Iran Sanctions: Right Intent, Wrong Approach

While the oil boycott the US and EU have instituted against Iran is understandable, in view of the repulsive nature of the Iranian regime, it will end up hurting the West rather than the rulers in Tehran, argues Friedbert Pflüger, Director of the European Centre for Energy and Resource Security (EUCERS) at King’s College London. According to Pflüger, the West should deal with Iran the way it dealt with the Soviet Union during the Cold War: with a policy of containment and cooperation, particularly in the energy sector. "While the dangers and malicious character of the ruling regime should not be watered down, stronger economic cooperation, like for instance the 'gas for pipes' deal in 1970 between Germany and Russia, should be pursued."

According to Pflüger, the West should deal with Iran the way it dealt with the Soviet Union during the Cold War

There is no denying the unpleasant nature of the ruling regime in Tehran given the country’s long-track record of state-sponsored terrorism, domestic human rights violations, and illicit activities over the past thirty years. Add to that the fiery and provocative rhetoric of its Holocaust-denying President Mahmoud Ahmadinejad and a recent report from the IAEA in November 2011 which suggested that Iran had carried out tests "relevant to the development of a nuclear explosive device", and you end up with the current stand-off in one of the most volatile and, at the same time, important geopolitical regions in the world.

The IAEA report has prompted the US and the EU to impose their harshest sanctions on Iran to date by prohibiting the import, purchase and transport of Iranian crude oil and petroleum products effective July 1, 2012. Related financial and insurance industries will also be restricted by the new measures, as well as the country’s petrochemical sector, the central bank and Bank Tejarat, the last large Iranian state bank still operating in the EU. Iran has responded in kind by threatening to block the Strait of Hormuz, through which 20% of the world’s traded oil flows as well as significant volumes of liquefied natural gas (LNG). The US, on the other hand, has pledged to keep the trade route open, raising the likelihood of a confrontation.

However, given Iran’s past ability to weather previous sanctions and even utilize them for political gain domestically, it begs the question: Are the latest round of sanctions, and the ensuing escalation of tensions, the right approach to finding a solution to the Iranian nuclear issue?

Global economy

Judging from prior experience it could very well be that the embargo will effect no (desired) change in Iran and worse, impel it to adopt an even greater hard-line stance while inflicting damage on Western economies in the process. Sure, leaders on both sides could stand to benefit politically. In the West, presidents Obama and Sarkozy are facing elections this year and being tough on Iran is usually good for the poll numbers. Iranian President Ahmadinejad, on the other hand, has lost a lot of popularity in his own country and needs foreign adversaries on which he can place the blame for Iran’s domestic woes. Economically, however, both sides stand to lose, and the West even more so than Iran, at least over the short-term. The latest sanctions seem to be guided more by political motivation and do not fully take into account the economic ramifications such a move will have on the global economy.

The embargo, which will go into effect in July, will very likely have a negative impact on the world economy by placing additional strain on oil supplies and pushing prices higher (oil prices have already risen due to increasing tension and the expected impact of an EU oil embargo), hence slowing growth and making it that much more difficult for economies still reeling from the global financial crisis to recover. This is especially true for countries in financially-troubled Europe, some of which are currently undergoing strict austerity measures. The Libyan oil supply disruption in the spring of 2011 is a case in point and may just have been a small foretaste of what we can expect in the near future.

Libya produced around 1.5 million barrels of oil per day (mb/d) in 2010. Following the drop of Libyan oil output in February 2011 as a consequence of the conflict, production declined to a mere 169,000 b/d in

While EU countries that adhere to the oil ban rush to find alternative supplies, likely at higher prices, competitors in Turkey and North Africa are exempt from the embargo and can continue to purchase cheaper crude from Iran
May, which resulted in a loss of more than 1.3 mb/d and added up to a loss of approximately 132 million barrels by the end of the same month. And while Libya exported the bulk of its oil, some 85%, only to Europe prior to the conflict (Libyan oil accounted for nearly 11% of total EU imports in 2010: Italy 28%, France 15%, Germany and Spain 10%, Greece 5%, and UK 4%; the US only imports 3% from Libya), the supply disruptions were felt worldwide due to the intertwined nature of international oil markets as Europe’s search for replacements placed additional strain on global supply.

Oil prices jumped from $92 a barrel in January 2011 to a high of $116 in April, despite the spring being a low demand season, before going back down to an average of $103 for the second half of the year after the IEA decided in June to coordinate the release of 60 million barrels of strategic reserves in order to ease fears in the international oil markets and to prevent additional downward pressure on economic growth due to the Libyan supply disruptions. This was only the third time there had ever been a release of emergency petroleum reserves, after the First Gulf War in 1991 and for Hurricane Katrina and Rita in 2005; the release was met with disapproval from both private oil companies who did not like the government interference in markets and some OPEC member countries that deemed the move to be unnecessary. (See Devin Glick, A Look at the IEA 2011 Release of Strategic Oil Reserves)

Iran’s oil production is more than double that of Libya’s, with a current output of approximately 4 mb/d, and it is the world’s third-largest net exporter of oil with some 2,2 mb/d. Should Iran be able to make good on its threat to block the Strait of Hormuz as a reaction to the sanctions, it is safe to assume that any ensuing disruptions in oil supply from Iran and the region would have a significantly harsher impact on oil prices and the global economy than the Libyan disruption last year. It is also doubtful that the available strategic reserves in the West would have the same cushioning effect as they did in the case of Libya, as the blow to global oil supply from a loss of Iranian oil would be considerably more difficult to absorb. Of course, European countries would not be the only ones affected by potential flow disruptions in the Strait of Hormuz. China is Iran’s biggest customer and imports 10% of its oil from Iran, as does India, while Japan and South Korea import 11%. In addition, Japan and South Korea purchase significant volumes of LNG from Qatar, which also flow through the strait. However, the blockage of the Strait of Hormuz is highly unlikely as Iran would in effect be shooting itself in the foot by blocking its own exports, which constitute 50% of government revenues, to countries that would still be willing to purchase their oil despite the sanctions.

Biggest buyers

Even if it does not come to flow disruptions and exports are “only” redirected to other destinations, the embargo will still have a profound impact on countries that are particularly dependent on oil from Iran and choose to enforce the sanctions. While the US stopped importing Iranian oil in 1987 and the EU currently imports about 450,000 b/d from Iran (only about 4% of its foreign oil), it is the concentration of these imports that are of significance.

Three southern European countries, namely Italy, Spain, and Greece, are the biggest buyers of Iranian crude in Europe and account for over 70% of the EU’s imports from the country; presently, Greece imports about a third of its oil from Iran, Italy 13% and Spain 12%. The refineries in these countries, which are already suffering from financial problems, will be particularly hard-hit by the sanctions because they cannot easily find replacements for Iranian type crude. And while importing EU countries that adhere to the oil ban rush to find alternative supplies, likely at higher prices, competitors in Turkey and North Africa are exempt from the embargo and can continue to purchase cheaper crude from Iran.
Another issue compounding the problem is that several EU countries have had their credit ratings downgraded in the last couple of months – five just recently including Spain and Italy. This means the oil they have to replace is going to cost a good deal more at a time when their budgets are already heavily burdened.

Greece, which has no domestic oil production and is in the midst of the worst financial crisis in its modern history, may end up suffering the most. According to EU data, the country imported 46% of its oil

In 2011 China, India, and South Korea increased their imports of Iranian crude
in 2010 from Russia, 16% from Iran, 10% from Kazakhstan and Saudi Arabia, 9% from Libya and 7% from Iraq. Due to its sovereign debt crisis and increasing fears of a Greek default, many banks have refused to provide financing for the country, which has forced Athens to stop purchasing oil from Russia, Kazakhstan, and Azerbaijan, hence increasing dependence on Iranian imports in recent months due to its more lenient payment policy. However, with the Iranian oil embargo coming into effect in July, Greece would stand to lose another major source for its oil imports; this would almost certainly worsen the fragile state of the Greek economy even further.

Finding replacements in time is another issue. One of the primary reasons for the July deadline was to provide states that are heavily dependent on Iranian crude with adequate time to find alternative supplies. However, some countries may have to look for replacements much sooner because Iran has threatened to cut off its oil exports before the deadline. An abrupt cessation of Iranian oil supplies to the recession-plagued economies of the EU would lead to steep price increases at a time when people can least afford it, thereby potentially sparking widespread public discontent and, again, severely hampering recovery efforts.

Moreover, Iranian oil has already started flowing to other demand centers. According to the US Energy Information Administration (EIA), in 2011 China, India, and South Korea increased their imports of Iranian crude, as oil volumes were reallocated to countries that imposed less severe sanctions on Iran. This indicates that a gradual shift of Iranian oil eastwards may already be taking place and the latest sanctions will provide a further impetus for that trend to continue. India, China and Turkey have refused to join the sanctions and are searching for alternative ways to pay for Iranian crude. India’s current plan is to pay Iran in gold for its oil in cooperation with Turkey through two state-owned banks, India’s UCO Bank and Turkey’s Halk Bankasi. China has indicated it may follow suit.

Escalation of tensions

Previous sanctions against Iran have actually created more opportunities for trade with China. As sanctions have driven away many international companies from the Iranian market, Chinese companies have capitalized on the opportunity to seize a larger market share. Over the past decade, the volume of bilateral trade between China and Iran has increased from US$2.5 billion in 2000 to US$29.3 billion in 2010. The newest set of sanctions will undoubtedly strengthen ties between the two countries even further, which could have potential long-term geopolitical ramifications irrespective of the government in power. Would such developments be reversible if regime change in Iran were to occur?

And how durable is the alliance between the Gulf States and the West? Most of Iran’s neighbors in the Gulf region are wary of its growing power, but would only grudgingly support military intervention. Qatar, for instance, is continually working towards improving relations with Tehran despite their differences – they are not interested in a further escalation of tensions, and understandably so, considering the close geographical proximity of the two countries.

Ironically, the sanctions may even serve to play a stabilizing role for the regime in Tehran and boost Ahmadinejad’s standing domestically. The regime lost a lot of credibility at home after the disputed 2009 presidential elections, so they will surely want to exude a position of strength now by not giving in to foreign demands on an issue that is viewed as a matter of national pride by both hardliners as well as reformists alike.

What is more, the escalating tensions between Shiite-dominated Iran and the West could have an impact on other Middle Eastern states with significant Shiite populations like Syria, Bahrain, and Iraq, who may sympathize with Iran’s predicament and take up its cause, leading to further radicalization in the region.

Especially Italy, Spain, and Greece will be hard hit by the sanctions. They account for over 70% of the EU's imports from Iran (photo: Adek Berry/AFP/Getty)
Let it be clear that there can be no illusions regarding the malevolent nature of the ruling theocracy in Tehran. The recent case of a German reporter who was beaten by guards during his five-month imprisonment in Iran and his account of the “horrible screams” emanating from a neighboring prison cell is yet another stark reminder of that.

However, the sanctions that have been undertaken must target the regime specifically and not the states imposing them. Ultimately, the arguments for the new sanctions are not convincing enough and are more an expression of helplessness rather than resolve. There is no indication that they will force Iran to bend this time around, rather the opposite is more likely. Instead, A NATO policy that was employed during the Cold War to ease East-West tensions could prove to be similarly effective in solving the current impasse between the West and Iran, although it must be said that the two cases cannot be compared one-to-one.

New incentives

The Harmel Doctrine of 1967, which was contained in the report “Future Tasks of the Alliance” drafted by then Belgian Foreign Minister Pierre Harmel and submitted to NATO, advocated a strong national defense, a firm stance against military build-up as well as good diplomatic relations with the countries of the Warsaw Pact. The NATO council of ministers decided to adopt the doctrine, which eventually helped to pave the way for the East-West détente of the early 1970s and led to the Helsinki Accords of 1975. The Accords marked the beginning of significant improvements in relations between the Soviet bloc and the West and brought human rights to the forefront of the East-West agenda.

A similar policy of containment and détente is needed in the case of Iran. While the dangers and malicious character of the ruling regime should not be watered down and open criticism of the gross violation of human rights in Iran must be resolutely maintained, stronger economic cooperation, like for instance the “gas for pipes” deal in 1970 between Germany and Russia, should be pursued. Such a strategy would by no means serve to appease the regime but, rather, help to contribute to a growing and self-confident middle-class in Iran, which is the ultimate long-term driver of regime change. A policy of isolating Iran will only lead to one thing – the weakening of the Iranian middle class, which constitutes one of the strongest and most vocal segments of the opposition within the country.

It is true that Iran has rejected previous political and economic incentive packages from the West, China, and Russia in exchange for the suspension of uranium enrichment, most recently in 2008. Nevertheless, it is necessary to offer new incentives recurrently, especially now in light of the possibility of a military escalation.

One of the most enticing, and mutually beneficial, incentives the West could offer Iran is improved cooperation in regard to energy. Iran’s proven oil reserves of approximately 137 billion barrels (about 10% of the world’s total oil reserves) and current production rate of some 4 mb/d imply a reserves-to-

The arguments for the new sanctions are not convincing enough and are more an expression of helplessness rather than resolve
production ratio of over 85 years, which indicates good prospects for production growth. Moreover, there is plenty of capacity to increase production as evidenced by the rate of new, large discoveries that have been made over the last 15 years, for instance in Azadegan, Hosseineh, and Kushk - all situated in the Zagros Basin, one of the main producing regions in the southwest of the country. This suggests that there is considerable potential for additional finds there, as well as in other less-explored parts of the country including the Main Central Basin, offshore in the Persian Gulf, and to the north in the Caspian Sea.

However, the country’s energy sector is plagued by massive problems, largely as a result of international sanctions. Currently, Iran’s oil fields have a relatively high decline rate of over 7 percent per year and low recovery rates of only about 20-30 percent. In addition, its main producing fields are well past peak production and in decline, resulting in a loss of about 400,000-700,000 bbl/d of crude production annually according to the EIA.

Moreover, most of the production increase since the 1990’s in Iran can be attributed to foreign investments including Sirri A & E (Total), Soroush-Nowruz (Shell, 150kb/d), South Pars 2&3 (Total, 112kb/d), South Pars 4&5 (Eni, 112kb/d), Darquain (Eni, 110kb/d), and Doroud (Eni, Total, 150kb/d). Without the participation of international oil companies (IOCs), Iran’s oil production would most likely have stagnated or even decreased from the 1990s on. Since then, few contracts have been signed between IOCs and Iran as a result of the sanctions; there are currently only a small number of upstream projects in development while ongoing projects have been hampered by a lack of foreign investments, technology and expertise. (See Energy Information Administration, Iran Country Analysis)

Buyback contracts

The country’s gas sector also has considerable potential for growth, especially in regard to LNG, but faces similar impediments like the oil sector due to the sanctions. The massive offshore South Pars field, which Iran shares with Qatar, has approximately 870 trillion cubic feet of largely untapped reserves, making it largest single gas field in the world. Whereas Qatar has utilized its share of the field (known as the North Field in Qatar) to become the world’s largest LNG exporter, Iran’s progress to date can only be termed modest at best. Its four LNG projects including Pars LNG, Persian LNG, NIOC LNG, and its 2006 MOU between NIOC and CNOOC to develop an LNG facility are still in the developmental stages and continued progress is highly uncertain.

Ultimately, real and significant developments in Iran’s energy sector can only be made possible by the availability of substantial foreign investments and the participation of IOCs which have the necessary technological expertise to exploit new and untapped reserves situated in geologically challenging terrain, maximize production levels, and enhance efficiency.

Improving energy cooperation will not only bode well for Iran’s energy sector in terms of increased

Without the participation of international oil companies (IOCs), Iran's oil production would most likely have stagnated or even decreased from the 1990s on
growth and production, but it also offers the West and the international community significant benefits such as new business opportunities and increased oil and gas supplies, which could serve to ease global demand and put downward pressure on prices. Hence, it is vital that the vast resource potential and the fruits that mutual energy cooperation can bear be both recognized by the West as well as clearly communicated to Iran.

Even if access to Iran’s energy sector would still remain relatively restricted to IOCs due to an investment regime based on buyback contracts and stipulations in its constitution, the temptation to re-vamp and modernize its oil and gas production facilities may persuade Tehran to make alternative concessions such as opening up other sectors of its economy. This would serve the same purpose of facilitating freer trade, a greater exchange of goods and services, and, inevitably, an increase in the flow of information which would ultimately help to strengthen the middle class.

The current sanctions strategy, on the other hand, is a prelude to a further escalation of the conflict, which could eventually lead to military action or even outright war - to the detriment of both sides. Given the volatile situation throughout the Middle East and North Africa, one can only hope that responsible statesmanship tries as much as possible to avert such a scenario.

 

About the author

Friedbert Pflüger is Professor and Director of the European Centre for Energy and Resource Security (EUCERS) at King's College London. He served for twenty years as a Member of Parliament and was State Secretary in the first Merkel government.