The Atlantic Councıl March 28, 2024 The axis of evasion: Behind China’s oil trade with Iran and Russia By Kimberly Donovan and Maia Nikoladze

 The Atlantic Councıl

March 28, 2024

The axis of evasion: Behind China’s oil trade with Iran and Russia

By Kimberly Donovan and Maia Nikoladze

The axis of evasion: Behind China’s oil trade with Iran and Russia

Oil revenue is a lifeline for the Iranian and Russian economies, but Western sanctions have jeopardized both countries’ ability to ship oil and receive payments. In response, Iran and Russia have redirected oil shipments to China—the world’s largest importer of crude oil. In 2023, China saved a reported ten billion dollars by purchasing crude oil from sanctioned countries such as Iran and Russia.

Over the years, Beijing and Tehran have developed an oil trade system that bypasses Western banks and shipping services. Russia adopted Iran’s methods for exporting sanctioned oil after the Group of Seven (G7) allies capped the price of Russian crude oil at sixty dollars per barrel in December 2022.

As a result, Iran, Russia, and China have created an alternative market of sanctioned oil, wherein payments are denominated in Chinese currency. This oil is often carried by “dark fleet” tankers that operate outside of maritime regulations and take steps to obscure their operations.

Oil revenue from China is propping up the Iranian and Russian economies and is undermining Western sanctions. Meanwhile, the use of Chinese currency and payment systems in this market restricts Western jurisdictions’ access to financial transactions data and weakens their sanctions enforcement efforts.

How China manages to import sanctioned Iranian oil

China has developed a way to import Iranian oil while bypassing the Western financial system and shipping services. Iran ships oil to China using dark fleet tankers and receives payments in renminbi through small Chinese banks. The dark fleet tankers operate without transponders to avoid detection. Once oil shipments reach China, they are rebranded as Malaysian or Middle Eastern oil, and bought by “teapots” in China. “Teapots” are small independent refineries that have been absorbing 90 percent of Iran’s total oil exports since Chinese state-owned refiners stopped transacting with Iran due to the fear of sanctions.

“Teapots” are believed to be paying Iran in renminbi using smaller US-sanctioned financial institutions like the Bank of Kunlun. This strategy allows China to avoid exposing its large international banks to the risk of US financial sanctions.

How Iran could make use of the renminbi payments from China

Once Iran gets paid in renminbi, it has two options for using Chinese currency: It can either buy Chinese goods or park assets in a Chinese bank. Iran cannot spend much in renminbi outside of China because the currency is not entirely freely tradeable, and is therefore less desired by other countries as a store of value or unit of account. The role of the renminbi in international trade has increased in the past few years, but it’s driven by China’s renminbi-denominated trade with its partners. The currency is rarely used for transactions by two countries when one is not China.

Consequently, in 2022, Iran bought $2.12 billion worth of machinery from China, as well as $1.43 billion worth of electronics. While data on financial transactions between Iran and China is not accessible, there is a high probability that Iran’s imports of Chinese technology are denominated in renminbi.

Another use Iran could find for the Chinese currency is building up foreign exchange reserves in renminbi. In October 2023, the deputy chief of the Central Bank of Iran said that Iran’s foreign reserves are increasing because of the growth in oil and non-oil exports. If oil revenues are a significant contributor to the growth of Iran’s foreign exchange reserves, and if China is buying Iranian oil in renminbi (trade data indicate that around 90 percent of Iran’s oil exports are going to China), then a considerable share of Iran’s reserves could be denominated in renminbi.

Additionally, Iran’s willingness to find alternative currencies and diversify away from the US dollar is coinciding with Beijing’s internationalization ambitions for its currency. Thus, Beijing may also have an interest in paying Iran in renminbi and building Iran’s renminbi reserves. (The Central Bank of Iran does not publish data on the currency composition of its international reserves. The absence of data makes it difficult to confirm this theory.)

Russia has been copying Iran’s methods for circumventing sanctions

Russia’s full-scale invasion of Ukraine and subsequent imposition of sanctions have put Russia in a similar situation as Iran. Russia also started using a “shadow fleet” to ship oil to China and has resorted to the use of the renminbi for trade to circumvent the oil price cap. It must be noted that Russia’s situation is not as dire as Iran’s when it comes to sanctions: Trading in Russian oil is tolerated as long as buyers pay sixty dollars or less per barrel, while buying Iranian oil is banned regardless of the price. This gives Russia more flexibility to ship oil to other destinations and, by extension, more bargaining power in price negotiations with China.

Nevertheless, Russia is now heavily dependent on China and has a similar model of trade with China as Iran: Russia exports oil to China and imports technology. In 2022, Russia received $88 billion from Beijing from energy exports and paid $71.7 billion for Chinese goods. Since Russia and China have switched to the use of national currencies, ruble-renminbi trade increased eighty-fold between February and October 2022.

But China helps Russia only to the extent that it does not harm its own interests. For example, after the United States created a new secondary sanctions authority in December 2023, three out of the four largest Chinese banks stopped accepting payments from sanctioned Russian companies. Russian officials claim that they are working with their Chinese counterparts to resolve the issue, but Beijing is unlikely to go back to transacting with sanctioned Russian entities as long as the sanctions threat prevails. Thus, while secondary sanctions did not directly target oil payments from China, this shows that if the West were to threaten to sanction large Chinese companies for importing Russian oil above the price cap, Beijing would likely comply.

How the West can begin to respond

The effectiveness of sanctions against Iran, Russia, and other heavily sanctioned regimes should not be analyzed in silos, because these countries don’t operate in silos. Knowledge sharing on evasion techniques and economic cooperation with China have allowed both Iran and Russia to mitigate the effects of sanctions.

Western authorities should start looking into financial linkages between heavily sanctioned regimes, as well as their economic cooperation with China, and consider how evasion techniques developed by previously sanctioned regimes can be used by newly sanctioned countries. This will help Western sanction-wielding authorities improve the design of sanctions and close loopholes before they can be exploited. Such analysis would also help the West develop an understanding of what sanctions can and cannot achieve, and what unintended consequences they could result in.

Kimberly Donovan is the director of the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @KDonovan_AC.

Maia Nikoladze is the assistant director at the Economic Statecraft Initiative within the Atlantic Council’s GeoEconomics Center. Follow her at @Mai_Nikoladze.