China and Iran; Long-term Energy Partnership
Sometimes the most important stories don’t make mainstream news. Last week, more details emerged on a previously announced 25-year, $400bn strategic energy partnership.
“The central pillar of the new deal is that China will invest $280bn developing Iran’s oil, gas, and petrochemicals sectors. This amount may be front-loaded into the first five-year period of the deal, but the understanding is that further amounts will be available in every subsequent five-year period, subject to both parties’ agreement.
There will be another $120bn investment in upgrading Iran’s transport and manufacturing infrastructure, which again can be front-loaded into the first five-year period and added to in each subsequent period should both parties agree.
Among other benefits, Chinese companies will be given the first refusal to bid on any new, stalled, or uncompleted oil and gas field developments. Chinese firms will also have first refusal on opportunities to become involved with any and all petrochemical projects in Iran, including the provision of technology, systems, process ingredients, and personnel required to complete such projects.
“This will include up to 5,000 Chinese security personnel on the ground in Iran to protect Chinese projects, and there will be additional personnel and material available to protect the eventual transit of oil, gas, and petrochemical supply from Iran to China, where necessary, including through the Persian Gulf,” says the Iranian source.
“China will also be able to buy any and all oil, gas, and petrochemical products at a minimum guaranteed discount of 12% to the six-month rolling mean price of comparable benchmark products, plus another 6% to 8% of that metric for risk-adjusted compensation.”
Under the terms of the new agreement, Petroleum Economist understands, China will be granted the right to delay payment for Iranian production for up to two years. China will also be able to pay in soft currencies that it has accrued from doing business in Africa and the Former Soviet Union (FSU) states, in addition to using renminbi should the need arise—meaning that no US dollars will be involved in these commodity transaction payments from China to Iran.
“Given the exchange rates involved in converting these soft currencies into hard currencies that Iran can obtain from its friendly Western banks – including Europäisch-Iranische Handelsbank (in Germany), Oberbank (in Austria), and Halkbank (in Turkey) – China is looking at another 8%-12% discount (relative to the dollar price of the average benchmarks), which means a total discount of up to 32% for China on all oil, gas, and petrochemical purchases,” the source says.
This is a hugely important signpost on the direction of travel for the way energy trade is being restructured and by extension for the geopolitical landscape.
The implications are:
· By aggressively sanctioning Iran, the US has accelerated the collaboration between the three major players on the Eurasian continent: China, Russia, and Iran.
· China’s energy import bill is currently in the region of $250bn. By shifting a large proportion of this to non-dollar settlement, China dramatically reduces the pressure on its US dollar reserves from its worsening current account balance.
· Being able to source a large part of its energy at a 32% discount to market prices is a massive boost for the Chinese economy and negative for oil prices. It is very bad news for high cost producers such as the US shale sector.
· Given this deal circumvents the US dollar and is directly flouting US sanctions on Iran, in order to disrupt this, the US is going to have to become even more aggressive in terms of its trade policy with associated detrimental effects on its own economy, which is already showing signs of weakening and ahead of an election in 2020.
This deal is a concrete example of the world shifting from a world dominated by the US and the US dollar to a multi-polar world with several important spheres of influence. In the long term, it is likely to be negative for the exchange value of the US dollar.