From the March 2014 issue of Investment Advisor • Subscribe!

In Iranian Oil Market, Timing Is Everything

When is insurance not insurance? When sanctions are involved

Advisors whose clients invest in shipping or oil might want to keep an eye on the situation in Iran. Sanctions against that country were eased on Jan. 20 for six months in a deal that sees Iran calling a halt to certain aspects of its nuclear program, thus opening the door for increased oil exports from Iran to other countries.

Sanctions put in place by the United States and the EU in the past couple of years have included measures to cut Iran's income from sales of oil, disconnecting Iranian banks from SWIFT and impeding the country's means of getting paid for its oil products. Insurers and reinsurers are prohibited from writing coverage for firms engaged in forbidden transactions—namely, the transport of exported Iranian oil.

The sanctions cut Iran's export of oil substantially, with European countries escalating or completing measures to cut their dependence on the country's petroleum products. While some countries, such as India and Japan, continued their trade with Iran, they did so without the benefit of insurance and reinsurance from the world's largest companies. Easing of the sanctions in January were seen as a way for Iran to boost its wounded oil trade, although restrictions still exist on how much oil it may export in total.

However, insurers have warned that when the relaxed sanctions expire on July 20, any claims that were submitted but not settled during the six months prior, or any claims for losses incurred during that period but submitted after July 20, might not be paid.

Oil tankers must carry protection and indemnity (P&I) insurance against cargo damage, injury and pollution. That coverage is provided for about 90% of ocean-going ships globally by the 13 mutual P&I clubs that make up the International Group of P&I Clubs.

While according to Andrew Bardot, secretary and executive officer of IGP&I, “very few if any” of the largest tankers, known as Ultra Large Crude Carriers (ULCC), are currently trading, the next class, known as Very Large Crude Carriers (VLCC), are required by international maritime authorities to carry mandatory third-party liability coverage.

However, under the sanctions, the IG clubs could not provide coverage to cargoes of Iranian oil, or even to tankers that functioned as floating storage vessels.

As a result, countries dealing with Iran in the face of sanctions have relied on other means of coverage, such as Japan's use of sovereign insurance to cover its imports of Iranian oil, or else have been compelled to cut their reliance on Iran as a source.

Optimism was high in November when the deal was announced, particularly since no pressure was to be put on China, Japan and India to cut their imports of Iranian oil and that “for such oil sales, [the agreement will] suspend the EU and U.S. sanctions on associated insurance and transportation services,” according to the agreement.

However, once the relaxed sanctions went into effect, warnings began to sound. Norwegian firm Gard AS said in a circular issued in January that it was seeking confirmation for how to treat claims that arise during the suspension period but aren't “crystallized or presented” until after July 20.

Gard said, “Members and clubs should proceed on the basis that beyond 20 July, 2014 (or any extension of the initial six-month period), clubs will not be able to respond to any claims presented in respect of liabilities arising during the 20 Jan.-20 July suspension period.” All other members of the Group have issued similar warnings.

Since it can take up to two years for such claims to be settled, such a narrow window of opportunity means shippers are basically uninsured.

The International Energy Agency said in November that it expected “small increases” in oil sales as a result of the suspension. However, shipping companies unwilling to take the risk of uncovered shipments are unlikely to boost cargo tonnage.

A more open approach to the West from Hassan Rouhani, Iran's leader, could lead to the country's coming more in line with accepted international practices. Already the country is at work on new contract terms for international energy companies, and it has said that those terms will be more favorable to foreign partners who can help the country develop its energy resources.

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