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Opinion

Asian crude importers can join hands over Iran sanctions

Opportunity for India and China to launch oil buyers' club after Trump's waiver ban

Iran is not the only country that will suffer greater pain under U.S. sanctions, with Washington suddenly ending waivers that enabled Tehran to export limited amounts of crude over the past six months.

China and India, the two biggest buyers of Iranian crude and largest waiver beneficiaries, are also taking a hit.

Tehran and Washington still could try to defuse the tensions by negotiation. But, with that looking unlikely, the Asian importers, which earlier accommodated U.S. demands to reduce their Iranian purchases, now have to halt them completely.

Diplomatically, the Asian giants are caught between a rock and a hard place and commercially, they don't have much choice. Defying the sanctions to continue importing crude from Iran would expose refiners as well as financial, shipping and insurance companies to punitive U.S. action. Getting locked out of the American financial system is an unpalatable risk for most entities involved. Even for China, for all its readiness to challenge the U.S. geopolitically, that would be a step too far.

One of the market's major fears was that Washington's decision to end its reliefs would send international crude prices soaring.

For China and India, the cost of crude imports would have gone up even more in their local currencies, which have been softening against the U.S. dollar recently.

But much to the relief of Beijing and New Delhi, and other capitals of importing nations, that has not come to pass so far. Benchmark Brent crude has remained anchored around $70 per barrel. The recent breakdown in the U.S.-China trade negotiations has cast a bearish shadow over economic growth, tempering global oil demand growth expectations for this year. Washington's assurances that Saudi Arabia and some of its OPEC peers will offset the loss of Iranian barrels have also calmed nerves.

However, China and India will pay a high price for halting their Iranian purchases and seeking replacement crude from other suppliers. Saudi Arabia and Iraq, suppliers of similar quality crude to Iran's and among the few producers capable of offering additional barrels under their term contracts, recently ratcheted up their monthly Official Selling Prices or OSPs for Asian buyers, in some cases to multi-year highs.

The major component of the Middle Eastern OSPs for Asia is the monthly average price of benchmark high-sulfur crudes from Oman and Dubai, which is determined by world market forces. However, the producers decide the differential to be applied on top of the benchmark, which can be a premium or a discount. It is this extra payment, which has shot up for Saudi and Iraqi crude cargoes that will load in June for Asian destinations.

Saudi Aramco also hiked the premiums to Europe, but eased those for crude loading for the U.S. in June. Iraq upped its premium for customers across the globe, but raised it by the biggest margin to Asia and by the smallest amount to the U.S. Both producers are reducing supplies to the U.S. to send more barrels into Asia, and want to maintain competitive pricing in America.

High-sulfur or sour grades of crude have historically sold at a discount to their low-sulfur or sweet counterparts, as they must undergo additional refinery processing to strip out sulfur, a carcinogenic element in fuels.

However, since the start of OPEC/non-OPEC production cuts in January 2017, it is the supply of sour crude, produced mostly by the Middle Eastern OPEC members, which has shrunk, reducing or at times even eliminating its discount to sweet grades.

Saudi Arabia is the biggest crude supplier to China, while Iraq takes the top spot in Indian imports. Both rank among the top five suppliers of crude to these countries.

China imported about 800,000 barrels per day of crude from Iran in April. That accounted for about 7.5% of the country's total crude imports during the month, which were at a record high of 10.64 million barrels per day. India's imports from Iran eased to around 317,500 barrels per day in April from 341,000 barrels per day in March, but still represented around 7% of total crude imports.

Japan and South Korea were also buying Iranian crude under the U.S. sanction waivers, but much smaller volumes than China and India. The North Asian countries are also relatively less price-sensitive.

The higher premiums that Asian refiners will have to pay for June are unlikely to be a one-off phenomenon, as Iranian exports are expected to remain locked out of the market for the foreseeable future. The U.S. has openly stated its aim is to squash Iran crude exports to zero.

Since the price crash of 2014, crude has been a buyer's market and several Middle Eastern economies heavily dependent on oil have suffered. They may view the exit of Iranian barrels from the market as an opportunity to turn the tables.

This feels like the return of the "Asian premium," a term coined for Middle Eastern producers charging crude buyers in Asia more than their customers in the rest of the world, through the 1990s and the early part of the noughties. The phenomenon was attributed to Asia being overly dependent on the Middle East for its supply security, in contrast to refiners in the Atlantic Basin, who had more alternatives.

The Asian premium had faded away in recent years, as soaring demand gave Asian buyers bargaining power. However, now there appears to be a "sanctions premium" -- Asian refiners bearing the cost of supply tightness caused primarily in their region due to the disappearance of Iranian oil.

Having to cough up more for alternative supplies is a double whammy for India and China, because they were getting Iranian crude at specially discounted rates and preferential credit terms. By paying Iran in yuan and rupees, the countries were also saving foreign exchange.

India and China both have close commercial ties with Iran and investment projects underway in that country. At the same time, they want to keep on the right side of Washington -- especially Beijing, which is locked in high-stakes trade negotiations with the U.S.

However, there is one way they could act -- give life to their planned "China-India oil buyers' club" and present a joint bargaining position over Iran to Washington.

Talk about the "buyers' club" -- major Asian importers joining hands for collective bargaining on oil purchases -- has been going on for nearly a year now. Japan and South Korea have not yet been roped in, but China and India were reported to be closing in on a landmark deal, following a recent visit by a senior representative from China's National Energy Administration to India.

It is time the two countries turned these plans into reality. OPEC is not the only counterparty they need to deal with on oil. Negotiating with the U.S. may be even more important. The current Iran crisis is an excellent opportunity for the new club to make its mark.

Vandana Hari is founder of Singapore-based Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy sector.

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