China oil deal with Iran could derail trade talks

Irianian oil

Don’t get too excited about the current thaw in the trade war. Despite both sides appearing to talk up the prospects of a deal ahead of talks that resumed in Washington yesterday, there has been a major development that could put any final agreement at risk. Since talks were last held, China has signed a multi-decade oil-supply deal with Iran and will pay for the crude in yuan, bypassing the established petrodollar system. With a foreign policy aimed at maintaining the US as the global hegemon, this really won’t play well with Washington hawks. It’s a serious step forward in the new cold war.

Under a 25-year deal that was agreed in August, China will buy oil, gas and petrochemicals from Iran at a discount of about 12%. In return for a cheap, guaranteed oil supply, China will inject a staggering $280bn (£224bn) in Iran’s investment-starved oil industry, which has been hit hard by US sanctions and has serious infrastructure issues. China has allocated a further $120bn to shore up the country’s transport infrastructure and will also deploy up to 5,000 Chinese security personnel in the country to protect its assets, as well as guarding shipments of oil on tankers between Iran and the Chinese mainland.

Shunning the dollar

Significantly, payment for the crude will be in yuan. This will allow China to bypass the dollar denominated international financial system. Iran has been trying to get countries to pay for its oil in currencies other than the dollar for many years, so Beijing must know this move will be controversial in Washington – and that’s why it has taken some time for details of the deal to leak out. US hawks want to see Iran brought to heel, but China is now giving the country an outlet for its oil, foreign currency and protection from military strikes.

China hopes that the yuan will one day challenge the dollar as an international and global reserve currency

Since Donald Trump started making unilateral decisions on international matters, such as rowing back on the Iran nuclear deal, there has been an increased focus on the US’s weaponisation of the international financial system to further its own foreign-policy goals. Washington has threatened businesses and countries with sanctions if they do not go along with its desires. This deal is a solution for bypassing and circumventing US sanctions by Chinese companies and the presence of Chinese troops in Iran will complicate any military action by the US in the future. Donald Trump’s trade war has accelerated the ideological battle taking place between Beijing and Washington and has hardened views on both sides. This is the result.

Last year, when the US unilaterally re-imposed sanctions on Iran, Treasury Secretary Steven Mnuchin threatened the Belgium-based Society for Worldwide Interbank Financial Telecommunications (Swift) with sanctions if it provided services to Iranian banks blacklisted by Washington. Swift is a key global payment system in cross-border transactions and the differences of opinion over Iran highlighted just how much influence the US body politic has over the international financial system. As a result, a number of Russian banks joined China’s rival international payment system (CIPS), which is free from US influence.

EU questioning dollar dominance

Obviously, for geopolitical rivals to the US, such as China and Russia, the power of Washington over dollar-denominated payment systems is a real problem. However, it’s turning into an issue for allies too. Jean Claude-Junker, the outgoing European Commission President, has argued that it was an “aberration” that the European Union (EU) paid for more than 80pc of its energy imports in dollars when just 2pc of the oil and gas was imported from the US. He said the euro would now become an “active instrument” of EU sovereignty.

China also wants other countries to consider joining them. Iranian Ambassador to New Delhi, Ali Chegini, has argued that India should follow China’s example and refuse to pay attention to the US sanctions on Iran, instead taking advantage of the opportunities presented in the Islamic Republic’s oil and gas sector.

“If India wants energy security, it should look at a stable source like Iran because of its resources, a strong government-to-government relationship, and the friendship between the two countries,” Mr Chegini said. India used to be Iran’s second-largest oil customer after China before the US withdrew from the nuclear deal in May 2018. New Delhi stopped crude oil imports from Iran on 2 May this year, when US sanctions on the Iranian oil sector kicked in. India is therefore now stuck in a tight geopolitical spot.

Oil instability

Last weekend’s attack on the Abqaiq oil installation is a reminder that the global oil industry is reliant on an unstable region and particularly vulnerable to the actions of the Saudi regime. The attack came after the oil deal has been agreed but has added a degree of complication for Beijing as Washington prepares to ramp up its sanctions against Tehran. Although Iran and China initially signed a co-operation agreement in 2016, the agreement is likely a reaction to both the trade war and the Trump administration’s wish to isolate Iran.

China hopes that the yuan will one day challenge the dollar as an international and global reserve currency. Current actions from Washington are likely to accelerate the moves by US rivals in Beijing, Moscow and Tehran to accelerate this trend. This means that links between the US and Saudi Arabia are also likely to get stronger. Preserving the pricing of commodities in dollars will now be more important than ever.

 


The above article was previously published by Charles Stanley on 23rd September 2019