How Iran Might Beat Future Sanctions: The China Card

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Behrouz Mehri / AFP / Getty

A general view shows the Lavan oil refinery, Iran.

Iran may have an ace in the hole as Western governments weigh sanctions in response to the often violent crackdown on opposition demonstrators. The card Tehran is likely to play? China.

On July 13 Iran's Oil Ministry announced that it had China's agreement to invest about $40 billion in refining Iranian gasoline. The deal would include financing the major new Hormoz refinery in southern Iran, which will be able to produce about 300,000 bbl. of gasoline and kerosene a day once the four-year construction project is completed. China would also overhaul Iran's aging Abadan refinery in the south so that its production could increase by 29%, according to Iranian oil officials, who provided no deadline for that project.

The deal has not yet been signed (and China has yet to confirm it), but if Iran pulls it off, it would solve one of the country's biggest headaches. For despite vast oil reserves and exports, Iran still imports about 130,000 bbl. of gasoline a day because its refineries are too few and too old to meet the demand at home. The Chinese deal would literally keep Iran's factories, homes and cars — in effect, a nation of 66 million people — running.

At the moment, Iran's gasoline imports are not affected by U.S. sanctions or the international, U.N.-agreed sanctions. But the willingness of other countries to sell gasoline to Iran has faltered as political pressure mounts over Iran's nuclear program. India, a major supplier, recently suspended exports of gas for a brief while, according to the Paris-based International Energy Agency. "If you really want to use effective sanctions, then you want to cut off gas imports," says Erica Downs, China energy fellow at the Brookings Institution in Washington. "If the Chinese do invest $40 billion and dramatically increase Iran's refining capacity, it would definitely weaken one of the weapons in the U.S. arsenal."

Iran's ties with China, which have steadily grown over the past decade, have accelerated rapidly in the past 18 months. In December 2007, the Chinese oil giant Sinopec Group signed a $70 billion deal to begin drilling in Iran's Yadavaran field, which has estimated reserves of about 17 billion bbl. In January of this year, China's biggest energy producer, CNPC, agreed to develop a medium-size oil field called North Azadegan — a deal worth about $2 billion. And last month, while demonstrators were fighting pitched battles with paramilitaries on Tehran's streets, Iranian oil officials flew to Beijing to negotiate a $5 billion deal with CNPC for the newest phase of Iran's huge South Pars gas field in the Persian Gulf. Pummeled by the drop in world oil prices from $147 per bbl. last July to about $64 per bbl. this week, "Iranians are feeling more and more of an acute need for capital," Downs says.

And China is awash in cash. Furthermore, having invested tens of billions of dollars in Iran's energy sector, China — a permanent member of the U.N. Security Council — looks almost certain to veto any new tough sanctions against the country. In contrast, in the U.S. and Europe, there are growing anxieties over Iran's nuclear program as well as outrage over last month's violence.

Major Western oil companies operating in Iran, including Total, Royal Dutch Shell and the Italian company ENI, have held off from signing new deals with Iranian oil officials for several months, perhaps waiting to see if President Obama's moves to open talks with Tehran will succeed in breaking the political impasse. The Chinese deal last month to develop the South Pars gas field came only after Total opted not to sign, fearing political fallout. Such fears have rarely fazed Beijing — and are unlikely to now.