As sanctions tighten, Iran gets squeezed
Iran is increasingly stockpiling its oil production as purchases decline because of sanctions.
May 23rd, 2012
02:00 AM ET

As sanctions tighten, Iran gets squeezed

By Jamie Crawford

Despite recent assurances by senior officials in Iran that the country will weather sanctions targeting the country's petroleum and financial sectors, the international effort is having a noticeable impact on the Iranian economy. And the situation may well figure into talks scheduled for Wednesday in Baghdad over the Islamic Republic's disputed nuclear program, U.S. officials say.

Iranian exports of crude oil fell sharply in April, and could be down by as much as 1 million barrels a day, as many countries seek to reduce their imports of Iranian oil ahead of sanctions set to come into full effect later this summer, the International Energy Agency (IEA) said in a report released earlier this month.

President Barack Obama has until June 28 to decide whether countries that purchase Iranian oil have significantly reduced their purchases, or face a cutoff in access to the U.S. financial system under legislation signed in December.

Separately, the European Union is set to enter into a complete embargo of Iranian oil on July 1. As countries diversify their purchases ahead of both sets of sanctions, U.S. officials say Iran's declining customer base for oil, as well as prohibitions on Iran's central bank, are having a broad impact on the overall Iranian economy.

"The value of their currency has dropped like a rock and that has a significant impact on Iran's ability to pay for the material it needs for its nuclear program," David Cohen, Treasury under-secretary for terrorism and financial intelligence, told an audience in Washington earlier this month.

"They are increasingly isolated - diplomatically, financially and economically," he said. "I don't think there is any question that the impact of this pressure played a role in Iran's decision to come to the table," for talks with the United States and its allies about the nuclear program.

As the sanctions deadlines draw nearer, Iran is losing oil revenue because of both declining sales volume, and declining prices as countries that still purchase the crude see it as a distressed asset, and seek to negotiate steep price discounts on every barrel purchased.

To be sure, Iran is still producing a great deal of oil. In its report, the IEA said Iran was pumping about 3.3 million barrels day. But as most of Iran's customers reduce their purchases, the agency said much of Iran's excess production is being diverted to storage both onshore, and aboard floating tankers at sea. Estimates of Iranian oil added to floating storage since March range from 450,000 to 800,000 barrels a day, while an additional 20 million to 25 million barrels have been added to onshore facilities, the IEA said.

Once on floating storage, Iranian tankers have been turning off ship transponders so their movements are more difficult to track. Analysts who follow the Iranian program say the elusive tactic serves two purposes: It allows Iran to ply the seas and engage in covert sales of the crude, often at greatly discounted prices. Also, Iran is loathe to signal to the world a high volume of floating storage, as that would be an acknowledgment that the sanctions are having an impact.

The tracking systems are required by international law on seagoing tankers as a means to protect against accidents and spills.

Even more financially detrimental to Iranian oil exports is the prospect of shutting down any of the country's oil fields should onshore domestic storage build up as more buyers go elsewhere to avoid being targeted by sanctions.

"It's not just at your tap, or at the faucet where you just turn it off and turn it on," Jamie Webster, a Middle East oil analyst at PFC Energy, said. "When you turn it back on, 10 to 40% of that oil will not be there again, and you're going to have to essentially build new pipes, do some more drilling."

Japan and 10 countries from the European Union have already secured waivers from U.S. sanctions as they have significantly reduced their purchase of Iranian oil.

Supporters of the U.S. legislation on Capitol Hill are pointing to Japan as a prime example of how far they are looking for countries to go in their reductions of Iranian oil.

Already in a precarious position with its energy security following last years earthquake and tsunami that also triggered a nuclear crisis, Japan's early commitment to reduce it's purchases of Iranian crude by 15% to 20% should serve as an example to other countries, congressional aides say.

Sens. Robert Menendez, D-New Jersey; and Mark Kirk, R-Illinois, who both authored the legislation targeting oil purchases through Iran's central bank, jointly endorsed a proposal recommending an approximately 18% reduction of Iranian oil purchases by all countries across the board in a letter to Treasury Secretary Timothy Geithner earlier this year.

"Congress is not going to be very happy about it," if other large importers of Iranian oil don't reduce to near the levels of Japan, a congressional aide told CNN while declining to be identified due to the sensitivity of the situation. The administration has "done a really good job of implementing the sanctions, better than any Republican I think expected, but if they don't fully implement, they are going to take a lot of heat up here," the aide said.

India, one of the biggest importers of Iranian crude, said last week that it would cut imports by 11% in the coming year as it has faced enormous pressure from Washington to reduce its purchases. While the announcement was welcomed by the administration, it was not clear whether an even greater reduction would be necessary to get a waiver.

"As (Secretary of State Hillary Clinton) said when she (was in India recently), we are making progress," State Department spokeswoman Victoria Nuland told reporters after India's announcement. "There's more progress to be made."

The administration is also looking to South Korea and China to make significant reductions in their purchases of Iranian oil. Earlier this year, China reduced its purchases by as much as 50%, but that decision was driven mostly by a pricing dispute over existing contracts China had with Iran.

And as the deadline on sanctions enforcement nears, analysts who follow the situation say China is taking advantage of the situation by buying Iranian oil covertly, but gaining significant discounts - as much as $20 a barrel - as a condition to keep purchasing.

Diplomacy and international relations are likely to play a role in the administration's determinations with China especially so long as there is some form of reductions to go along with the significant price squeezing by the Chinese.

"I think the administration is really trying to thread this needle delicately," said Mark Dubowitz, executive director of the Foundation for Defense of Democracies, who has followed the sanctions program closely. "Between on one hand really forcing Iranian oil off the market and forcing significant discounts on the oil that's being sold, but on the other hand not doing it too aggressively, because in doing so, it would face the possibility of returning to high oil prices we saw a month or two ago."

Both China and India have said they do not support either the EU or U.S. sanctions, and have not asked for a waiver.

For its part, Turkey, which along with South Africa, had recently ramped up its imports of Iranian oil in advance of the looming sanctions, is aware of the coming deadline.

TUPRAS, a private enterprise and Turkey's sole importer of Iranian crude, recently announced it would cut Iranian imports by 20% from the previous year's quantities. Presently, the crude imports from Iran account for 30% of Turkey's total imports, or just over 200,000 barrels a day, a Turkish official told CNN.

The company intends to replace that lost volume with Iran with additional purchases from Libya, the official said.

And because U.S. sanctions target any transactions of Iranian oil processed through Iran's central bank, Iran is facing a hard currency squeeze as more international banks refuse to repatriate any profits of oil sales back to Iran in their national currency, the rial. Iran is essentially being forced to barter and take profits in the form of the currency of the country purchasing the oil.

"Iran can't do anything with (Indian) rupees or (Chinese) yuan except buy Chinese and Indian goods and services that it really doesn't need," Dubowitz said. Without the ability to convert their sales into Iranian currency, and repatriate their profits, "all the oil they sell is going to be useless to them," he said.

Complicating matters even greater for those countries that are permitted to continue their purchases of Iranian oil at reduced rates is the increased difficulty in acquiring maritime insurance because of the sanctions.

With nearly 95% of all maritime insurance being underwritten in Europe, many of those insurers are denying coverage for anything that involves Iranian transactions.

In the absence of insurance, governments themselves would have to step in and guarantee liability on the event of a spill or some other catastrophe. Many Iran watchers expect the insurance sanctions to become particularly troublesome to Iran.

Whether the increasing pressure on Iran has brought about a willingness on its part to consider significant concessions on its nuclear program remains to be seen.

The so-called P5+1 group of the United States, Russia, China, France, Great Britain and Germany will discuss the issue with Iran in the Iraqi capital Wednesday. Most who follow the situation closely are skeptical about any significant announcements by Iran about its nuclear program in the near-term.

But regardless of whatever progress is made, some analysts say the United States should not be hasty in its response.

"I think the temptation which needs to be resisted is not to offer too much sanctions relief too fast," Dubowitz said. "Because this whole system which is being held together by the fear of U.S. penalties is going to quickly unravel, and I think the administration will lose all of the leverage that it so diligently assemble over the past few years."

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Filed under: Iran • Sanctions
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