Exclusive: Saudi readies oil line to counter Iran Hormuz threat

DUBAI (Reuters) - Saudi Arabia has reopened an old oil pipeline built by Iraq to bypass Gulf shipping lanes, giving Riyadh scope to export more of its crude from Red Sea terminals should Iran try to block the Strait of Hormuz, industry sources told Reuters.

Riyadh took the step as international pressure grows on Iran to curb a nuclear program that Western powers say has a covert military purpose. A European Union embargo on buying Iranian oil takes full effect on Sunday, cutting Tehran's income.

With the sanctions regime tightening on Iran, grains traders said its attempts to secure millions of metric tons (1.1023 tons) of wheat through barter deals with India and Pakistan are failing, and Tehran is about to pay premium prices on international markets to secure food supplies and stave off popular unrest.

Iran's chief nuclear negotiator Saeed Jalili warned world powers on Thursday against adopting "unconstructive measures" that harm talks, state television reported. "Those who replace logic in talks with illegitimate tools are responsible for harming the constructive trend of talks," Jalili wrote to EU foreign policy chief Catherine Ashton.

The effects of tensions have been diverse, with Saudi Arabia's decision to widen its export routes the latest evidence of states in the region preparing for difficulties.

The Iraqi Pipeline in Saudi Arabia (IPSA), laid across the kingdom in the 1980s after oil tankers were attacked in the Gulf by both sides during the Iran-Iraq war, has not carried Iraqi crude since Saddam Hussein invaded Kuwait in 1990.

Saudi Arabia confiscated the pipeline in 2001 as compensation for debts owed by Baghdad and has used it to transport gas to power plants in the west of the country in the last few years.

Iran threatened in January to block the Strait of Hormuz in retaliation for U.S. and European sanctions that target its oil revenues in an attempt to stop the nuclear program.

An EU ban on Iranian oil starts on Sunday and Israel has threatened military action against the country's nuclear facilities if talks with Western powers fail to stop uranium enrichment.

Alarmed, Saudi Arabia has now quietly reconditioned IPSA to carry crude, test pumping along the line over the last four to five months, several sources with knowledge of the project say.

"The testing started because Saudi Arabia wanted to secure alternative routes to export oil," an industry source in Saudi Arabia said.

Western industry sources said the tests through the 1.65-million barrel-a-day line had delivered into storage facilities at Mu'ajjiz near Yanbu on the Red Sea for at least four months.

More than a third of the world's seaborne oil exports pass through the narrow Strait of Hormuz from the oilfields of Saudi Arabia, Iran, Kuwait, Iraq, the United Arab Emirates and Qatar. Qatar's liquefied natural gas exports are all shipped through Hormuz.

PETROLINE

Worried about its reliance on Gulf shipping, Saudi Arabia increased its capacity in 1992 to pump oil from fields predominantly clustered in the east across the country to the Red Sea. Capacity rose to about 5 million barrels a day through two parallel pipelines known as the Petroline.

Saudi crude exports run as high as 8 million bpd but rising demand for its crude in Asia, shipped out of the Gulf, and falling demand from Europe, usually sourced from Red Sea ports, meant Petroline's pumping capacity was never fully used.

The smaller Petroline pipeline was converted to carry natural gas from the east to booming industrial centers in the west a few years ago, slashing Saudi's east-west crude transport capacity to Red Sea ports.

Saudi Red Sea industries are now reliant on gas fed from fields over 1,000 km away and the prospect of cutting them off to export crude through Petroline during a Gulf shipping blockade is not an attractive option.

Until recently the Saudi government had considered the risk of such a disruption in the Gulf too small and its western gas needs too great to switch Petroline fully back to oil. But as tensions over Iran's nuclear program rose, it decided to put IPSA on standby to transport more crude west in an emergency.

The United Arab Emirates has built its own Hormuz bypass pipeline, which is due to start exporting from the Gulf of Oman next month.

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With its oil income crimped by embargoes and its ability to import essential products curtailed by sanctions targeting its banking system, Iran had turned to India and Pakistan for wheat to meet some of its needs, but grain traders say talks with both Delhi and Islamabad are deadlocked.

Food is not targeted under Western sanctions aimed at deterring Iran's nuclear program, but in recent months it has paid high prices for grain to work around a freeze on financial transactions due to the measures.

"There is great doubt in the market about whether the Indian deal will happen. They are never going to get the phyto-sanitary standards worked out," a European grains trader said. "The Indian wheat cannot reach the standards the Iranians traditionally demand."

As Iran's second-biggest crude client, India hoped to reassure Tehran on quality and secure wheat sales to help settle part of its $10 billion a year-plus oil import bill through a barter-style mechanism using rupees. India said last week it can export up to 3 million metric tons of wheat if supplies are requested.

In Washington, sources said the Obama administration is expected to extend exceptions on Iran financial sanctions to China and Singapore, perhaps as early as Thursday.

"There should be an announcement today," on China - Iran's top buyer of crude - and on Singapore which buys fuel oil from the OPEC member, said one of the sources who works in the U.S. government. Earlier this month the administration granted exceptions to India and six other economies. Japan and 10 EU countries got the exceptions in March.

Iranian Oil Minister Rostam Qasemi warned South Korea on Thursday that Tehran would reconsider ties with Seoul if the country stopped importing oil from Iran, the official IRNA news agency reported.

South Korea announced on Monday it would halt imports of Iranian crude from July 1 due to an EU ban on insuring tankers carrying Iranian oil, becoming the first major Asian consumer of Iranian crude to announce suspension of crude imports.

(Additional reporting by Reem Shamseddine in Khobar, Richard Mably and Peg Mackey in London; editing Richard Mably and David Stamp)