Implications of European Union Sanctions against Iran

24 January 2012 FDI Team

Background

On 23 January 2012, the EU placed an immediate ban on all new contracts to import, purchase or transport Iranian crude oil and petroleum products. Where existing contracts exist, EU countries have until 1 July to cancel them. EU officials also agree to freeze assets in Iran’s central bank.

Discussion

The EU’s move is a significant toughening of sanctions and has the potential to further weaken Iran’s economy. While about 20 per cent of Iranian oil goes to Europe, it remains unclear who else would be supportive of the EU action and whether Iran would find alternate markets. Iranian oil could also be replaced by increased production, particularly from Saudi Arabia.

US and EU officials have approached a number of Asian buyers with mixed results.

China, which presently imports about 20 per cent of Iran’s oil, and is its biggest market, is sending conflicting messages.  It has recently halved its oil imports from Iran in favour of bolstering ties with other Gulf producers. Whether this is a means of encouraging Iran to comply with inspection of its nuclear facilities, or is a means of striking a harder bargain to purchase oil, is not clear.

Japan has increased its oil imports from other sources, primarily Saudi Arabia, while still purchasing Iranian oil. South Korea has actually increased its oil imports from Iran, but could comply with US demands should the situation with North Korea deteriorate.

India, on the other hand, appears to have confounded expectations from Washington and is looking to increase its oil imports.

The Iranian Government faces a dilemma.  The EU move will undoubtedly impose added pressures on a weakened economy already affected by previous sanctions and rising unemployment, inflation and prices. Officials will also be influenced by public perceptions, especially in light of the upcoming March elections.

Iran may unequivocally comply with demands to open its nuclear facilities for inspection. To do this, however, may work against national pride and the perception that Tehran needs a nuclear capability to ensure its ultimate defence.

On the other hand, the worsening economy and potential for political instability may encourage Tehran to admit IAEA inspectors, particularly if its nuclear development does not have a military capability. By so doing, it could claim that its statements were correct all along. This approach could be influenced by the fact that an IAEA team is due to carry out an inspection later this month.

Linked to either approach could be the perception or actual intent to increase tension by attempting to close the Strait of Hormuz, to foment unrest within Shia communities, to increase tensions in Iraq and Afghanistan or to support international terrorism.

Despite statements by some Iranian officials that the Strait of Hormuz would be closed, recent announcements suggest otherwise. In part, this may be because of the presence of two US carrier battle groups in the region and the inevitable destruction of much of Iran’s naval and air assets, as well as its nuclear plants.

EU member states will be forced over the coming months to engage alternate markets to secure their energy security. The Organization of Petroleum Exporting Countries (OPEC) is likely to increase output quotas to avoid a potential “oil shock”. Saudi Arabia and Russia are expected to absorb most of the EU demand. 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 maintain a “business-as-usual” environment, particularly given the current economic climate in the EU, oil reserves may be tapped. Far from fostering certainty, the reduction in reserve capacity may create uncertainty on the world market, spooking traders and creating price volatility.

For Australia, the direct implications are likely to be negligible. 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. Indirectly, however, Australia is susceptible to a range of potential contingencies from a prolonged Iranian crisis.

 

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