As Iran Sells More Oil to China, the U.S. Gains Leverage

A new report from Bloomberg, citing data from Kpler, an analytics company, claims that Iranian oil exports to China will reach 1.5 million barrels per day this month, the highest level in a decade. The report has led to a flurry of criticism from hawks that President Biden is failing to enforce U.S. sanctions on Iran’s oil exports and thereby gifting Iran billions of dollars in oil revenue. But in reality, Iran appears unable to spend most of the money—a situation that is giving Biden leverage he can use in future negotations.

Iran’s resurgent oil exports are earning the country a lot of money. The crude oil price is currently hovering at around $80. Iran discounts its oil for Chinese customers, so the actual selling price is probably closer to $74 dollars per barrel. At this price, Iran’s 1.5 million barrels per day of exports are earning the country around $3.3 billion per month.

These back of the envelope calculations are necessary because China’s customs administration stopped reporting the value and volume of oil imported from Iran back in May 2019, when the Trump administration revoked a series of waivers permitting limited purchases of Iranian oil by select countries. When looking to the Chinese data alone, Iran’s export revenue appears much smaller than it is, hiding the true trade balance.

In the most recent three months for which we have customs data, Iran’s imports from China averaged $826 million. In the same period, Iran’s non-oil exports to China averaged $357 million. When not counting Iran’s oil exports, Iran appears to be running a trade deficit with China of around $469 million. But when adding the reasonable estimate of $3.3 billion of oil exports, the monthly trade balance swings dramatically in Iran’s favor. In recent months, Iran has likely run a trade surplus with China of around $2.8 billion per month.

In other words, Iran is earning billions of dollars it appears unable to spend. After all, Chinese goods, especially parts and machinery, are a lifeline for Iranian industry. If Iran was able to buy more Chinese goods, it would be doing so. Two other data points confirm this interpretation. Exports from the UAE to Iran remain depressed, so Chinese goods are not arriving in Iran indirectly. Purchasing managers’ index data for the manufacturing sector also indicates that Iranian firms continue to struggle with low inventories of raw materials and intermediate goods. Moreover, Iran is continuing to doggedly pursue the release of its frozen assets, including $6 billion that will be made available for humanitarian trade as part of the recent U.S.-Iran prisoner deal. Iran would not be so desperate to strike such deals were its oil revenues in China readily accessible. In short, Iran is selling its oil and earning money, but it is not getting the full economic benefit from the surge in oil exports.

Chinese exporters and their banks remain wary of trading with Iran, where entities and whole sectors remain subject to U.S. secondary sanctions. For most Chinese multinational companies, trading with Iran is not worth the risk. In the first six months of this year, Chinese exports to Iran averaged $898 million per month. Exports remain 35% lower than in the first six months of 2017, the most recent year during which Iran enjoyed sanctions relief.

It remains to be seen whether Iran can sustain this new, higher level of oil exports. Oil markets can be fickle, and China’s economic wobbles could depress demand. But for now, Iran’s significant trade surplus with China also means that its renminbi reserves must be growing. This is a novel situation. Historically Iran has run a small trade surplus with China. Between January 2012, when the Obama administration launched devastating financial and energy sanctions on Iran, and January 2016, when the implementation of the nuclear deal granted Iran significant sanctions relief, the average monthly trade surplus was just $511 million (China’s purchases of Iranian oil are reflected in customs data for this period). In other words, assuming its oil revenues are stuck in China, Iran’s reserves are now growing four times faster than in that period.

At first glance, this might look like a major failure for the Biden administration. Biden purposefully maintained the “maximum pressure” sanctions imposed by Trump in an effort to sustain leverage for negotiations and Iranian oil exports remain subject to U.S. secondary sanctions. But those who claim that Biden is failing to enforce his sanctions are failing to see the wisdom of the current U.S. enforcement posture.

First, Biden is loath to deepen already heightened tensions with China. Sanctioning Chinese refiners for their purchases of Iranian oil, thereby targeting China’s energy security, would be a dramatic escalation in the growing economic competition between Washington and Beijing. Second, such escalation would be entirely pointless given the circumstances around Iran’s oil exports—namely that Iran is not getting the normal economic benefits. Given that Iran is earning more money but cannot spend it, the U.S. is actually gaining leverage for future negotiations.

Unlike Trump, Biden has made a serious effort to engage in nuclear diplomacy with Iran and is likely to continue those efforts if there is a reasonable opportunity to achieve a new diplomatic agreement that contains Iran’s nuclear program. But U.S. negotiators have struggled to make a compelling offer to their Iranian counterparts. Many Iranian policymakers felt the promised economic uplift of sanctions relief would be too small. Iran’s opening gambit in the negotiations with Biden included the claim that sanctions had inflicted $1 trillion of damage to Iran’s economy and that Iran was owed compensation.

With its oil exports significantly depressed, Iran has been unable to significantly grow its foreign exchange reserves, which the IMF estimates at around $120 billion. If Iranian officials believe that they need to remediate $1 trillion of economic damage, the windfall represented by the unfreezing of foreign exchange reserves does not count for much.

The longer the sanctions remain in place, the more money will be needed to undo the cumulative effects of U.S. sanctions, which have now hobbled Iran’s economy for over a decade. It is politically impossible for Biden to promise any kind of compensation for Iran—the best that the U.S. can do is promise to once again unfreeze Iran’s own money as part of a new diplomatic agreement.

For this reason, it is a good thing if Iran’s reserves are growing. Iran’s oil exports to China are kind of like payments made as part of a deferred annuity insurance contract. One day, Iran will be able to cash out on that policy. But it can only cash out if it meets the conditions set by the U.S. In other words, every barrel of oil Iran is currently selling to China is increasing U.S. leverage for future talks. It would be wise to let the oil flow.

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