Filling the ‘teapots’: How Russia, Iran bypass Western sanctions on oil

US-led sanctions on Iran and Russia aimed to leave little breathing space for the two energy-rich countries and cripple their economies to force them into a position of weakness.

But the efforts have spectacularly boomeranged on the West.

A host of nations dependent on energy imports have been cut off from two of the major energy producers, causing disruptions in the global energy markets.

The ultimate winner in the drawn-out sanctions game appears to be China, which let Russia leapfrog Saudi Arabia in 2023 to become its biggest crude oil supplier.

Meanwhile, Beijing continues to consume about 90 percent of Iran’s total oil exports, which is helping the heavily sanctioned economy keep its head above water.

As a result, China managed to save a total of $10 billion in 2023 alone, thanks to crude oil purchases from the sanctioned countries at less than the going rate.

“China is the big winner. It gets cheap energy and commodities from Russia,” says Timothy Ash, associate fellow in the Russia and Eurasia programme at Chatham House.

“Russia is now the junior partner in the partnership without limits. It is clear the dominant power is China,” he tells TRT World.

This begs the question as to how the two countries—Iran and Russia—are bypassing the Western sanctions to sell their energy to the world’s largest importer of crude oil.

According to a recent report by the Atlantic Council titled ‘The axis of evasion: Behind China’s oil trade with Iran and Russia’, the three countries have created an “alternative market of sanctioned oil” in which payments are denominated in the Chinese currency while oil is transported via tankers that operate outside of maritime regulations.

“Oil revenue from China is propping up the Iranian and Russian economies and is undermining Western sanctions,” wrote Kimberly Donovan and Maia Nikoladze of the Economic Statecraft Initiative of the Atlantic Council’s GeoEconomics Center.

“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,” they said.

How Russia bypasses sanctions

One of the sanctions imposed on Russia after its offensive in Ukraine stops Western shipping companies and insurance providers from getting involved in Moscow’s crude oil exports above the rate of $60 a barrel.

In response, Russia has resorted to using a so-called ‘dark fleet’ to transport oil to buyers like China. This fleet consists of old vessels with no insurance and obscure ownership, and it has grown to an estimated 1,400 ships.

In exchange, Russia receives payments in the yuan as opposed to the dollar, mitigating the impact of sanctions.

Even though the yuan isn’t among the world’s leading reserve currencies – such as the dollar, the euro, and the yen – it is arguably the “only relatively stable, widely traded currency” issued by a non-sanctioning authority.

Russia used the proceeds of its energy sales to China, which totalled $88 billion in 2022, to import Chinese goods worth $76.1 billion in the same year.

Filling ‘teapots’ with Iranian oil

Iran also circumvents the Western sanctions by sending oil to Beijing in ‘dark-fleet tankers’ against payments in the yuan via second-tier Chinese banks.

That’s because, unlike Russia – allowed to sell oil globally as long as the price is less than $60 a barrel – there’s a blanket ban on the sale of Iranian oil using Western banking and shipping channels.

Small, independent refineries in China—known as teapots—buy Iranian oil shipments after rebranding them as Malaysian or Middle Eastern oil. These ‘teapots’ now process as much as 90 percent of Iran’s total oil exports since large-scale state refiners like Sinopec and PetroChina stopped lifting Iranian crude in 2019.

In exchange, these refiners pay their Chinese crude suppliers in the yuan through banks like the US-sanctioned Bank of Kunlun.

“This strategy allows China to avoid exposing its large international banks to the risk of US financial sanctions,” Donovan and Nikoladze added.

Just like Russia, Iran uses the renminbi-based proceeds of energy sales to China to pay for imports from Beijing. Iran purchased machinery, nuclear reactors, boilers and vehicles for about $4 billion in 2022 from China.

The analysts from the Atlantic Council believe it is highly probable that Iran’s imports of Chinese technology are denominated in renminbi, even though data on financial transactions between Iran and China is not accessible.

Iran also appears to be helping China in its effort to make the renminbi an international reserve currency. A growing number of countries seem to be realising the importance of moving their international reserves into currencies, and institutions are perceived to be less vulnerable to possible sanctions.

The realisation came after Russia’s central bank was refused access to $300 billion of its international reserves due to the sanctions imposed after the Ukraine offensive.

If the deputy chief of the Central Bank of Iran is to be believed, its foreign exchange reserves are increasing “due to the growth of oil and non-oil exports”. There’s no official data on the currency composition of Iran’s foreign exchange reserves, but the statement suggests Tehran is building up its forex buffer in renminbi.

Ash of Chatham House says the sanctions were designed to limit backdraft to the West, which unfortunately dulled their impact.

“In the end, sanctions have to be tough, and the West has to take some pain,” he says.