oil as well as crude oil in order to qualify for a sanctions exemption.

“We’ve seen reports of some countries trading with Iran taking advantage of the current, narrow definition of crude oil to purchase fuel oil,” said Rep. Ed Royce (R., Calif.), chairman of the House Foreign Affairs Committee. “So it is critical that Congress broaden the definitions contained in law, to starve Tehran of much-needed hard currency and deny it the means to acquire a nuclear-weapons capability.”

The Obama administration is taking a more cautious approach. A State Department official said the department is tracking the situation but has determined China is cutting its petroleum purchases and reducing the amount of money transferred to Iran, although China has publicly expressed opposition to the U.S. sanctions.

The goal of the [sanctions] law is to reduce revenue to Iran,” a State Department official said. The official said that on the whole, the “letter and spirit of the law” are being followed.

The ability of the U.S. to press China and other Asian countries to further reduce their imports of Iranian crude could become more difficult as oil consumption in those nations grows. Though China has curbed its dependence on Iran, it still turns to that country for 7.5% of its crude imports.

“It’s now politically imperative to keep ties with China on an even keel,” said Michal Meidan, an analyst at Eurasia Group. “While Iran is still a top priority of the administration, they may have to live with some of these discrepancies for the sake of the bilateral relationship.”

In June, China won its third exemption from U.S. sanctions, but it has struggled to maintain a steady decline in Iranian crude imports. China’s crude imports from Iran fell 21% in 2012 from 2011, but were down only 3.5% in the first seven months of 2013, customs data show. The sharp drop in 2012 was partly due to commercial disputes between China Petroleum & Chemical Corp., or Sinopec, and National Iranian Oil Co., or NIOC, that froze some shipments for several months.

The House bill passed in July would require all importers of Iranian oil to collectively reduce their imports by an additional one million barrels a day. Iran’s exports in 2012 totaled 1.5 million barrels a day, which means buyers like China and India would have to make deeper cuts to stay in compliance. In the U.S. Senate, a related sanctions bill is expected to be introduced in September, although it’s unclear whether it will include the same measures.

People familiar with Iran’s fuel-oil exports said Iran has been trying to sell more refined oil products to China because of the sanctions.

Iran’s fuel oil is purchased by Chinese trading companies such as Zhuhai Zhenrong Co., said the people familiar with Iran’s exports. Zhuhai Zhenrong already is China’s biggest importer of Iranian crude and has been sanctioned by the U.S. for exporting gasoline to Iran. The traders then resell the product to small, independent Chinese refineries, the people said. A Zhuhai Zhenrong spokeswoman said she was unaware of Iranian imports and didn’t comment further.

Such small refineries, called teapot refineries, represent almost a quarter of China’s overall refining capacity, according to energy consultancy ICIS C1 Energy. They are configured to process fuel oil rather than crude because Beijing gives state refiners priority on crude-oil processing.

One person said Iran’s fuel oil has been discounted due to the sanctions, making it more lucrative than Russian fuel oil, which China more commonly imports, though China’s fuel-oil imports from Russia also rose a tad in the first seven months. An NIOC official, meanwhile, said Iran’s fuel-oil sales to China are priced according to the market.

China is facing a scarcity of fuel oil as refineries in neighboring countries such as South Korea and Russia learn to break it down further into more expensive refined products, said Kang Wu, an analyst at FGE. “China’s import of Iranian fuel oil is part of the equation of China’s overall fuel-oil demand.”

China is set to surpass the U.S. as the world’s largest net importer of oil in October, according to a forecast by the EIA. China’s oil demand grew 3.8% last year and is expected to rise 3.7% this year, the International Energy Agency said. The IEA expects near-flat U.S. oil demand in 2013.

Another major buyer, India, signaled this month that it may need to boost imports from Iran despite showing a 26.5% decline in the year ended March 31, the most recent data available. India’s finance minister said last week that the country wants to boost imports of Iranian crude as it wrestles with economic woes.

By The Wall Street Journal



The Iran Project is not responsible for the content of quoted articles.