Western Resolve to Break Iran’s Oil Shield: Implications for Australia

Wednesday, 18 January 2012

Background

Iran boasts ten per cent of world oil reserves and is currently the third-largest exporter. This strategic share has allowed the Islamic Republic to create an “oil shield”, protecting the government’s survival and alleged nuclear programme. Recently, however, the United States and its allies have invoked strict sanctions aimed at removing Tehran from the international oil market. The immediate impact on Australia will be negligible, although concerns linger over the implications for trade partners. Within this context, Iran’s removal as a competitor in the gas market presents opportunities for Australia to leverage these developments to its advantage. 

Comment

On inauguration, President Obama attempted to take a more conciliatory approach towards Iran than that of his predecessors, but Tehran was quick to rebuff his overtures. In the subsequent years, a right-wing, militaristic cadre has come to the fore in Iranian politics. These developments and the alleged Iranian nuclear programme have forced the President to return to the 30 year old American policy of “pressure and persuasion”, adopted following the Islamic Revolution. Intersecting trends suggest the diplomatic pivot will shift again in 2012, with the United States adopting a more austere policy towards Iran.

Last New Year’s Eve, in a sign of a more determined approach, President Obama enacted sanctions against the Iranian Central Bank, attempting to weaken that nation’s crucial oil export business. Additionally, financial institutions and businesses that have connections with the bank will be prevented from opening and maintaining operations in the United States. According to the Brookings Institute, when fully enforced the sanctions will excise Iran from the oil market, slashing its primary revenue stream. 

The growing resolve against Iran has seemingly spread across the Atlantic to the European Union. Traditionally reticent about the implementation of sanctions, press reports suggest the EU will impose an embargo on Iranian oil imports, with details due in late-January. While the United States has not imported Iranian oil since 1979, several EU countries continue to be major purchasers. Accordingly, analysts contend, countries such as Italy, Greece and Spain will resist strict adherence to the sanctions and are currently readying applications for waivers. 

The vast majority of Iranian oil flows to markets in the Indo-Pacific. Emerging markets, including China and India, and energy-poor states, such as South Korea and Japan, form Iran’s main customer base. Key US allies, Japan and South Korea have signalled their intent to reduce demand for Iranian oil. Exports to China and India are likely to continue unabated.  

Fundamentally, the latest round of sanctions is aimed at forcing Iran to curtail its nuclear ambition, while preventing an oil shock that could destabilise the world economy. 

Australian policy towards Iran largely mimics that of the United States and the EU. In early December 2011, Foreign Minister Kevin Rudd announced an expanded suite of sanctions, targeting key figures within the government and Iran’s nuclear programme. Additional sanctions are likely in 2012, to bring Australian policy into line with that of key allies.

Australia is a net importer of oil, with approximately two-thirds of demand sourced from overseas markets. Vietnam, Malaysia, Indonesia, United Arab Emirates and Papua New Guinea provide the overwhelming bulk of Australia’s oil requirements. According to a Congressional Research Service report in late 2011, Australian imports of Iranian hydrocarbons, including mineral fuels, crude oil, natural gas, distillates and the like, are minor – totalling $138 million in 2010 – an insignificant statistic in comparison to key import partners.

Regardless, however, Australian energy providers must ensure due diligence and a robust framework, to ensure compliance with current and potential sanctions against Iran. Australian investors considering ventures in Iran’s energy sector should be aware that the latest embargo represents a substantial risk to commercial operations. Complementary sectors must also exercise caution, particularly logistic and shipping companies. Beyond the energy sector, Australian financial institutions, insurance companies and broker-dealers must ensure a rigorous approach to Iran; it will likely be tested in 2012 and beyond.

Given Australia’s export-focussed economy, it is vitally important to consider the implications of sanctions against commercial partners. Recalcitrance from Beijing and New Delhi will continue; their consumption of Iranian oil may even potentially increase. While both countries pursue a policy of diversification to ensure energy security, decreased demand for Iranian oil from the European Union is an opportunity neither country is likely to ignore.

While the specifics of the EU sanctions remain unknown, it is clear that members will be required to engage alternative markets. While Saudi Arabia is likely to be moderate in new contract negotiations, given its own concerns towards Iran, Russia may adopt a more opportunistic policy. To offset the loss of Iranian oil, the Organization of Petroleum Exporting Countries (OPEC) is expected to increase output. Concurrently, the EU may tap oil stocks to maintain the volume of oil available at the current level. Ostensibly, this favours a “business-as-usual” approach. The reduction in reserve capacity, however, may create uncertainty on the world market, spooking traders and creating price volatility. It is a concerning prospect, particularly given the likelihood of geopolitical shocks in other supplier states such as Iraq, Nigeria, Syria and Yemen.

Sanctions may create a minor oil imbalance, amplified due to the world economic climate. Australia will avoid significant exposure, due to guaranteed supply and increased energy security for key export markets in Asia. 

Perhaps a more pressing concern for Australia stems from Iranian statements about the closure of the Strait of Hormuz. Over 20 per cent of the global oil trade and a third of global liquefied natural gas (LNG), transits that critical chokepoint. Closure of the Strait, through an international embargo, military operation, or political decision in Iran, would cause a worldwide oil shock, comparable to the 1973 and 1979 crises. Australia would certainly not be immune to such developments. Questions remain, however, over the capability and intent of Iran to close the Strait of Hormuz.

Finally, Australia should seek to position itself as alternative market to Iran during these latest developments. While oil-poor, Australia boasts a strategic share of LNG, a commodity targeted by sanctions, yet largely ignored in the press. The reduction of Iranian gas and resulting concerns over surety of supply from other Gulf states in the event of a crisis, makes Australia an ideal candidate to play a larger role in global hydrocarbon requirements. Currently, most Australian gas projects are in the early construction phases of development, preventing Australia from capitalising on rising gas prices in the spot market. By the middle of the decade, however, Australia is expected to exploit its strategic share of LNG to become a leading global supplier. While long-term contracts currently exist, reserving significant ratios of gas for regional energy utilities, scope exists for greater exploration in existing gas basins and untapped tenements, to increase supply. Suspected shale deposits throughout northern Australia create further prospects for supply.

Australia, using its unique energy credentials, must position itself as a key alternate supplier of future gas requirements, to promote the deterrence and dissuasion elements on which the current sanctions are based. 

Liam McHugh

Manager

Northern Australia & Energy Security Research Programmes

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