Thursday, December 13, 2012

Turkey, Iran, and "gold for gas"

What should we make of the so-called "gold for gas" trade between Turkey and Iran?

Turkey depends on Iranian natural gas to produce a large part of its electricity. In normal times, the Turkish natural gas monopoly BOTAS probably would have paid for Iranian natural gas with euros or dollars. The transaction would have been settled through euro- or US-denominated accounts that both BOTAS and the the National Iranian Gas Company (NIGC) held at a bank in Europe. That's my guess, at least.

It's become dangerous for Iranian companies to keep accounts in Europe lest they be frozen. So the NIGC has probably opened an account at a Turkish bank like Halkbank, a large government-owned institution. BOTAS likely keeps an account there too. When natural gas gets delivered across the border, Halkbank settles the trade by crediting NIGC's account and debiting BOTAS's account.

What the heck does the NIGC do with all the Turkish lira it accumulates at Halkbank from gas sales? There's only so much Turkish stuff that Iranians need to buy. Converting it into dollars or euros and sending it to Europe is probably risky, if not impossible. One avenue open to the NIGC is to go to Istanbul's Grand Bazaar and buy gold with its stash of lira deposits, then ship this gold back to Iran. This explains the huge outflows of gold from Turkey starting in early 2012.

So assuming I've got the mechanics right, claims to the existence of outright gold-for-gas trade between Turkey and Iran are exaggerated. Turkey's natural gas purchases continue to be settled via the banking system, not by barter. The gold end of the trade is just the second leg of the round-trip.

Oddly, the value of gold flowing from Turkey to Iran represents far more than the value of natural gas flowing in to Turkey, implying that something else is at work. One explanation is that Turkey buys a lot of Iranian crude oil too. A temporary waiver granted by the US allows Turkish banks to settle Iranian oil trades. I'd bet that a lot of the deposits earned by Iranian institutions from oil sales are also being sold for gold at the Grand Bazaar.

Secondly, a large chunk of India's oil trade is settled in Turkey. Since 2011, Indian oil refiners have been opening euro-denominated accounts at Halkbank. They've used these accounts to credit the accounts of Iranian companies and banks, thereby paying for Indian oil imports. How useful are Turkish-domiciled euros? Can Iranian firms easily transfer them elsewhere in order to buy stuff? Probably not. My guess is that most international banks are hesitant to accept Turkish euros, especially if they're linked to Iranian trade. Buying gold and repatriating it may be the best way for Iranian companies get their hands on purchasing power.

Insofar as obeying US sanctions, there's nothing illegal in any of this. Turkey is allowed to buy as much natural gas from Iran as it wants, and the US waivers granted to Turkey and India allow oil trades to be cleared by Halkbank and other banks without sanction (see my previous post). Converting deposits into gold and shipping it back to Iran is hardly a dodge – it's a fallback towards an inferior medium of exchange. For Iran, in a world of bad payments options, gold is the least bad.

Nevertheless, various US senators want to put the kibosh on what they refer to as the "gold game". The idea here is to punish banks that settle Iranian natural gas trades by excluding them from the US banking system. Faced with this threat, Halbank and other Turkish banks would likely refuse to deal with NIGC and, as a result, the Turkey-Iran natural gas trade would collapse. Now, such an extreme outcome would be highly unlikely since Turkey depends on natural gas for electricity and Turkey is a US ally. Most likely the US would grant Halkbank some sort of waiver allowing it to keep accounts for NIGC as long as these accounts were monitored to prevent NIGC from purchasing gold.

Indeed, if you read the fine print of the Menendez-Kirk-Lieberman Sanctions on Iran document, it is stipulated that banks engaging in Iranian natural gas transactions will be exempted from being cut off from the US banking system "so long as the purchasing country holds the payment for Iran in an account to be drawn on for permissible trade." What qualifies as permissable trade will probably not include gold. If Menendez et al. passes into law, it'll probably reduce the outflow of Turkish gold. But if NIGC and BOTAS decide to skirt the banking system altogether and deal directly in gold and gas, then you'll really see the start of the "gold-for-gas" game.

From a "moneyness" perspecitve, here are my thoughts. The monetary blockade has increased the liquidity of gold, thereby building a larger premium into the gold price. Any return to a more normal situation ie. Iran clearing trades again via the USD clearing and settlement system, will hurt gold's moneyness and lower the gold price.