Andrew S. Erickson

The first Iranian oil embargo beginning in 1979 effectively handed Marc Rich, whose company ultimately became Glencore (one of the world’s largest physical oil and commodities traders), the keys to a multibillion dollar oil-trading kingdom. Now China’s increasingly global oil trading companies are in the catbird seat. Chinese firms can be confident that Beijing values stable and secure oil supplies much more than cooperation with the U.S. on the Iranian nuclear issue.

The EU sanctions, which will affect about 450,000 barrels per day of oil imports to Europe (pdf), will likely engender the transfer of billions of dollars in oil earnings from the Iranian government to China’s main oil trading firms: Zhuhai Zhenrong, Unipec, Chinaoil, and Sinochem. These firms have become major players in the global physical crude oil market. In 2010, 3 of the 10 largest global crude oil and products traders hailed from China (see chart).

Unipec, China’s largest oil trader does not publicly report trading volumes past 2006, when it sold 106 million tonnes of crude oil and 14 million tonnes of refined products. Based on the company’s trading more than 3 million barrels per day of crude in 2011, we estimate that Unipec’s trading volumes now exceed 150 million tonnes per year, potentially making it a larger oil trader than even Vitol and Glencore. Unipec’s activities in the global oil tanker market suggest it is moving very large volumes of oil. In 2011, the company was the world’s second-largest tanker charterer, trailing only Royal Dutch Shell, according to Poten & Partners (pdf).

Of the Chinese oil traders, Zhuhai Zhenrong may be the best positioned to profit because it has strong relationships in Iran and also well-insulated from U.S. and European political pressure that will follow once U.S. and European governments realize that this embargo is likely to be just as leaky as any other. The company enjoys Beijing’s blessing, has no exchange traded stock, has no U.S. assets, and offers virtually no leverage that could be exploited by outside interests seeking to pressure it. Sinochem and Unipec have slightly more exposure to external pressure since their parent companies have parts of the company that are publicly traded, but will still enjoy strong political and diplomatic support from Beijing.All this said, the embargo is likely to trigger significant conflicts within the Chinese government. Once the embargo is in place, Iran will likely need to substantially reduce the price its crude in order to entice Chinese buyers to purchase larger than normal volumes. The question will then be “who enjoys the profits created by the provision of discounted oil?”

There is a range of possibilities. One option is for the traders to simply keep shipping the bulk of their oil to Chinese refineries as they have been doing and let the refineries enjoy the windfall of having lower-cost oil supplies. This might be the simplest outcome in domestic political terms, particularly since Chinese refineries have often lost profits under policy restrictions in recent years. However, it is more likely that the Chinese traders will either sell the oil on the international market for cash, or swap it for oil from other countries that can then be sent to China or other markets.

For example, if the crude oil spot price were $100 per barrel and Iran had to discount its oil to $80 per barrel to entice buyers, a Chinese trader could then swap the Iranian crude to another firm. By swapping its Iranian crude for another oil cargo at market prices (or a higher price than it paid the Iranian sellers), the company can gain “extra” oil relative to what it originally paid in Iran and resell it for a profit.

To make the oil palatable to buyers who want Iranian oil, but do not want to run afoul of U.S. and EU sanctions, traders can blend it with oil from other countries and take other means to disguise the oil’s origin. This is common practice when oil thieves sell oil from Nigeria and one also used by Saddam Hussein’s government, which at points smuggled up to 480,000 barrels per day of oil into the world market despite UN sanctions (pdf). Iran’s heavy crude oil, the country’s largest export stream at present, is similar in weight and sulfur content to the Ural blend that Russia exports, potentially creating swap or trading opportunities. We also anticipate that Iran will trim exports of heavy, higher sulfur crude in favor of more valuable lighter oils that have less sulfur and could be more easily blended and sold into the global market.

China’s refinery operators will not be happy if they have to keep buying crude from the traders at market prices when the traders have been getting discounted Iranian barrels that could have been shipped back to China. Since both sides of the equation have strong political allies, and in some cases are parts of the same corporate constellations (Unipec is a wholly-owned subsidiary of Sinopec, China’s largest oil refiner measured by the amount of oil processed), the politics stand to become contentious: Trading bosses may want to maximize their units’ profits, as opposed to transferring crude at below-market prices to the company’s refineries. Alternatively, if China’s domestic market for refined products weakens, firms like Sinopec may sell or swap more of their Iranian crude into the world market and embrace the traders as a profit center.

Policymakers and investors alike must consider how EU sanctions targeting Iran’s nuclear program may well help reshape the physical oil trading world in ways that favor China’s rising state-backed oil traders. In today’s globalized, economically dynamic, and resource-hungry world, unintended consequences can matter tremendously.