Beijing’s Tehran Temptation

Erica S. Downs
Erica S. Downs Former Brookings Expert

July 30, 2009

Iran’s recent invitation to Chinese oil companies and banks to invest $43 billion in Iran’s oil industry was understandably dismaying to U.S. policymakers. After all, Tehran is attempting to trade access to its abundant oil and natural gas reserves for diplomatic support on its uranium enrichment program, and China’s growing appetite for energy makes it vulnerable to such temptations.

Iran, however, might find that taking diplomatic advantage of China’s energy needs is easier said than done. Not only are China’s national oil companies unable or unwilling to deliver the projects Iran is hoping for, but energy is just one of several competing interests that drive Beijing’s stance toward Tehran. As a result, Washington still has an opportunity to influence China’s Iran policy.

It might seem strange that a major oil producer needs this level of energy investment. But though Iran has the world’s second-largest proven oil reserves, it imports as much as 40 percent of its gasoline because it lacks domestic refining capacity. Iran’s current effort is aimed at getting the Chinese to bankroll the construction of refineries. If Iran can produce all the gasoline it needs at home, then the United States won’t be able to follow through on its threat to cut off its supply. An agreement with China would allow Tehran to prove that U.S. efforts to isolate Iran aren’t working.

Iran has good reasons to hope that its efforts to woo China’s oil companies will be successful. First, Iran’s underdeveloped oil and natural gas reserves are a grand prize for Chinese firms, whose late arrival to international exploration and production has made it difficult for them to acquire attractive investment opportunities abroad.

Second, Beijing has a proven track record of providing cash and infrastructure assistance to countries that supply it with oil. In the first half of 2009 alone, Chinese banks extended more than $45 billion in loans to countries including Brazil, Kazakhstan, Russia, and Venezuela, all major energy producers battered by the fall in oil prices.

Third, Chinese companies are willing to discuss new projects in Iran at a time when major international oil companies are holding back under pressure from their home governments. Last month, China National Petroleum Corporation (CNPC) inked a deal to replace Total in the development of the enormous South Pars natural gas field after Iran grew frustrated with the French company’s foot-dragging.

But there’s a catch. Chinese firms — and their Iranian counterparts — do not have the technology needed to liquefy Iran’s natural gas and can’t gain access to it due to U.N. and U.S. sanctions. Although Chinese companies are working to develop their own such technology, it will probably take them several years to match that of the major international oil companies. Additionally, Chinese companies lack experience in managing large, complex projects like gas liquefaction ventures.”

It’s also not clear that Chinese companies are in any rush to actually pump large sums of money into Iran. Unfortunately for Tehran, these firms have a history of signing agreements for projects in which they have no intention of making substantial investments until after sanctions are lifted and geopolitical risks reduced. CNPC, for instance, signed a contract with Saddam Hussein’s government for the Ahdab field in 1997, held off on investing due to U.N. sanctions, and then inked a new agreement with the postwar Iraqi regime in 2008. In short, though China’s oil companies might be eager to get their foot in Iran’s door, they appear just as reluctant as other foreign companies to breach sanctions.

More importantly, Beijing recognizes that a nuclear-armed Iran would almost certainly be detrimental to its energy security. Iran’s development of a nuclear weapons capability — and the regional nuclear arms race this might trigger — would foster instability in the Persian Gulf, jeopardizing the free flow of oil into the market. It could also strain China’s relationship with Saudi Arabia, which has been China’s top crude oil supplier for most of this decade and opposes Iran’s going nuclear. And despite appearances, China does not want to jeopardize its relationship with the United States. Not only does Beijing value its relations with Washington more than its ties to Tehran, but it relies on the U.S. Navy to protect the sea lanes between the Persian Gulf and China.

Chinese companies are unlikely to completely abandon their interest in Iran’s vast hydrocarbon reserves, but if the Chinese government is assured that its country’s oil firms will be “first in line” to gain access to Iran’s largest oil and natural gas fields, it might be willing to step up its efforts to press Tehran on Iran’s nuclear program.

Washington should remind Beijing that a nuclear-free Persian Gulf is likely to do more to bolster the security of China’s oil supplies than pumping billions of dollars into a country whose nuclear ambitions might threaten those very investments. And after the recent post-election upheaval, U.S. officials can make the case that China’s commercial interests would be better served by waiting to see how the Iranian political situation plays out.

With any luck, Tehran’s latest temptation will be one Beijing can resist.