Iranian oil tankers have been quietly offloading their supply into Chinese ports, according to ship tracking data, despite U.S. sanctions on crude from the Islamic Republic.
These flows, which experts say show no sign of stopping, could seriously disrupt U.S.-China trade talks as well as oil markets if Beijing decides to actually use them.
Estimates as to the volume of Iranian crude that's made its way to China between last January and May vary from 12 million to 14 million barrels, an amount that market watchers say could dramatically impact the price of oil.
"If China were to aggressively purchase Iranian crude oil and/or draw down on these stored volumes, oil prices would likely fall by $5.00 to $7.00 per barrel," John Kilduff, founding partner of energy trading firm Again Capital, told CNBC on Thursday. "It would be a meaningful outlet for Iranian supplies that have been severely crimped by the sanctions."
Stephen Brennock, an analyst at PVM Oil Associates, agrees. "It's fair to assume that global oil prices would come under pressure if China decided to draw on the Iranian oil stored in its ports," he said. "It would also likely trigger a harsh response from the (President Donald) Trump administration."
But there is at least one reason Washington hasn't sounded the alarm over these Persian barrels. China keeps them in what's called "bonded storage," which means the oil has not been cleared through Chinese customs and is not being used, therefore not actually violating U.S. sanctions. Kilduff estimates that another 20 million barrels are "en route, likely headed for this bonded storage."
This benefits both Iran and China in a few ways.
Iran's onshore and floating storage is rising in inventory due to reduced exports — but it can't just stop pumping oil because its export capacity has plummeted. That's because leaving the oil underground could lead to permanent damage to its oil wells. So, in the words of one analyst, "They need to tuck that oil away instead of endangering the future output of their oilfields."
Putting it in Chinese bonded storage offers Iran a convenient solution, and one that means it doesn't have to use so many of its tankers as floating storage facilities.
The setup also advantages Iran, Kilduff says, "because it gets its oil pre-positioned in the key Asian market, ready for sale, if sanctions get eased, a financial work-around is struck, or via barter transactions, where the oil is traded for goods."
Meanwhile, the situation advantages China because it gets a major discount on the oil and it functions as payment for work that Chinese companies are doing in Iran, analysts say.
"These risky barrels are heavily discounted by the Iranians," Kilduff said. "So, it's a good deal."
Chinese storage is "a convenient place to store and gives the Iranians and Chinese options, especially if the Chinese wish to flout U.S. sanctions," Richard Nephew, program director at the Center on Global Energy Policy at Columbia University, told CNBC. "Neither likes the U.S. and private sector ability to track tankers. This helps to address that problem, even if we can also all see how storage is tapped."
The Chinese Commerce Ministry and National Energy Administration did not respond to CNBC's requests for comment.
The Trump administration re-imposed heavy sanctions on Iran last year and tightened the noose on its oil exports last May after ending sanctions waivers that let some of the world's largest buyers of Iranian oil keep importing it. That waiver list included China.
The new sanctions came after Trump withdrew the U.S. from the 2015 Iranian nuclear deal in May of 2018, which was meant to offer economic relief to Iran in exchange for limits to its nuclear program. Tensions have skyrocketed between the two countries as Tehran starts to roll back its nuclear enrichment limits under the deal.
But the crude stockpiles also present a liability for China, analysts say — not least because of its more than year-long trade fight with the Trump administration.
The Iranian oil stored in China's bonded tanks is still owned by Tehran, specifically by the state-run National Iranian Oil Company, so therefore doesn't yet breach any sanctions.
"However, such a move risks Washington's wrath," said PVM's Brennock. "U.S. sanctions on Chinese entities would inevitably be imposed which, in turn, would add some spice to their long-running trade battle." The Chinese economy has already suffered due in large part to the trade war with Washington, hitting its slowest pace of growth in 27 years during the second quarter of 2019.
The Trump administration to date has put tariffs on $250 billion worth of Chinese products, while China has retaliated with $110 billion in levies on U.S. goods. The American president has most recently threatened new tariffs of 10% on $300 billion in Chinese goods.
"It is a liability for China because running afoul of the U.S. sanctions is serious business," Kilduff said. "China's very large, state-owned refiners are major international players in the global oil and refined products market. They cannot and will not risk being cut off from the U.S. financial system. The U.S. could easily determine that 'bonded storage' is a euphemism for landed supply."
Meanwhile, the only liability for Tehran is that they have to "seriously discount" these suspect barrels, Kilduff added. "The economic squeeze is considerable."
According to Kilduff and Again Capital, there are another 20 million barrels headed for China's bonded storage. What the Chinese decide to do with those barrels may determine whether they prove to be a wrench in trade war discussions, a bargain buy for China, or a ticking time bomb for oil markets.