Previous Reviews

Number 85 ● November 22, 2018

U.S. Sanctions Strategy Against Iranian Oil is an Upstream Battle

Micha'el Tanchum*

The United States President Donald Trump, from his brash yet successful presidential campaign to his unconventional foreignpolicy initiatives in office, has been consistently under-estimated by analysts and opponents alike. Now the naysayers against the effectiveness of President Trump's renewal of sanctions on Iran's petroleum industry may be facing a similar peril. While there is a growing consensus among those who believe the immediate impact on Iran's oil export revenues will be minimal, they seem to ignore the potentially crippling effect of sanctions in the longer term. The reason for this short-sighted view is a downstream focus on Iranian exports without significant attention given to Iran's upstream capability to sustain its oil and natural gas production.

On November 5, 2018, the United States re-imposed sanctions on Iran's oil exports, having withdrawn from the "IranDeal," formally known as the Joint Comprehensive Plan of Action (JCPOA), on May 8, 2018. The July 2015 JCPOA agreement between Iran and the P5 +1 nations (The five permanent members of the United Nations Security Council – the U.S., U.K., France, China, and Russia – plus Germany) provided for certain limitations on Iran's nuclear development program in exchange for the reduction of international sanctions.After a 180-day, wind-down periodending on November 4, 2018, the Trump administrationre-imposed sanctions that were liftedby the prior Obama administration pursuant to the JCPOA.

Sanctions were placed on Iran's petroleum industry, its shipping industry, as well as onfinancial transactions with Iran including underwriting, insurance, and reinsurance services critical to Iran's oil and natural gas exports.

However, scepticism about the impact of the renewed sanctions increased when the Trump administration concurrently granted waivers to eight countries, among them the largest importers of Iranian oil including China, India, South Korea, Japan, and Turkey. In 2017, these five countries purchased 70 percent of Iran's crude oil and condensate exports. China, a signatory to the JCPOA, constitutes almost one-quarter of Iran's petroleum export market. China and India combined purchased 42 percent of Iran's crude oil and condensate exports. Moreover, the European signatories to JCPOA and the European Union (EU) have declared that they will abide by the agreement as long as Iran continues to fulfil the JCPOA conditions.

The United States' European allies and particularly the EU have taken an adversarial position to the U.S. reversal of policy toward Iran. The EU has implemented its Blocking Statuteto provide compensation for EU firms affected by U.S. secondary sanctions. Additionally, the EU is attempting to implement a Special Purpose Vehicle (SPV) an alternative accounting mechanism outside the SWIFT system and in the EU's currency, the Euro, instead of the U.S. dollar. The SPV could render EU-Iran transactions unmonitorable by U.S. sanction enforcement. Saying that "Europe refuses to allow the U.S. to be the trade policeman of the world," France's Economic Minister Bruno Le Mairehas vowed that France will lead the effort to defy the U.S. sanctions and promote Euro-based commercial trade with Iran.

Beyond the rhetorical defiance of the EU, the actual extent to which EU-Iran trade will continue remains unclear. Major European companies in the energy, shipping, and insurance industries, among others, that began entering the Iranian market have announced the suspension of those activities.

Perhaps most counter-productive to U.S. efforts to reduce Iran's oil revenues in the short term is the market itself. Iran's loss of market share for oil exports due to sanctions will likely be offset by higher global oil prices, rendering Iran's immediate revenues little affected. In February 2018, the Brent spot price remained in the lower $60-range and then spike to almost $80 per barrel following the U.S. May withdrawal from the JCPOA. In October, the price reached $86 per barrel in the faceof collapsing Venezuelan production. The U.S. has worked assiduously with its Arab Gulf allies to increase production in order to drive down the price as well as pressuring the Baghdad and Erbil governments in Iraq into an agreement that would free up 200,000-400,000 barrels from the disputed area of Kirkuk to reach the global market.As a result, Brent crude dipped below $70 per barrel as of November 9, 2018. Yet, even oil prices in the $60-range will the help Tehran offset revenue loss from declining imports, as the Iranian government's current annual budget (calculated over the Iranian year from March 2018 to March 2019) is based on oil prices at $55 per barrel.

Although Iran 's the world's fifth largest oil producer, the large proportion of mature oil fields in Iran renders Iranian oil industry, as well as its natural gas industry, highly vulnerable to the impact of U.S sanctions. Iranian oil fields have relatively high decline rates (8-11 percent) and rela­tively low recovery rates (20-25 percent).Prior to the JCPOA, Iran hadnot brought a new oil field on stream since 2007. More than simply capital investment, Iran desperately needs current technologies for enhanced oil recovery (EOR) in its existing fields. Without modern EOR technologies, Iran is compelled to inject a significant proportion of its yearly natural gas production into the nation's mature oil fields in order to maintain its oil production. Prior to the JCPOA, Iran reinjected 12.4 percent of its gross gas production into oil wells to enhance recovery.

Considering Iran’s high rate of domestic petroleum consumption, the economic impor­tance of foreign earnings from its oil exports, and the stra­tegic importance of its position in East Asian oil markets, Iran will need to continue to improve its recovery rate, therefore gas reinjection into oil fields will remain a high priority.However, at the same time, Iran's household, commercial, and small industries sectors account for slightly over 50 percent of Iran's natural gas consumption while Iran must devote approximately 14 percent of its natural gas to its lucrative petrochemical production. Petrochemical products made from natural gas are one of Iran’s few successful industrial exports.Iran has developed a significant position in Asian markets, with petrochemicals constituting a large proportion of Iran’s non-oil exports to China. Expanding the productivity of its petrochemicals industry is one of Iran’s top priorities.

With U.S. sanctions preventing Iran from obtaining EOR technologies, Iran cannot simultaneously maintain its upstream oil production while satisfy increasing gas demand for petrochemicals production as well as risinggas demand for domestic power generation. In 2013-14 at the height of the previous sanctions regime, Iran had to grapple with the same dilemma. Unwilling to sacrifice oil production and fearful of deeply cutting domestic electricity production, Tehranwas forced to decrease gas delivery to its petrochemical plants and caused a 7.5 million ton drop in petrochemical production. Thus, when viewed from the prospects of Iran's upstream capabilities, the U.S. withdrawal from the JCPOA creates difficult and enduring problems for the production of oil and natural gas beyond the immediate term.

With Washington's ability to impede international investments in Iranian oil and natural gas production to preclude Iran from obtaining vital EOR technologies, the structural fragility in Iran's economy would likely be exacerbated if there is insufficient gas for re-injection, industrial activity, and residential power consumption. Thus while Iran may face no significant loss of oil export revenue in the short term, Tehran may suffer devastating consequences in the longer-term battle over Iran's upstream production.

*Dr. Micha’el Tanchum is a Fellow at the Truman Research Institute for the Advancement of Peace, Hebrew University and non-resident, affiliated scholar with the Center for Strategic Studies at Başkent University in Ankara, Turkey (Başkent-SAM) 

Tel Aviv University, Ramat-Aviv 61390, Tel Aviv P.O.B. 39040, Israel