Indian Problems from U.S. Iran Sanctions Is a Personal Déjà Vu

Indian Problems from U.S. Iran Sanctions Is a Personal Déjà Vu

by | published August 7th, 2019

Today, I have decided to provide you a peek at what I used to do for a living. It is occasioned by a situation emerging from the renewal of U.S. sanctions against Iran and its impact on India. It brings me back to my more personal involvement during the last period of Iranian sanctions.

India is widely expected to be the next global energy demand dynamo. While China is currently receiving the primary focus, most analysts I know have concluded India will take over the top spot in less than a decade.

The overall picture shows worldwide energy needs to be gravitating quickly to the Asian market. While traditional end-user leaders North America and Western Europe have been leveling off for years, Asia has been racing ahead. As I have noted several times here in Oil and Energy Investor, every projection shows Asia increasingly controlling the pricing of energy products at least through 2035.

The combination of a continuing population explosion and accelerating economic growth has catapulted the continent into the center of the international energy mix. Given its size and market impact, China has been holding dominant stage for more than a decade.

But it gets interesting a few years from now…

A Look to the Past

That’s when most believe the fulcrum will pivot from China to India as the driving force for the Asian market as a whole – a few years from now.

In this, the continued availability of energy is decisive. But India is now sandwiched by two separate U.S. sanction initiatives that directly impede economic development.

The latest of the two is the American decision to apply a full sanctions package against Venezuela. New Delhi had turned to importing more heavy oil from beleaguered Caracas as a way around its greater difficulty in securing Iranian volume directly from the global market.

That is coupled with the fact that India’s refinery sector has been largely built to process the heavy grade of Iranian crude. That’s where the second – the renewal of U.S. sanctions against Iran’s oil trade – does not simply deprive the Iranian economy of vital energy. It once again threatens a major payments problem as well.

My network of contacts has been following the Indian approach with some interest, given the major impact it has on the overall Asian market. India has been importing some Iranian oil indirectly, with anecdotal evidence suggesting it may finally be moving closer to China in its need for Iranian-grade crude.

The possible resulting Chinese-Indian conduit for evasion of U.S. sanctions bring almost a decade, close to when I began writing Oil and Energy Investor. Then, I had been phasing out more direct involvement in U.S. intel community field operations but was still providing classified briefings to policymakers.

What follows is a significantly abbreviated (and vetted) version of one of them. It provides a glimpse of what I was doing back in those days and indicates more moving parts in these affairs than what appears in the media.

The Iranian Oil Ministry has increased pressure on New Delhi to resolve the payment crisis or run the risk of not receiving any further Iranian exports. Ministry sources in Tehran have confirmed that the threat is serious. As one expressed it, “The time has come for us to stop subsidizing consumer countries’ inability to finance transactions. It is their responsibility to come up with the solution, not ours.”

Contacts at the Iranian Ministry of Oil assure that past due payments could be cleared as soon as the Iranian Ministry of Finance and Reserve Bank of India (RBI, the Indian central bank), agree on the currency regimen by which to route the payments.

China and South Korea, whose trade surpluses with Iran allow them to use the yuan and won, respectively, to offset the clearing problem, have been able to avoid a payments impasse. This is accentuated by Iran making a number of capital-intensive heavy machinery, automobile, and other purchases from the two countries using the proceeds from oil sales.

That may change. According to intel received, Iran and China are negotiating the use of a barter system to exchange Iranian oil for Chinese goods and services, after Beijing has found it increasingly difficult to avoid U.S. financial sanctions blocking upwards to $30 billion in payments for oil imports. A de facto system similar to bartering has already been in place to the extent that Iran makes purchases of Chinese goods in lieu of receiving cash.

India, on the other hand, is more directly exposed. Sanctions are making it more difficult for Tehran to access the international banking network. That, in turn, has increased the cost of trading transactions for Iran (needing dollars to trigger the contracts) and increased the problems for receiving countries (requiring that they enter into indirect and less efficient ways of funding purchases).

Of more immediate impact on Iran was the Indian decision to stop using a German bank as a conduit for payment of Iranian crude imports. The move was obliged when German Chancellor Angela Merkel intervened to instruct Deutsche Bundesbank, the German central bank, to stop clearing payments from India to the German bank in question, which is under U.S. sanction. The situation once again highlighted a weak link in the Iranian system to finance crude oil sales and oil product purchases.

The German bank in question is the Hamburg-based (but Iranian-owned) Europäisch-Iranische Handelsbank (EIH). This “European-Iranian Trade Bank” has been serving as the primary institutional structure in settling sales of Iranian crude. In September of last year, Washington put EIH on its blacklist, saying it has provided banking services to Iranian companies involved in weapons proliferation. It became the seventeenth financial institution blacklisted by Washington for allegedly supporting weapons proliferation or international terrorism.

The blacklisting put added pressure on European banks to avoid dealing with EIH. That created a major problem for Iran. DOT [U.S. Department of the Treasury] noted in its evaluation at the time: “As one of Iran’s few remaining access points to the European financial system, EIH has facilitated a tremendous volume of transactions for Iranian banks previously [blacklisted] for proliferation.” The impact on the European banking community is also more acute in the case of EIH. While owned by the Iranian government, EIH is still licensed to do business as a German bank.

The blacklisting has a significant impact in India. One of our sources confirms that the Indian Foreign Affairs Ministry issued a formal advisory last fall to Indian companies and banks against having any dealings with EIH. It is the dropping of EIH that has precipitated the problem with ACU [Asian Clearing Union] settlements.

The Indian Finance Ministry has proposed two or three alternative houses to serve as a “clean” transaction channel. Yet none of these is acceptable to the Iranian government. Aside from increasing the complexity and inefficiency of the clearing mechanisms, thereby reducing even more the proceeds Tehran can expect from the crude sales, there is another drawback to using any other arrangement. Iran loses control over the funding flow.

High-reliability intel says Teheran has used EIH to funnel funds in a number of directions unacceptable to the West. This was its primary pipeline to moving money to Hezbollah and others, as well as for the purchase of dual usage equipment. All of that is now over, adding to the expense and inconvenience of developing other networks.

EIH had also been implicated in an ongoing problem with oil revenue back home. For several years, both Iranian sources and members of the Majlis [parliament] have attempted to receive explanations from the government on where a substantial amount of oil proceeds actually went.

For three years, ending in the latter half of 2008, Iran had been running a surplus of oil revenues resulting in large part from the steady rise in crude prices. As several sources reminded us at the time, Iranian law required that the government must transfer any additional income from oil sales to the treasury or the foreign hard currency reserves. Yet a significant portion of the oil sales profits was not making it back to either. At one point, a group of Majlis members demanded that the government account for some $120 billion in oil revenue, a request never adequately answered.

There is ample indication that the Iranian government had insulated oil proceeds from the transmission required by law, specifying either moving the money back to the treasury or to the foreign hard currency reserves. Assets conclude there was a preservation of an unknown amount of those revenues in EIH for use “off the books.” Given the largely absent auditing of external investments made from the proceeds, significant leverage emerged.

Indian refineries and the RBI were caught in the crossfire. They lost the ability to make payments to Iran via the only two avenues available, one provided by regional central banks (ACU), the other effectively by the German central bank (EIH). ACU had been the more efficient way to settle transactions but ended the practice of taking the contracts. It comprises a regional payment mechanism among the central banks (and, thereby, the commercial banking systems) of nine nations, including India and Iran, through which payments can be made either in dollars or euros.

The use of both currencies has become more difficult in the wake of the sanctions and an Iranian opposition to using either currency. The move, more bravado than anything else, largely reflected the rising inability of Tehran to obtain the currencies at acceptable rates. Iran earlier had insisted that it would not trade outside the ACU system. Sources suggest ACU had been relied upon for indirect Iranian access to dollars and euros, through which Iran would rely on the regional central bank backing for ACU transactions.

The U.S. position for some time has been that ACU was a primary conduit for Iranian evasion of the sanctions and has further stated it considered the Asian clearing mechanism a means whereby Tehran continues to fund its support of international terrorism and funds unacceptable weapons programs.

While the clearing problem affects all bilateral trade between the two countries, now running at about $12 billion a year, the bulk is comprised of NIOC [National Iranian Oil Co.] crude oil sales. The primary problem involves financing the final stage of Iranian exports to India.

India has made several attempts to develop payment routes other than ACU. Contacts have told us these alternative approaches have included, among others, Turkey and Russia. The Indian Oil Ministry would certainly prefer using the rupee, but the structure for the rupee-dollar exchange required to conduct international oil trade is not acceptable to Tehran and would likely present an inflation problem in the Indian domestic economy.

Currently, all primary Indian importers of NIOC oil are unable to conclude transactions. The list includes major refiners Mangalore Refinery & Petrochemicals (MRPL), Essar Oil, India Oil Co. (IOC), Hindustan Petroleum (HPCL), and Bharat Petroleum (BPCL). All are in the process of looking for new suppliers, with Saudi Arabia, UAE, Kuwait, and even Iraq as possibilities.

The volume at stake is substantial. India imports about 400,000 barrels per day from Iran, comprising over 12 percent of the national daily demand requirement. The flow has been in jeopardy after RBI announced payments could no longer be settled using the ACU, thereby effectively cutting the trade off from reliance upon the entire clearing system of regional banks.

Iranian oil exports are technically at risk in all of Asia, given the ACU decision. However, no nation has become as exposed to the clearing problem as India. And among the Indian end-users, MRPL is the most acutely impacted. The major refinery complex has an annual contract to import 7.1 million tons of oil from NIOC, about 142,000 barrels a day. While the company will not comment officially, sources tell us MRPL is currently carrying a debt to NIOC in excess of $2.9 billion for past deliveries.

This is a rising debt that Iran cannot not ignore, given its current financial difficulties in clearing its sales globally and the certainty that allowing New Delhi to slide will make matters worse with other buyers experiencing similar problems. India’s accruing debt has reached $5 billion, according to information provided by a Bank Markazi [Iranian Central Bank] source.

While not addressing the issue publicly, a BPCL source has said the refinery secured an equivalent monthly allotment from Saudi Aramco. HPCL, however, acknowledged the situation by confirming that it will not receive crude supplies from Iran until the payments problem is resolved.

Source also confirmed that HPCL has sought an additional one million barrels from Saudi Aramco, adding that the refinery is operating under a rolling month-by-month plan. HPCL runs a 130,000-barrel per day refinery in Mumbai and a 166,000-barrel per day facility at Vizag. HPCL has a term deal with NIOC to buy per year an amount of crude equivalent to 70,000 barrels daily.

Aramco has been the leading supplier of oil to India (Iran being second). But it is uncertain how long Saudi Arabia would continue to fill the void.

In D.C., a related problem has emerged. DOT has been working with the Indian authorities to resolve the payments clearing problem. Several U.S. government sources have also acknowledged the policy difficulty of assisting a foreign ally to purchase Iranian crude.

In response, assets in Teheran note that Saudi crude is not the same as Iranian. Riyadh can persuade India to buy its oil only by special discounts. There is a reason Indian refineries would prefer to continue importing Iranian crude and acknowledge shortcomings with replacing those consignments from other sources (such as Saudi).

Much of the Indian refinery base operates on equipment geared to Iranian crude grades and composition. Saudi production has much heavier sulfur content and would pose some technical problems for the Indian processing facilities.

In addition, there is heightened uncertainty in Tehran, given the shaky situation at the Ministry of Oil. Normally, such a decision as cutting off supplies to an importing country would come from the minister. The [Iranian] president [at the time Mahmoud Ahmadinejad] under increasing political pressure took over control of the oil and gas sector personally.

Some within the Indian government are ascribing the latest Iranian threats as primarily political in nature. According to one source, “The Iranians cannot afford to drop India as a major oil client and we cannot afford to drop Iran as a main supplier. That should give us some space to continue negotiations.”

Talks between the central bankers of both countries failed to find a way that would enable India to continue oil imports. “We have asked the Iranian side to provide a clean channel that could be used for transferring funds to NIOC by Indian oil-importing entities. Our only concern is that the channel should not be under any sort of surveillance by any global or national agencies that could create similar problems at a later stage,” one Indian official part of the delegation said. “There is no issue of currency for such transfers. Apart from the dollar, any other currency can be used for making payments. But we need the channel,” he added.

There has been no progress of any substance since.

The two countries ultimately used a banking channel through Istanbul, facilitated by the Russians. Turkey had received an exemption from EU sanctions and secured a further allowance from Washington (not completely made public).

But in 2019, EU sanctions are not the issue and the current U.S. administration is not likely to provide any leeway this time around.

That means the Indian situation will get worse, obliging New Delhi to move closer to Beijing in circumventing U.S. policy.



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