The Iranian Question: Stand Up or Step Out

It's time to face reality: Western sanctions are highly unlikely to force a nuclear rethink in Iran without getting Asian consumers on-board to tighten economic screws, and doing so at Gulf State behest. Everyone is transfixed with Western policy hype rather than Asian realities as to how an effective sanctions policy could work in practice. Without a fundamental shift towards internationally aligned pressure, we are merely looking at a policy of escalation dressed up as nuclear containment. Given inherent risks involved, it's time to globally step up, or step out…

Few analysts doubt that Iran is working towards nuclear weapons capability (source: politicsandfinance.blogspot)

Few analysts doubt that Iran is working towards nuclear weapons capability, the real question is under what timeframe and what conditions they hope to do so. Latest Western policy responses' (leaving Israeli bombast and Republican chatter aside) has been to go for energy sanctions to bring Iran to yield. Considering Tehran relies on oil exports for 80% of hard currency and 65% government revenues, that's a smart idea. Sadly, the execution looks lousy.

If we want to play the pressure game, actions must actually work to have any strategic merit and avoid becoming outright counterproductive. Any external threats the West sends Tehran’s way will be converted into domestic political capital. Think on-going sabre rattling over the Strait of Hormuz, Parliamentary elections in March 2012, let alone Presidential elections in June 2013. This is where poorly aligned sanctions have placed us: on a sticky Persian wicket.

Take US sanctions for starters. Despite the rough ride Washington will give the Iranian Central Bank as the clearinghouse for Iranian oil payments, President Obama still has wiggle room to grant waivers to states trying to 'wean' themselves of Iranian oil. That means Japan (350,000b/d) off-take, and South Korea (230,000b/d) will still be in the offing for Iranian crude by June 2012.

Europe looks far (far) worse. The black market is one factor. Middle men will ply Iraqi, Egyptian, Turkish and Russian routes for all they are worth. But the bigger problem is of the 500,000b/d of Iranian crude being cut, the bulk of supplies go to economically beleaguered Southern European states: Italy 180,000b/d, Spain 154,000b/d and Greece 110,000b/d. The last thing any of the ‘PIGS’ need is more expensive oil. Tehran knows this, so much so it’s even talking up its own pre-emptive boycott ahead of the July 2012 deadline. Don’t expect PIGS to play by Brussels rules on this, any more than Turkey will steer its own independent course.

If Europe can’t make its own sanctions stick, you can forget ever getting Asian consumers to sign up to sanctions. A point which highlights the three tonne elephant in the room; Asia simply isn't on-board. Despite glib assumptions that Indian would cut its 400,000b/d of Iranian imports by signing from US hymn sheets, the blunt reality is that Delhi is following China’s 550,000b/d Persian lead, preaching from a ‘Chindia’ gospel to source Iranian supplies. Sure, both nations have taken their chance to drive down Persian prices, so much so that Iran has already recalibrated its budget to $85/d breakeven price. But as long as major Asian consumers remain in the offing for Iranian oil, Tehran can remain economically viable to shift 2.5mb/d onto global markets. Western sanctions alone aren’t going to shift the nuclear needle.

Flip the signals

It’s therefore surprising that Saudi Arabia has been patting itself on the back by positioning themselves to cover any Persian supply gaps. Saudi messaging (with IEA subscript) has helped to moderate benchmark prices, and indeed, taken the string of Iranian Strait of Hormuz tails. Yet this slow squeeze strategy to moderate oil prices and let Western economic ‘pressures’ play out, is merely counting down the nuclear the clock in Tehran. This is ‘business as usual’ 101.

The real power play for the Saudi’s is therefore not feeding global oil markets to keep things on an even keel, but the exact opposite. If the Saudi’s flipped price signals on their head by withholding, or at least threatening to without oil supplies from markets, global attention would rapidly shift to Iran as fast as oil prices headed north. Not just in Washington and London - but more importantly - Delhi and Beijing. Prospective Saudi oil ‘embargoes’ would be more than enough to grab Beijing’s attention compared to current policy malaise in play.

At the end of the day, China’s key supply relationship in the Middle East is heavily anchored in Gulf States. Out of China’s 5.5mb/d or so of imports in 2011, 2.3mb/d were sourced from Saudi Arabia, Iraq, the UAE and Kuwait, with Iran only accounting for 550,000b/d of supplies. China knows that Arab output

At the end of the day, China's key supply relationship in the Middle East is heavily anchored in Gulf States
will always trump Persian production. ‘Chirabia’ rather than ‘Chiran’ is the key relationship Beijing needs to get right. If China’s core suppliers in the Gulf call time on Iranian nuclear ambitions, expect Beijing (and thus India) to comply accordingly, either to exert serious diplomatic pressure on Iran to change course, or sever all oil ties. Political pieces would then be sufficiently in place to push for UN sanctions if still needed: even the notoriously stubborn Russian veto might falter once the Kremlin saw which way the wind was blowing.

High Saudi Stakes

Sounds easy enough, but getting China to tighten the Iranian noose via Saudi rope would raise the geopolitical stakes, and massively so. Especially for Saudi Arabia: Riyadh is well aware that in extremis, Iranian threats to close the Strait of Hormuz (partial or total) hold good. That’s not as a long term military ploy, but by using inelastic consumption vs. price spikes to blow the global economy to smithereens. It also knows Iranian missiles could reach Abqaiq refining plants (i.e. 5-6m/d of Saudi production) and perhaps more importantly, slow burn options to stir Shia schisms in Bahrain, Syria, Lebanon, Iraq, and Saudi Arabia at times of Tehran’s choosing.

Such considerations will weigh heavily on Saudi minds before the oil weapon is primed, but in the final analysis, they arguably remain secondary security concerns compared to an Iranian nuclear capability. It’s this primary fear (rather than external posturing) that the West should focus on to prompt movement in Riyadh. But in doing so, we should be in little doubt that once Iran can no longer rely on Asian consumers for oil receipts due to Saudi price pressures, the sparks mentioned above could easily fly.

This is the gauntlet of orchestrating a serious sanctions policy: if it works, things could rapidly escalate and degenerate into war if Iran lashes out. Conversely Iran could decide to dig in deep and sweat things out. Eventual pressures of sustained higher oil pressures could force a major climb down across consumer states. Not only would consumers be defeated by their own ‘embargo’, Iran could claim a political victory, picking up its nuclear pieces. Little progress would be made; even if power changed hands amid the carnage, Tehran’s nuclear line would remain largely the same. Regime change is not at the root of the problem, or indeed the solution.

Risk reward ratios?

But if this spells out the downside risks; what’s the upside potential of serious sanctions? Ideally Iran would change tack, deciding that the economic and political costs of nuclear weaponisation are too high. That’s obviously a long shot, but it could at least provide a window of opportunity to use economic

The bottom line is clear: any sanctions policy confined to Western pressures is not going to stop the nuclear clock
pressures to open diplomatic channels with Iran towards a negotiated position that all sides could live with. That would entail close controls and inspections of what Iran could do in the nuclear field – albeit without pitching this as a political climb down or humiliation for Tehran. Tightly worded assurances over non-intervention might help, as would putting Beijing at the forefront of negotiations for aesthetic purposes. Formal membership of the SCO could be a useful chip to pull Tehran back into the fold as a ‘diplomatic deliverable’.

Hopelessly naïve some might say? But the costs of not going down the sanctions road are also quite high for China. The further Iran inches towards it nuclear end game, the far more likely it becomes one of the players involved will make a rash move. The list of problems this presents for regional instability and the global economy are as long as they would be cataclysmic. Translate that into security terms, Beijing has to become a credible provider, not consummate consumer of geopolitical stability if it wants energy supplies to consistently pan out. A brutal choice between Saudi and Iranian production could be the pièce de résistance case study to focus Chinese minds should Beijing fails to wield any serious nuclear influence with Tehran.

Hence the bottom line is clear: any sanctions policy confined to Western pressures is not going to stop the nuclear clock. Either we pick our game and force Riyadh to pull Asia into the sanctions game, or we need to fundamentally reconsider whether living with a nuclear Iran - unpalatable as it is - remains a better option than trying to preventing the ‘inevitable’? Given the ‘transitional’ enrichment risks involved, we’re rapidly nearing the time when we either have to step up, or step out of Iran.