March 08,2008

Can China Have the Iranian Energy Cake and Eat It Too?

By Kong Bo
When the U.S. Congress derailed China National Offshore Oil Corporation’s (CNOOC’s) $18.5 billion bid for Unocal Corporation on the ground of economic and national security concerns in 2005, some energy experts warned that the move was a mistake and would only drive Chinese national oil companies (NOCs) further to resource-rich countries which the U.S. finds unsavory.
 
Reactions in China to CNOOC’s Unocal fiasco soon vindicated those warnings. For years, Fu Chengyu, Chairman and CEO of CNOOC, had been advocating that Chinese NOCs invest more in North America by virtue of its low political risks. The vitriolic political backlash against CNOOC’s commercially-driven acquisition attempt, however, not only repudiated him but also forced him to conclude that political risks in the U.S. are actually higher than elsewhere. Further, interventions by the U.S. congress to help Chevron, CNOOC’s rivalry, win an upper hand in the bidding contest for Unocal, proved to many in China that the U.S. government promotes free trade only when it works in its interests and that market cannot be relied upon for energy security. China’s response of choice, therefore, seems obvious-the central government should help its NOCs search for energy where U.S. influence is weak.
 
Iran offers a fertile ground for China to exercise this choice. Official relations between the U.S. and Iran have been frozen since militant Iranian students, angered by the U.S. decision to allow the exiled Shah to enter the country, took 52 American diplomats hostage in November 1979. The Carter Administration imposed a complete embargo of Iranian oil immediately and severed diplomatic ties with Iran in April 1980. In May 1995, President Clinton issued Executive Order 12959, banning U.S. trade and investment with Iran. Consequently, these decisions have limited American presence in Iran. By contrast, deepening bilateral ties with Iran have enabled China to become the country’s largest trading partner and investor. China’s growing dependence on foreign oil and gas also draws it closer to Iran, whose oil and natural gas deposits, accounting for 11.4% and 15.5% respectively of the world’s proven reserves. These reserves remain largely untapped because of the dearth of investment.
 
Hence, a synergy has developed between Iran and China whereby the former supplies the latter with crude oil, increasingly natural gas as well, whereas the latter provides the former with badly needed investment. Currently, Iran is China’s third largest supplier of crude oil and it sources 12.6% of China’s total imports. Everyday, it ships 410,000 barrels of crude to the fastest growing Asian economy. Meanwhile, the flagships of the Chinese petroleum industry, especially China National Petroleum Corporation (CNPC), China National PetroChemical and Corporation (Sinopec), have invested heavily in the Iranian energy sector. In the aftermath of the Unocal fiasco, their investments have gained further momentum. For example, in January 2007, CNPC announced that it would invest $3.6 billion for developing Block 14 of the South Pars natural gas field. In December 2007, Sinopec agreed to invest $2 billion dollars to develop the Yadavaran oilfield. On February 27, 2008 Iran’s Oil Ministry news website SHANA announced that it would sign a $16 billion contract with China to develop the North Pars natural gas field. Although the CNPC and CNOOC deals have not been signed yet, thus far Chinese NOCs have already invested over $5 billion in Iran’s energy sector.
 
While these investments in Iran reflect Chinese NOCs?struggle to supply the galloping economy at home, they have also mounted serious challenges to the country’s relationship with the United States. At a time when Washington is ramping up pressure on Iran to stop its nuclear program, the announcement of big deals between Chinese NOCs and Tehran does not resonate well with the State Dept or Congress. Indeed, senior diplomats at the State Department and lawmakers in Congress perceive these deals as a slap in the U.S. face with respect to its policy toward Iran. The fact that Beijing did not notify Washington of these big deals in advance makes matters even worse. Thus, Sinopec’s $2 billion deal in Iran caused a plethora of consternation in Washington, with many policymakers feeling betrayed and infuriated. The pressure is now building up in Washington to punish Sinopec, which is listed in New York in addition to Hong Kong. Under the Iran Sanctions Act (ISA) introduced in 1996, originally called the Iran-Libyan Sanctions Act, the U.S. President will impose at least two out of a menu of seven sanctions on any foreign companies that make an "investment" of more than $20 million in one year in Iran’s energy sector. The State Department has the right to determine the violation of the ISA within six months. Just as the State Department is still debating whether to impose sanctions on Sinopec, SHANA announced that Iran’s Oil Ministry and CNOOC would sign a $16 billion deal on February 27, 2008 which immediately prompted a threat from the State Department and the Treasury Department to launch investigations to determine if the deal violated the ISA .
 
The question thus arises: can China have the Iranian energy cake and eat it? From a Chinese point of view, ties between China and Iran date back many centuries and Chinese view themselves as having the right to pursue their energy interests anywhere. After 2005, when the U.S. congress made it impossible for Chinese NOCs to invest in America, it was only a matter of time before Iran, with its large reserves, became a focus of Chinese overseas energy investment. China views these energy investments in Iran as bringing more hydrocarbons to the world energy market in order to enlarge the global energy pie, thus benefiting every consuming nation. Lastly, Chinese companies see themselves as being under no obligations to comply with U.S. domestic law.
 
Nevertheless, it is not in Beijing’s interests to see Iran developing nuclear weapons and neither does Beijing have wish to challenge U.S. policy toward Iran. Therefore, Beijing has demonstrated a great deal of sensitivity to the US stance over Iran. Although known for its aversion to sanctions, Beijing has not only supported the U.S. at the United Nations over the Security Council Resolution 1696, 1737 and 1747 but also cooperated with the Treasury Department in implementing financial sanctions against Iran. Concerned about the resulting negative reactions in Washington to CNOOC’s $16 billion deal, the agreement is now postponed to "the near future" and Beijing once again supported the new Security Council resolution 1803 that approved a new round of sanctions against Iran for refusing to suspend uranium enrichment and heavy-water-related projects.
 
The possibility of sanctions against Sinopec, as well as CNOOC should it sign the $16 billion deal, is not off the table, but as Washington examines the possibility it has to recognize one reality-no firm has been sanctioned under the ISA thus far. The U.S. did not sanction Turkey, a U.S. ally, when it built a natural gas pipeline to Iran in 1997. Neither did it sanction Total in 1998 when the French oil company signed a $2 billion contract with Iran. More importantly, more than 30 U.S. companies, including Halliburton and General Electric, are operating in Iran. Singling out Chinese NOCs would risk not only retaliation from the Chinese side through the World Trade Organization but also a deterioration of the bilateral relationship. The underlying issue, however, is China’s need for energy. Blocking Chinese energy investment in one location simply drives it to look for opportunities elsewhere. Maybe the Unocal deal, in hindsight, should have gone through.
 
(Copyright by Kong Bo. Kong Bo is a Ph.D. candidate specializing on China’s energy policy at the Johns Hopkins University School of Advanced International Studies. He also serves as Energy Columnist/Economist for www.chinastakes.com)
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