Iranian Endgame: Part I — Sanctions and Asia

Iran is back — and with a vengeance. Despite all the excitement of the Arab Awakening, the structural realities of Iranian nuclear ambitions were never going to go away. It’s not crunch time yet, but regional and external policy makers in the Middle East need to pose a very serious and very fundamental policy question: Are they ultimately happy to live with a nuclear armed Iran or not?

How that question is answered will have massive implications for global energy supplies, Middle East (in)stability, global economics and global politics writ large over the next few years. Yet the most important short-term answers will not come from the West. Rather, it will be determined by how emerging nations in Asia interact with long-established Gulf States. This is where the most telling hydrocarbon pressures will arise to force Tehran to capitulate (or not) to Western demands.

Gradations do, of course, come into the equation. But the working assumption, without compelling evidence to the contrary, is that Iran is rational (and some would argue sensible) to try and develop nuclear weapons beyond civilian power capabilities. Unsavory regimes without nuclear arsenals haven’t exactly come out well of late — think Saddam for one, Ghaddafi for two.

Compare that to the benevolent benefits North Korea’s “Great Leader” Kim Jong Il wangled out of international leaders. Nukes work — at least as far as political testosterone and security protection is concerned. Iran firmly buys into this logic not as a political point, but as a veritable “article of faith” on the Persian street.

The real question is therefore under what timeframe and what conditions Iran wants to reach its nuclear end goal. If Tehran wants to gain the strongest possible hand from its nuclear posturing, a slow boat to nuclear capabilities is the most likely approach.

Get the timing right, balancing ambition with long-term credibility, and Iran could potentially gain far greater political concessions from external powers compared to a dash-for nukes-strategy. Sporadic (i.e., carefully timed) IAEA inspections will be put into the mix as a sign of “good will” and “good intent” along the way.

What makes the timing issue more fraught is the saber rattling on all sides of the fence. This is where the greatest scope for miscalculation and escalation rests. Any rash moves towards a nuclear fast track from Iran could result in radical responses from Washington — and indeed those considerably closer to Tehran.

Israel is making things increasingly clear that it won’t let the nuclear clock tick down to zero without taking assertive action — a move many Republican presidential hopefuls are more than happy to echo. Whether Washington can control Israel (or even wants to) is an open question.

But should things get that far, sparks will obviously fly. The list of downside risks for regional instability and the global economy are as long as they would be cataclysmic. Western policy makers need to be remarkably careful to differentiate long-term Iranian intentions from short-term bluster to avoid making a bad situation exponentially worse.

Iran’s theocratic regime is just as vulnerable as its monarchical Gulf neighbors and Arab nationalist republics to populist political pressures. External threats inevitably translate into domestic political capital for Iranian political elites to cash in.

If actions are to be taken by the West, they must at least be effective to have any strategic merit to avoid becoming outright counterproductive. Getting dragged into games of Persian political chicken without a serious strategy will merely result in the West laying an egg for Iran’s Supreme Leader to hatch at times of “theocratic choosing.” Relatively feeble Western pressures will be used for political gain in the March parliamentary elections, not to mention the presidential elections in June 2013.

The unfortunate upshot is that we are currently on a path of escalation dressed up as nuclear containment, albeit without any serious economic bite. That’s a shame, precisely because oil is the only credible key to brokering some kind of agreement that all sides can live with without resorting to doomsday scenarios.

The trouble with sanctions

Iran needs oil exports for 80% of its hard currency and 65% of government revenues. Assuming the West wants to apply serious hydrocarbon pressures as its policy option of choice, it’s going to have to play a far smarter game. Forget Iran, forget Israel and focus on Saudi Arabia and China. Sounds odd at first, but this is where hydrocarbon fundamentals point towards if the Iranian nuclear clock is to be synchronized with international expectations.

So far, the debate over Western sanctions has merely elevated Iran’s underlying hedge (nuclear enrichment vs. oil price spikes) to unmerited attention. For all the headlines about Iran’s threats to block the Strait of Hormuz in retaliation against the West’s embargoes, those threats are no more credible than any prospective U.S.-EU sanctions will prove to be effective.

Iran would only ever use the Hormuz option as a last-ditch attempt to hold onto power or to stop a potential invasion. How long such a blockage could last, or how effective it would be, totally misses the point. This is about inelastic consumption versus price hikes scuppering the global economy, not how many vessels and mines Iran can muster.

More than a third of all seaborne oil trade is what’s at stake. No matter how much Riyadh talks up its East-West export line, or how realistic are UAE options to ship directly to the Indian Ocean, Tehran can hold the global economy at ransom via the Strait.

The beauty for Iran is that it doesn’t have to make good on its Hormuz threats anytime soon. On the other hand, the United States and the EU assuredly have to make energy sanctions stick if their credibility is to be maintained.

This presents three major problems. The first (and most politically trivial) is the black market. No sooner had the EU enacted sanctions in January than smuggling routes for Iranian crude were being mapped out in Iraq, Turkey, Egypt and the Urals. Smugglers and middleman love sanctions — because money can be made. Iran will be no exception.

The second is more serious, and it relates to how well sanctions will stick. U.S. sanctions are clearly going to give the Iranian Central Bank a rough ride as the clearinghouse for Iranian oil payments. Many Iranian traders are already jumping ship to other currencies or gold.

But the small print still allows President Obama to grant waivers to countries that can show that they are taking steps to “wean themselves of Iranian oil.” Whether the likes of Japan (which buys 350,000 barrels of Iranian crude per day) and South Korea (230,000 barrels) will actually reduce their purchases remains to be seen. It seems likely that Tokyo and Seoul will still be in the market for Iranian oil by June — at least to some degree.

That’s bad — but Europe looks considerably worse. Europe uses 500,000 barrels per day (bpd) of Iranian crude, the bulk of which go to Italy (180,000 bpd), Spain (154,000 bpd) and Greece (110,000 bpd). The last thing these economies need right now is more expensive oil.

Iran knows this, so much so that it’s likely to launch a preemptive boycott on the likes of Greece (which sources Iranian crude via open credit) long before European sanctions take effect. And don’t expect Portugal, Italy, Greece or Spain to play by Brussels’ rules on this, either. Turkey, too, will take its own line, balancing private-sector interests against governmental instincts.

If Western nations don’t stand together on sanctions, the chance of compelling China and India to embargo Iranian oil is, of course, close to zero. And this points to the far larger problem here: Asia isn’t on board. Glib assumptions that India would cut its 400,000 bpd of Iranian supplies as a result of U.S. pressures have failed. Delhi is playing the “Chindia” game, following China’s lead to source Iranian supplies to bulk up its strategic reserves.

It’s true, both nations have been haggling for major Iranian discounts via Unipec and Zhuhai Zhenrong (China) and ONGC and Essar (India), so much so that Iran has rebalanced its budget to price expectations for oil at $85 a barrel. But the key point is that Iran can still shift 2.5 million bpd of production towards Asian markets to stay in the black.

In this context, Western sanctions can only ever have a limited bite.

Editor’s note: Part II of this article can be found here.

The views and opinions expressed in this article are solely the author’s and do not necessarily reflect the views of the Clingendael International Energy Programme or its staff.