Oil Sanctions In Store for Iran?

Would they make any difference?

Iran's economy runs on oil. On paper, at least, Iran would appear to be highly vulnerable to sanctions targeted at its oil export business.

Iran is the second largest oil producer in the Organization of Petroleum Exporting Countries ("OPEC"), and the fourth largest crude oil exporter. Iran has a 2.2 million barrel-a-day export business. It earned $56 billion in the first seven months of 2011, according to U.S. Energy Department estimates.

According to the Heritage Foundation, Iran's oil export revenues provide about 85 percent of its government finance. Thus, aiming economic sanctions directly at Iran's oil exports could land a serious blow to the Iranian regime's sources of funding for its nuclear enrichment and missile programs.

The question is whether such sanctions are likely to be broad-based enough in terms of participants and happen in time to have the desired impact of crippling Iran's nuclear ambitions, without causing a massive blowback to the global economy.

Nothing meaningful can be expected from the UN Security Council, where Russia and China will veto any further ramp up in sanctions beyond the four ineffective rounds of sanctions against Iran approved by the Security Council between 2006 and 2010. Thus, only bilateral and regional sanctions are possible.

U.S. sanctions already prohibit virtually all trade with Iran, except for limited activities "intended to benefit the Iranian people" such as humanitarian aid. The U.S. has just recently expanded its sanctions to include companies that help Iran's oil and petrochemical industries.  However, this will have only indirect effects, assuming that Iran does not find ways to evade the sanctions as it has done before. Since the United States imports no oil from Iran, and has not done so for some time, future American oil purchase decisions will have no direct market effect on Iran's oil revenues.

The main leverage that the U.S. has is a blunt financial instrument - a cut-off of any firms doing business with Iran's central bank. Iran conducts its vast oil export business through its central bank, linking its national oil company with its oil customers. If the United States were to follow Britain's example and take steps to isolate Iran's central bank from the global financial markets by imposing sanctions on any company or government that deals with the central bank, Iran's ability to get paid for its oil would be severely hampered. So far, however, the Obama administration has not gone that far because it fears disruptions to the global oil market, causing prices to spike at a time when the global economy is already sputtering.

Assuming the Obama administration continues to dither on cutting off Iran's central bank, the only way to hurt Iran's oil trade short of military action is through the decisions of Iran's major oil customers to look elsewhere for oil.

Don't hold your breath waiting for any bold decisions to cut off current purchases of Iranian oil, however. So far, it's virtually all talk and no action.

The European Union governments agreed on December 1st to examine sanctions against Iran's energy sector. However, no decision is likely until sometime in January.

According to Reuters, EU members take 450,000 barrels per day of Iranian oil, which accounts for about 18 percent of Iran's exports.

"We need a common position of all European Union member states," Energy Commissioner Guenther Oettinger told Reuters when asked about a possible ban.

France, Britain, and Germany are among the EU countries that are reported to be favorably disposed to the idea of a ban. However, other EU members are balking, including - no surprise - Italy and Greece. Italy, in fact, was the largest oil importer from Iran in Europe last year, purchasing 10 percent of Iran's exports. Perhaps Italy's dependence on Iranian oil will decrease once Libyan oil comes back on line, but Italy's economy is too fragile at the present time to risk losing any important source of energy.

Let's face it. Europe has its hands full. The European Union is trying these days to move towards more integration on a host of issues, not the least of which is solving its present economic mess. Considering the precarious economic state the members of the European Union are grappling with these days, many EU members facing domestic pressures at home are not likely to make a concerted decision to cut off oil purchases from Iran that may well cause them more economic pain in the short run than it will Iran.

Most of Iran's oil exports go to Asia. Two-thirds of its oil exports are shipped to China, India, Japan and South Korea. Without their full participation in banning purchases of oil from Iran, oil sanctions will not mean very much. And China will likely increase its purchases in the face of any sanctions imposed by other countries, counteracting any effect on Iran such sanctions might have had.

Indeed, China alone accounted for 22 percent of Iran's export volumes during the first half of this year, Bloomberg reports. That figure is larger than the entire EU's share of Iran's oil exports and will likely increase if European or other countries cut back on their purchases. China will not only be motivated to increase its imports from Iran for political reasons, in an effort to counter the West and move closer to Iran. According to Robert McNally, president of the Rapidan Group, a Washington-based energy analysis firm, China and other Asian countries will benefit from the discounts that Iran is expected to offer. Lower prices can be expected to result in a higher volume of purchases.

"The Iranians would have to accept a lower price for their crudes, because they'd have to dump it into Asia. They would have to compete more aggressively to sell what they would be selling in Europe elsewhere," said McNally.

Mark Dubowitz, executive director of the Foundation for the Defense of Democracies, a national security think tank, said their modeling "shows that if only China was purchasing Iranian oil, they would be able to drive for discounts of about 39 percent on every barrel of Iranian oil."

Iran's revenue stream would most likely go down in such circumstances, but not to any catastrophic degree. Meanwhile, China would receive a huge windfall that would further advance its competitive position.

Japan and India have accounted for the purchases of 14 percent and 13 percent of Iran’s oil respectively.

Japan signed a contract with the National Iranian Oil Company for the purchase of oil through at least 2012. It is unlikely to participate in an outright ban on the purchase of oil from Iran.

“Iran represents roughly 10% of Japan's crude imports,” said a spokesperson for Japan’s Ministry of Foreign Affairs recently. “We need to be very careful in making such a decision, given that our priority is securing energy supply in the aftermath of the massive earthquake in last March,” he added.

India's central bank has taken steps already to cut the flow of oil money to Iran by blocking payments, although some Iranian crude oil is still finding its way to customers in India.

South Korea, the world's fifth largest crude oil importer, is not planning a ban on crude oil imports from Iran, but is considering a ban on Iranian petrochemical product imports, according to sources in Korea's economic ministry quoted by the Brunei Times.

In sum, oil sanctions alone are not likely to be effective because they will be a patchwork at best. And they may have the unintended consequence of helping China, which will probably end up paying less for Iranian oil because of discounts. Iran will suffer some economic consequences but not enough to offset the negative effect on the global oil market unless Saudi Arabia, and possibly Libya and Iraq, are able to quickly make up the difference. Then again, other oil-exporting countries, unfriendly to the United States, such as Venezuela and Russia, will very likely seek to profit from the purchase vacuum created by the sanctions.

The only real economic sanction that can bring the Iranian regime to its knees is to cut off its central bank from the world financial markets. Britain has shown the way. But President Obama has to lead closer to the front this time, not from behind.

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