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Iran Looks East
by Vivienne Walt    Fortune Magazine
Entered into the database on Saturday, March 05th, 2005 @ 03:51:12 MST


Untitled Document It was 1978, and thousands of students were rampaging through the streets of
Tehran, burning barricades and chanting their vision of a radical Islamic
republic that would transform Iran forever. Halfway across the world, a
young Iranian student was sitting in an economics class at the University of
California at Berkeley, listening to his professor's predictions about the
future. "He told us to watch China," Mohammed Rafsanjani recalls, sitting in
an ornate reception room in one of the Shah's old palaces atop a snowy
mountainside in north Tehran. "He said, 'If each Chinese person buys one
aspirin, we can sell a billion aspirins.'"

Rafsanjani soon abandoned his doctoral studies at Berkeley and flew home to
join the revolution, arriving on the same plane as his hero, Ayatollah
Khomeini. But the economics lesson stuck in his mind. And these days he has
good reason to think about it. Now gray-haired and 59, Rafsanjani sits on
Iran's key governing body, the Expediency Council, which settles some of its
thorniest political decisions, including policies on trade. And China?
During the past few months that country has arrived in force in this
oil-rich nation of 70 million, looking to solve a headache that will take a
lot more than aspirin to overcome: a critical shortage of energy for its
galloping industrial growth and for the millions of new cars on its roads.

After nearly a year of talks with Iranian oil officials, China's Sinopec
Group is set to sign the biggest deal Iran has negotiated in a decade. Its
ripple effects over the next few years are likely to extend far beyond
Iran's balance sheet. The long-term alliance with the world's
fastest-growing economy could give the mullahs in control greater
international security than they have enjoyed since the Islamic revolution
26 years ago. It could also seriously challenge the options open to Iran's
bitterest foe-the Bush administration, which has hinted that it is
considering a military strike against the country if Iran is found to be
pursuing nuclear weapons. "What we have right now is trade with China," says
Hadi Nejad Hosseinian, deputy minister of petroleum. "But when we invest in
each other for 30 years, this is a marriage."

Under the gas agreement reached last October, China will import more than
270 million tons of natural gas over the next 30 years from Iran's South
Pars field in the Persian Gulf, the largest natural-gas reserve on the
planet, which Iran shares with its tiny neighbor Qatar. That will bring Iran
about $70 billion in hard currency. And that's just the start. The two-part
deal also gives Sinopec a half-share in one of Iran's most important new
discoveries, the Yadavaran field, an energy-rich area in southwest Iran,
allowing the company to explore for oil over the next few decades. With the
field's oil reserves estimated at about 17 billion barrels, China's
operations could be worth another $100 billion.

For Iran's energy industry, the deal offers a way out of a problem it has
labored under for decades, as it attempts to maintain its creaking oil
infrastructure: a way of attracting investors over the long haul. U.S.
sanctions were imposed a decade ago, just as Iran was beginning to recover
from its devastating war against Iraq, which destroyed hundreds of oil
facilities and killed about 300,000 Iranians. Since then Europe's big oil
companies-including Total, ENI, and Royal Dutch/Shell-have continued
operating in Iran, benefiting from the absence of the American majors.

But European companies work under tight constraints. American sanctions
threaten penalties against foreign companies that invest more than $20
million a year in Iran's oil industry. That pressure is "a major factor in
weighing the attractiveness and disadvantage of working in Iran," says a
Western oil executive operating in Tehran who asked to remain anonymous.
Added to that, Iran bans foreign companies from outright concessions to oil
resources. Under the buyback model Iran created a decade ago, the government
requires oil companies to turn over whatever fields they develop to the
government's National Iranian Oil Co. (NIOC) the moment production begins.
As Iran has tried to kick-start its new natural-gas industry, it has found
itself outgunned by little Qatar-with 1% of Iran's population-which allows
foreign companies far more freedom and exports six times more gas from their
shared South Pars field. "There has been a clear and widely shared view that
Iran needed to catch up," says the Western oil executive. "They've been keen
to export and finding it very difficult to achieve that."

Iran's top oil officials say that after years of uncertainty they have
finally found their ideal partner. "China and Iran are perfectly matched for
each other," says Ali Akhbar Vahidi Ale-Agha, deputy managing director of
Petroleum Engineering & Development, a NIOC subsidiary, sitting in his
Tehran office in January at the end of daylong meetings with Sinopec
executives. "China has the world's biggest market of customers and no secure
resource for energy. We have a lot of energy, and we need foreign currency.
And they have a lot of money to invest. It's a win-win situation."

Travel around Tehran, and the win-win relationship takes on more reality
than signatures on contracts. China's presence seems to be everywhere in
this sprawling capital of about 12 million people. Its official trade volume
with Iran was about $7 billion last year, a fivefold increase since 1999.
Two thousand Chinese are now living in Tehran, and more than 40 Chinese
companies, including Hauwei, the telecom systems giant, have offices here.
Throngs of Iranians shop for Chinese refrigerators and microwave ovens,
items that were unavailable a few years ago. The Tehran Metro, which opened
in 2003-with separate cars for men and women-has a metal plate affixed to
each car reading changchun car company china.

China's North Industries Corp. (Norinco) beat Siemens in its bid to build
the Metro's first two lines for $836 million and is now a leading contender
to construct four more lines. The service has been a godsend for Tehran
residents eager to escape the traffic above ground; the air has become so
thick with car fumes that schools were shut in early January when the
pollution index hit 168 (compared with 52 that day in Manhattan). The
subway's first line leads to the tomb of Ayatollah Khomeini, one of Tehran's
most sacred shrines, south of the capital. Trains run every few minutes,
jammed with passengers who buy 1,000-rial tickets (about 11 cents). Chinese
companies have also won major contracts to build a dam north of Tehran and a
highway running to the Caspian Sea, while another is eyeing a contract to
lay a 240-mile oil pipeline to the Caspian for about $400 million.

By December, China's invasion of Iran had tempted Wang Wentian to join the
stampede. Wang, 41, says he was persuaded to open a Chinese restaurant in
Tehran after China's commercial attaché to Iran visited his eatery in
Afghanistan, which he started after the Taliban were defeated in 2001. As
the only one of its kind in the country, the restaurant has been mobbed with
American soldiers and relief workers. Over dinner in Kabul the Chinese
diplomat told Wang he could duplicate his success in Tehran, where "Chinese
businessmen were arriving and asking where they could eat Chinese food,"
Wang says. One week before Christmas, Wang opened Darband, the city's first
Chinese-run restaurant, in a two-story white house up a twisting mountain
road in north Tehran. Within days of its opening, Wang became known for
having dared to flout Islamic tradition by importing young Chinese
waitresses-an unheard-of profession for women since the revolution. With an
eye for marketing, Wang touted his waitresses in newspaper advertisements
and outfitted them in satin turquoise trousers and Chinese tunics, with
matching headscarfs to comply with Iran's stringent dress code. Then he
turned the adjoining low-slung building into a store selling Chinese
porcelain vases and dishware.

It is on big projects, however, that China shows its edge. Its bids usually
undercut those of European and Japanese companies. Iranians locked into
business deals with Europe now regret their earlier decisions, which they
made at a time when the American embargo had left European companies almost
alone in the market. "China is coming to our market in a speed you wouldn't
believe," says Saeed Laylaz, vice president of Iran Khodro Diesel, the
country's biggest truck manufacturer. "Their costs are a third of Europe's,
and the relationship is excellent." He says his company made a fateful error
by forming a partnership with DaimlerChrysler years ago. In 2003, China's
Chery Automobile Co. signed a deal with a local manufacturer to build its
first overseas plant, in Iran, aiming to produce about 30,000 cars a year.
Now, says Laylaz, "we're losing the market to the Chinese."

But in the words of Hossenian, the deputy oil minister, all that is just
trade. Now comes what he calls the "marriage." Analysts believe China's new
energy deal in Iran will drastically shift the country's economic focus away
from the West. Within weeks of the announcement of China's gas deal,
Pakistani and Indian officials flew to Tehran to conclude negotiations over
a $4 billion pipeline that will ship gas from Iran across Pakistan into
India. Those energy deals could provide a toehold in Iran for both China and
India as they scramble for minerals Iran has in quantity: coal, zinc, lead,
and copper. Through a tight alliance with China, Iran can build links across
Asia. "The whole mood around here is to look thataway," says Siamak Namazi,
managing director of the Atieh Bahar consultancy in Tehran, pointing to the
East. "That's where the money is, not the West."

In its deal with China, Iran has a lot more than money at stake. Analysts
and officials believe the longer term importance of the gas deal could be a
tangible political realignment. After sitting through months of talks with
Chinese officials over the contract, Hosseinian says the two countries will
now "trust and support each other." As Iran's ambassador to the UN until
2002, he spent years fighting U.S. pressure over his government's program of
uranium enrichment. He was in New York City in 2002, listening to President
Bush declare Iran part of the "axis of evil." Now, with a Chinese alliance,
Iran believes it will be more insulated from a possible U.S. attack.

Under pressure from Washington, British, German, and French officials won
assurances in December that Iran would freeze its uranium-enrichment program
in return for new European investment and a trade deal. Many in Washington
doubt Iran will honor that. "What do we do then?" asks Ellen Laipson,
executive director of the Henry L. Stimson Center in Washington, D.C., a
think tank on nuclear issues. "The true believers want to go for regime
change. And others say, 'How are we going to do that? We don't have the
troops. We don't have the money.' " In early January, when The New Yorker
reported that U.S. Special Forces were already inside Iran weighing
potential military action, President Mohammed Khatami told reporters, "We
have prepared ourselves."

At least one preparation is securing a political alliance against U.S.
action. While Laipson believes Iran might be "overstating the insurance" it
will get from its new friendship with Beijing, China, which has a permanent
seat on the UN Security Council, has already said it will not support any
U.S. proposal to attack Iran. "Iran has to rely on the Chinese veto, since
the Russians are too difficult to predict," says Namazi. "Iran has to get
close to China, and it's using its hydrocarbons to do so."

China's representatives in Tehran make it clear they have no interest in
questioning Iran's policies on nuclear weapons or human rights. "We don't
care about the sanctions, and I don't think the Chinese government cares,"
says China's commercial attaché Lu Chang Jin, the diplomat who lured Chinese
restaurateur Wang to Tehran. "From the Iranian side, they need our equipment
and our machinery, and even our technology. We don't believe politics should
be part of business."

In early January the U.S. imposed penalties on eight Chinese companies,
including Norinco. State Department officials claim the companies are
exporting high-performance metals to Tehran, which could be used to develop
long-range missiles capable of striking Israel. But Lu insists the threats
from Washington will not slow down the explosion of Chinese companies coming
to Iran. "Why should we have to ask America's permission to do business
here?" he says. "We are a sovereign country." Analysts believe that defiant
attitude is likely to grow in tandem with China's involvement in Iran. "U.S.
sanctions will pale into insignificance once the China energy arrangement
takes off," says Davood Bavand, professor of international relations at the
University of Tehran, who was once the Shah's ambassador to the UN.
"Washington will need to find other ways to impose pressure on Iran."

Unexpectedly, that pressure might come from the same place as the spark that
ignited Iran's revolution 26 years ago-from among the millions of young
Iranians. Three-quarters of Iran's population is younger than 30, thanks to
Ayatollah Khomeini's revolutionary edict that women have big families. About
1.8 million Iranians turn 20 each year, and many of them are unable to find
jobs. One businessman says he recently had 200 responses to an advertisement
for a secretary's position. "These people were all born after the
revolution-they're a ticking time bomb," says an Iranian banker who did not
want to be named. "Who's going to create all these jobs? Not the

Added to the crisis, large sectors of Iran's economy-including construction,
tourism, and transportation-rest in the hands of bonyads, Islamic charities
created after the revolution from the confiscated property of the Shah and
notable aristocrats. Their board members are appointed by the ruling Islamic
clerics, and there is little oversight into their activities, even though
they have grown into vast conglomerates. "This organization took in more
than $3 billion last year," says Ahad Mohammadi, who heads the Tourism and
Recreation Centers Organization of Iran's biggest bonyad, the Mostazafan and
Janbazan Foundation. Mohammadi, who also heads the Iran-China Friendship
Association, says that figure is small compared with other sections of the

Literate and well educated, many middle-class youth seem eager to tell a
foreign journalist-often in flawless English-how alienated they feel from
the mullahs, some of whom they suspect are making vast profits off the
bonyads while most Iranians live in poverty. Despite the high risk of
arrest, many say bluntly that they have little interest in Islam and are
focused instead on finding well-paying jobs that can give them the material
comforts they see on Western television shows. "I was one of the fans of the
revolution's ideals, but they've made us hate it," says a 22-year-old
economics student, referring to the mullahs. She says she has studied the
conservative economic theories of Milton Friedman, in which she and her
friends are intensely interested. "We have a sick economy, and we could be
so rich," she says, sitting in the Jaam-e-Jam food hall in north Tehran, the
favorite new gathering spot for young Tehranis, which offers American-style
barbecued chicken wings and shows music videos on large screens. She, like
many other middle-class youths thronging the city's shopping malls, has
relatives who left for Europe after the revolution, whose wealth provides an
infusion of hard cash.

Up in the spacious living room of the Shah's old palace, Mohammed Rafsanjani
admits that it has become urgent to satisfy the growing financial demands of
millions of youths. His brother, Ali Hashemi Rafsanjani-regarded as perhaps
the most powerful politician in Iran, second to the Supreme Leader Ali
Khamene'i-is a strong contender in the presidential elections scheduled for
June. Ali Hashemi Rafsanjani heads the Expediency Council and was President
for eight years, until 1997. This time around, his top priority would be
privatizing the outdated government behemoths and creating millions of jobs,
says his brother. "Unemployment and inflation are both high," he says. "We
need to concentrate on productive employment. The world has changed."

And with those changes, Iran has found an important new ally. Whether
China's injection of new business will generate the modern economy Iran
needs is unclear. Analysts believe that the pressure of Iran's educated
young millions and their growing presence in the country's professions will
ultimately require the involvement of the world's biggest economy-the U.S.
Until then, however, the "marriage" with China could last a long time.