Iran Sanctions Redux

August 10, 2018 12:30 PM
Photo Credit: 
REUTERS/Mushtaq Muhammed

President Donald Trump’s withdrawal in May from the Iran nuclear deal, a central promise of his 2016 presidential campaign, has already worsened Iran’s economic turmoil, even though the first set of US sanctions was reimposed only this month. But the real test of the administration’s efforts to pressure Iran will come on November 5, when the drive to get the European Union, China, and India to reduce oil purchases from Iran takes effect. It is far from clear to what extent these countries can and will go along.

Trump’s anti-Iran campaign so far has led several multinational companies to cut back ties with Iran. For example, Boeing and Airbus have canceled large-scale Iranian airplane orders. Total, the French oil and gas company, plans to withdraw from the development of the South Pars offshore gas field. Maersk has said it would decline Iranian cargo. Siemens has backed away from new business with Iran. And Peugeot has suspended its joint venture to produce cars in Iran.

By reimposing sanctions, the Trump administration seeks to force Iran to renegotiate the nuclear deal—known as the Joint Comprehensive Plan of Action (JCPOA)—to impose new constraints on the Iranian military and compel Iran to forego its nuclear program.[1] In addition, US officials want to squeeze Iran’s revenues to force it to stop its missile development, participation in conflicts in Syria and Yemen, and support for international terrorism.

But to succeed, US policy requires Iran’s major customers—Europe, China, and India—to cooperate by sharply reducing oil imports from Iran. Getting their help would be challenging under normal circumstances but even more so now with the White House threatening a major trade war with China and Europe.

Renewed sanctions hit Iran at a vulnerable time. Pervasive economic mismanagement, coupled with holdover sanctions barring direct US trade with Iran and inhibiting growth of foreign trade and investment in Iran, has weakened the Iranian economy, caused the rial to plummet in currency markets, and spurred an outflow of funds from Iran. The economic turmoil has ignited nationwide protests, creating a political crisis for President Hassan Rouhani, who staked his reputation in 2015 by agreeing to the Iran nuclear deal, in which Tehran said it would curtail Iran’s nuclear capabilities in return for sanctions being lifted by a coalition of world powers organized by Washington.

The first set of US sanctions, which took effect on August 7, block significant trade and financial transactions in Iran. The second set, covering Iran’s energy sector, will kick in on November 5 and seek to block Iran’s major source of income.

When enforced, the second round of sanctions will have a more pervasive impact than those already implemented. Iran’s energy exports were worth an estimated $64 billion in Iran’s fiscal year ending March 20. Oil and gas accounted for almost two-thirds of Iranian exports in the most recent fiscal year.

In the first half of 2018, Iran was exporting around 2.4 million to 2.6 million barrels per day of crude oil. In the second quarter of 2018, the European Union, China, and India—Iran’s major customers and targets of impending US sanctions—imported about 2.1 million barrels per day from Iran, according to Paris-based shipping-data tracker Kpler.[2] Cutting off those purchases entirely seems unlikely, given these countries’ dependence on Iranian energy. But the administration’s effort may succeed in cutting them in half, which would still put a big dent in Iranian revenues.

Will the European Union, China, and India cooperate with the US oil sanctions?

To date, Trump’s trade war clearly has hurt US efforts to convince other countries to embargo oil from Iran. The European Union cut off purchases from Iran five years ago but is reluctant to do so again, fearing that Iran will renounce the nuclear deal if its oil exports are blocked. In addition, the Trump administration’s tariffs against European steel, and its threats to hit EU trade in autos and parts, have put a heavy cloud over US-EU relations, making it difficult to get EU countries to coordinate actions with the United States against Iran. The recent Trump-Juncker accord temporarily deferred a looming US-EU auto crisis but did not yield EU cooperation on US policy toward Iran.

US efforts to persuade China to follow suit suffer the same problems, only more so since Trump already has targeted $50 billion of Chinese exports to the United States and threatened to impose tariffs on another $200 billion of Chinese products. Chinese officials reportedly have refused to cut Iranian imports.

As for India—also a target of US steel tariffs—Prime Minister Narendra Modi’s government has quietly increased its purchases from Iran in recent months. India could still agree to reduce its purchases from its currently inflated base, and there are indications that a US-India deal is brewing that encompasses sanctions and defense cooperation. But India is unlikely to cut back Iranian imports sharply from historic levels.

Perhaps because of these challenges, oil markets and Western financial markets remain buoyant. Market participants don’t expect the United States to hit European and Asian countries with major new sanctions if they don’t cut off Iranian oil, so markets must anticipate some compromise that results in reduced purchases of Iranian oil in return for waivers or exemptions from US secondary sanctions.

Such expectations are not unreasonable and seem to forecast a reduction in Iran’s oil exports comparable to 2015 (800,000 to 1.3 million barrels per day) that led Iran’s leaders to accept the JCPOA. But at that time, global oil markets were soft and prices low. Today, the price of Brent crude is up 50 percent from a year ago (2018Q2/2017Q2). US officials would do well just to match the results of the previous sanctions episode in 2015.

In what could be interpreted as a softening of demands from Washington, Trump and State Department officials initially called for an embargo on Iranian oil with no exceptions, potentially removing more than 2 million barrels per day from world markets. In the president’s Executive Order of August 6 authorizing the latest sanctions, the policy reverts to the Obama era goal of getting Iran’s customers to reduce their purchases significantly in return for periodic waivers from US sanctions.

Assuming the new sanctions reduce Iran’s oil exports by about 1 million barrels per day, then additional production by Saudi Arabia and drawdowns from reserves could offset in the near term both the sanctions’ impact and the current production outages/disruptions in Venezuela and elsewhere and prevent a sharp spike in oil prices. However, this would exhaust most of the spare capacity in major producing nations and increase vulnerability to potential, unforeseen supply disruptions.

Compounding this risk, one significant and forecasted development is already likely to further destabilize markets and increase crude and product prices. The International Maritime Organization (IMO) has issued regulations—which will take effect in 2020—requiring marine fuels to meet a low-sulfur standard of 0.5 percent. Marine fuel accounts for about 6 percent of global demand for petroleum products, and about 3 million barrels per day would have to switch from high- to low-sulfur fuels. Refineries are not well equipped to meet this demand, and prices of both crude oil and distillates could well go up. In its latest oil market report, the International Energy Agency conservatively projects the price of low-sulfur diesel to increase by 30 percent due to the IMO regulation.

US policy seems unprepared for such contingencies. Given current oil market conditions, US policymakers need to better guard against the risk that their sanctions squeeze on Iran could precipitate a new oil shock.

Notes

1. Under the JCPOA, the United States maintained its “primary” sanctions blocking almost all direct US-Iran trade and investment. However, licenses were granted to allow the importation of Iranian-origin carpets and foodstuffs and the export to Iran of US-origin civil aircraft and parts and to provide servicing of that equipment. The US Treasury also issued licenses to provide foreign firms relief from “secondary” US sanctions, allowing them to engage in financial transactions pursuant to trade and investment with Iranian entities that were not on the list of Specially Designated Nationals (SDN) subject to sanctions. Hundreds of individuals and entities were taken off the SDN list, including the National Iranian Oil Company and other energy companies and banks (though not those listed for terrorist financing).

On August 7, 2018, after an initial 90-day period giving time for companies to settle existing contracts or divest Iranian holdings, the first set of US sanctions was reimposed. These sanctions largely affect foreign firms that trade and invest in Iran and do business with US financial institutions, and foreign entities “owned or controlled” by a US person that have been doing business with Iran. They also revoke post-JCPOA licenses allowing trade in carpets, foodstuffs, and civil aircraft. The policy authorizes sanctions against persons who engage in or support:

  • the purchase or acquisition of US dollar banknotes by the Government of Iran;
  • Iran’s trade in gold or precious metals;
  • transactions involving graphite, raw or semi-finished metals such as steel and aluminum, coal, and software for integrating industrial processes;
  • “significant transactions” in Iranian rials or accounts outside of Iran denominated in rials;
  • purchase, subscription to, or facilitation of the issuance of Iranian sovereign debt; and
  • trade and investment in Iran’s automotive sector (though not the export of finished vehicles to Iran).

On November 5, 2018, the second set of US sanctions will enter into force, barring the purchase, acquisition, sale, transportation, or marketing of petroleum and petroleum products and petrochemical products from Iran.  The measures authorize sanctions against persons who provide material support, or goods or services, to the National Iranian Oil Company, the Naftiran Intertrade Company, the Central Bank of Iran, or those on the SDN list and those part of Iran’s energy, shipping, and shipbuilding sectors (including port operators).

2. See “Oil Buyers Weigh Response to Curbs,” Wall Street Journal, August 7, 2018.

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