By Amena Bakr and Raissa Kasolowsky
DUBAI (Reuters) - The United States and Dubai are negotiating an end to the desert emirate's Iranian oil imports to head off the threat of U.S. President Obama sanctioning a trade that has riled Gulf Arab oil producers, industry sources and diplomats said.
Washington in the summer tightened controls on financial transactions for importing Iranian condensate, a light hydrocarbon, as part of U.S. efforts to starve Tehran of revenues for its disputed nuclear program.
But Dubai is still buying the oil while U.S. officials encourage the Dubai-government-owned Emirates National Oil Company (ENOC) to find another source of supply.
"The Americans did ask ENOC to stop importing but this is still going on," a UAE oil industry source said of the continued imports by fuel-poor Dubai.
"We have discretion under executive order and we are working with UAE to ensure imports wind down," a U.S. official said.
Iran's condensate sales are its biggest source of income after crude and refined products, with Dubai its biggest buyer ahead of Asian buyers including China.
ENOC refines the condensate at Dubai's Jebel Ali refinery to provide the city's 2 million mainly expatriate, often wealthy, residents with cheap subsidized fuel at 1.72 dirhams, 47 cents, a litre.
U.S. and European sanctions have succeeded in cutting Iran's crude exports by half this year, slashing oil revenues and piling pressure on Tehran to drop a nuclear program that Washington and Brussels fear is designed to develop weapons.
But Dubai's condensate imports from Iran are up nearly 20 percent from last year, according to estimates by some market analysts, with ENOC continuing to bring in Iranian supply in barter deals, Gulf industry sources familiar with the matter said.
Saudi Arabia, the world's biggest oil exporter and a significant condensate seller, has complained that ENOC's trade undermines sanctions against its OPEC rival Iran, a western diplomat said.
"The Saudis aren't happy that another GCC (Gulf Cooperation Council) member is effectively supporting Iran and undermining sanctions and they've made their feelings known," said the diplomat.
An executive order issued by Obama this summer gives the U.S. president the option to sanction those who buy Iranian condensate.
Gulf oil industry sources said that ENOC is still in talks with U.S. officials over how the Dubai fuel retailer can stop buying Iranian fuel completely. It operates at a big loss because it is obliged by UAE rule to sell gasoline at a fraction of international market rates. Officials at ENOC were not available to comment.
As long as the multi-billion dollar loss-making company shows it serious about halting the imports, the U.S. government is likely to hold off on imposing sanctions on a financial center that is home to many thousands of U.S. citizens and the Middle East base of dozens of U.S. businesses.
Under new sanctions for oil-related transactions effective since June 28, Washington can punish foreign banks that carry out financial transactions for any petroleum products from Iran.
But traders say the fuel trade is mainly done through barter deals and it is unclear what the United States would do if ENOC refused to stop. It is not known what Dubai delivers to Iran in return for the barter, if anything.
Unlike Dubai's neighboring Abu Dhabi National Oil Company refineries, which has plentiful cheap crude, ENOC loses hundreds of millions of dollars each year buying fuel on international markets and retailing at low fixed prices.
Thoughts of raising fuel prices in the UAE were swept away by the Arab spring, despite the fact that non-emiratis make up 89 percent of Dubai's population and are beneficiaries of subsidies that squeeze state coffers.
Because Dubai's small oil fields produce far less crude than it needs to meet demand, Iranian condensate is an attractive feedstock for its 120,000 barrel per day (bpd) Jebel Ali refinery.
ENOC's continued trade with Tehran grates with other Gulf Arab nations. Saudi Arabia and Qatar could be alternative suppliers for ENOC but are unlikely to supply condensate as cheaply as Iran.
"Qatar has offered to sell ENOC condensate instead of buying from Iran, but I don't think any discount is being offered," said an Abu Dhabi-based industry source.
With Dubai unable to raise pump prices without oil-rich Abu Dhabi's agreement and sanctions-battered Iran keen to sell any fuel it can, the lure of Iranian condensate supplies for ENOC is unlikely to fade any time soon.
"Covert trading with Iran will continue if the other countries don't offer a discounted alternative," said an oil trader in Dubai.
(additional reporting by Timothy Gardner in Washington, Humeyra Pamuk in Dubai; editing by Daniel Fineren, Richard Mably)