Look East: The Weight of Oil Sanctions on Iran’s budget

20%. That’s the proportion of Iran’s oil exports to the European Union.

Iran's flags

If you’ve been hiding under a rock for the last 6 years, then you would probably not understand the extreme tension that surrounds Iran’s nuclear program. There is the media, different governments’ interests in play, different companies’, and various groups of influence acting. Behind that thick wall of smoke lies the effects the issue has on the Iranian economy. Ramping inflation, rising unemployment, fast-receding government revenues, and the oft-quoted oil dilemma for economic stability. The latest of these has been invoked multiple times as determinant – crucial. The oil industry makes up 60% of the government revenues and around 80% of Iran’s exports.

Certain voices, notably in conservative think-tanks, argue that an Iranian nuclear weapon is underway (Matthew Kroenig, John Bolton). The only tangible proof of what Iran is really doing is the latest IAEA report which cites item 50: “While the Agency continues to verify the non-diversion of declared nuclear material at the nuclear facilities and LOFs declared by Iran under its Safeguards Agreement, as Iran is not providing the necessary cooperation, including by not implementing its Additional Protocol, the Agency is unable to provide credible assurance about the absence of undeclared nuclear material and activities in Iran, and therefore to conclude that all nuclear material in Iran is in peaceful activities”[1]. Common sense would call for patience, especially when Kroenig names one of his latest articles “Time to Attack Iran” [2].

But let’s focus on the generally ignored side of the matter: how much weight does the oil factor have in pressuring Iran’s nuclear program?


A Booming Business, Slowed Down

In November 1995, Iran opened his energy sector to foreign investment, using buy-back agreements[3]. Increased demand from China in a relatively unoccupied reserve of oil and gas guaranteed that Iran’s oil and gas sectors would boom. China spent about $45 billion dollars in infrastructure in Iran since 1999, asserting its position as Iran’s primary trade partner and expanding Iranian oil and gas productions.

One important characteristic of Iran’s petroleum industry is that its expansion is fairly new. Since 2007, Iran produces a 2010 estimate of 144 million new barrels (for 2012). This figure has to be revised since sanctions have altered the course of some projects, but it is still significant if we would only account for China’s. Recent developments (see Katzman [8]) have prompted European and Asian investment to flow in a country where American FDI is illegal (see Iran Sanctions Act of 1996).

Rational Allies

American policy-makers failed to gather enough guarantee from Iran’s major trade partners to convene on a set of drastic measures, proving once more that our globalised world is increasingly multi-polar. More interestingly, China and India know that sanctions won’t be effective, and put bluntly, aren’t convinced by the dangerous nature of Iran’s nuclear program. India’s commerce secretary Rahul Khullar was even quoted as saying in February that India should “promote its own exports and investigate business opportunities created by the sanctions”.

Source: The Economist
Source: Reuters for Der Spiegel

Iran’s oil exports to India represent 14.6% of its total exports. Nearly two months after EU foreign ministers met in Brussels to implement sanctions, an 80-person Indian trade delegation was sent to Tehran to formulate an enhanced bilateral trade agreement. The goal of $25 billion in trade for 2015 (a $10 billion increase from the present $15 billion) was finally agreed upon [4]. The U.S.’ immediate response was calling for sanctions against India if it didn’t re-evaluate its agreement with Iran before July. It is expected to see India reluctant vis-à-vis of oil import cuts from Iran as discussions between the US and India go by, and little progress is made [5]. Indian Foreign Minister Syed Akbaruddin stepped in to declare that while restrictions imposed by individual countries “have an impact on commercial interactions, from a legal perspective, there is nothing that binds us to follow them.”[6]

As for Japan and South Korean, representing 15 and 11% respectively of  total exports, the two countries have repeatedly promised efforts to curb Iranian imports. However, the Energy Information Agency reported last month that the two countries have increased their oil imports in January.

With 18% of exports, Turkey has promised to also curb its imports of Iranian oil. Pressured by the United States, the Turkish government promised an objective of a 20% decrease by July.

China makes up about 24% of Iran’s oil exports, and that figure is expected to increase in the next two years. What we are witnessing here is not a debilitating slowdown of the Iranian oil production, rather a transition to an Asian-focused industry. China has found its local oil well, and is enjoying the advantages of talking to someone nobody wants to talk to. It is expected to soak the Iranian supply as demand for Saudi Arabian crude increases.

Among arguments for the effectiveness of sanctions last month were also talks about contracts and payments currently being processed for European energy companies after the Belgium-based institution SWIFT (Society for Worldwide Interbank Financial Telecommunication) blocked any transfer to Iranian banks[7]. Alternatives for Asian companies were rapidly implemented.


By the way, thanks for the investments

Iran’s oil sector has boomed in the last twenty years, triggered by foreign investment into infrastructure. The Khatami years from 1997 to 2005 planned reforming the mostly closed economy, by implementing an attractive economic space for FDIs. European companies invested extensively in Iran’s oil sector from 1999 to 2006, stepping ahead of American energy companies who were condemned to do any business with the Islamic Republic after the Iran Sanctions Act of 1996.

In the case of a lengthening of oil sanctions, Iran’s government and the NIOC (National Iranian Oil Company) could invoke contractual clauses to European petroleum and gas companies which have primarily invested in many oil/gas fields throughout Iran to transfer full ownership of certain fields. Middle East expert Kenneth Katzman listed in an October 2010 report to the U.S. Congress every oil infrastructure project installed post-1999 in Iran. Companies like Total (France), ENI (Italy), Royal Dutch Shell (Netherlands), Norsk Hydro (Norway), Statoil (Norway), GVA Consultants (Sweden), Repsol (Spain) and OMV (Austria) have spent an aggregated amount of up to $14.3 billion in various infrastructure projects [8]. This could be a lost investment if Iran were to cut off trade with European companies (or the reverse).


A supertanker


Nearly 95% of the world’s oil tankers are insured by the same group of insurers, the London-based International Group of P&I Clubs. In July, the EU group will no longer be authorised to insure tankers to and from Iranian ports. This gives times for Iran to find alternatives to supply its oil and gas.

China is already assisting Iran by giving away supertankers, and building some more for at least two years. To give some clearance, Iran’s fleet is already consisting of 39 ships with a capacity of 61.5 million barrels. Reuters estimates that 17 ships would be needed to maintain current supply while China guaranteed to supply Iran with 12 in the next two years [9].

Efforts from Asian companies have also been made to pressure their governments into authorising insurance from Asian banks. In last resort, Iran could eventually take care of the coverage of foreign tankers.

Additionally, if sanctions were to last, the Iran-Pakistan-India would prove useful for Iran’s logistics. Renouncing to US foreign aid in the construction of a gas plant on its soil, Pakistan signed with Iran in 2010 the agreement on the pipeline, and completion is estimated for 2013.

If the West were to look in the other direction, Iran can always find friends and money in the East.


The Policy

In the short term, the oil sanctions are likely to have an effect on budget revenues, but the proposed Iranian budget for March is aimed to offset oil dependence by cutting spending by 5.6% and increasing investment to foster growth by 20%. Also, while oil demand is decreasing in Iran, the price of oil generated by fears over the situation there, creates more revenue for the government (pretty ironic, isn’t it?). The new budget aims at resolving domestic economic issues for more stability [10].

In February, the EIA reported an estimate decrease of 1.6 million barrels per day exported out of the current 2.3 after the sanctions would be fully enforced. What the report couldn’t predict accurately was the fact that Iran is rapidly shifting their supply. Two months later, we have tangible proof that sanctions are increasingly being bypassed by Asian countries, which are already the main clients of Iran’s oil. Interestingly enough, there hasn’t been any threat of sanctions made to China, which represents a quarter of Iran’s oil exports.

Sanctions on the Iranian oil industry were expected to inflict a major blow to Iran’s budget. However, there is no evidence that sanctions will have a concrete effect on its long-term previsions, let alone its funding for the nuclear program. In the same way the European Union has to pay more for its energy, adding to the issues of economic slowdown, debt, unemployment, Iran will face smaller budget revenues, adding to its issues of unemployment, inflation, and poverty.



[1] Access the latest report report by the Director General of the IAEA at: http://www.iaea.org/Publications/Documents/Board/2012/gov2012-9.pdf

And more information about the Additional Protocol here: http://www.iaea.org/Publications/Factsheets/English/sg_overview.html

[2] Access Matthew Kroenig’s article published in Foreign Affairs at: http://www.foreignaffairs.com/articles/136917/matthew-kroenig/time-to-attack-iran.

And also, Colin Kahl’s response to Kroenig at: http://www.foreignaffairs.com/articles/137031/colin-h-kahl/not-time-to-attack-iran

[3] You can find more information on Iran’s buy-back agreements at: www.irantender.com/english/…/Buy%20Back%20In%20Iran.doc

[4] http://articles.economictimes.indiatimes.com/2012-03-12/news/31153405_1_bilateral-trade-iran-plan-tehran-times-report

[5] http://articles.timesofindia.indiatimes.com/2012-03-16/us/31201039_1_iranian-crude-oil-imports-iranian-oil

[6] http://www.businessweek.com/news/2012-03-14/u-dot-s-dot-may-sanction-india-over-level-of-iran-oil-imports

[7] http://www.huffingtonpost.com/2012/03/15/swift-iran-sanctions_n_1347361.html

[8] Kenneth Katzman lists international oil infrastructure projects in Iran, accessible via the Federation of American Students: http://www.fas.org/sgp/crs/mideast/RS20871.pdf

[9] http://rt.com/news/iran-tanker-fleet-sanctions-988/

[10] http://cnsnews.com/news/article/proposed-iran-budget-reduces-oil-dependence