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Sep 23, 2009 | 12:17 GMT

15 mins read

Iran Sanctions (Special Series), Part 1: The Nuts and Bolts

Summary
The real thrust of Western sanctions against Iran is a subtle one. Iran's Islamic Revolutionary Guard Corps (IRGC) — a U.S.-designated foreign terrorist organization — is so entrenched in the Iranian economy that any corporation would be hard-pressed to do business in Iran's energy sector without touching the IRGC. And these corporations could quickly lose confidence in the safety of their investments in the United States, the largest consumer market in the world. Nonetheless, a number of firms are still willing to take such risks in supplying gasoline to Iran. Editor's Note: This is part one of a three-part series on what sanctions against Iran could mean for Iran, U.S.-Russian relations, Israel and the global economy.
Click here to download a PDF of this report Click here to download a PDF of the entire Iran Sanctions Series The United States has strongly implied that Iran's failure to negotiate seriously and place curbs on its suspected nuclear weapons program will result in long-threatened, "crippling" sanctions against the Islamic Republic. The U.S. administration has not detailed precisely what would make these sanctions so "crippling," but an effort is under way to target Iran's Achilles' heel — the country's heavy reliance on gasoline imports for roughly one-third of its domestic energy needs. Despite being a major crude-oil exporter, Iran is sorely lacking refining capacity thanks to economic sanctions, lack of foreign investment and rapidly rising consumption. The assumption built into a sanctions regime focused on Iran's gasoline trade is that with enough diplomatic muscle, the West can pressure companies supplying gasoline to Iran into turning their backs on Iran for the sake of maintaining healthy investment relations with the West. The policy also makes an assumption that by squeezing Iran's gasoline supply, the Iranian regime can be coerced into engaging with the West and making real concessions on its nuclear program instead of resorting to more drastic retaliatory options (an issue that will be explored in more depth in the third part of this series).

The Evolution of Iranian Sanctions

The United States has a broad sanctions regime against Iran that began under the Carter administration nearly three decades ago. The United States government currently prohibits U.S. investment in any area of Iran's economy and bans most U.S.-Iran trade relations with a few exceptions, including pistachio and rug imports (for the most part). Washington stepped over the extraterritorial boundary in 1996 with the Iran-Libya Sanctions Act, which penalizes any foreign company that invests more than $20 million in developing Iran's energy sector. Iranian military and banking institutions have also been cut off from the American financial system since 2007. In addition to Washington's unilateral sanctions, there are four U.N. Security Council (UNSC) sanctions that target corporations and individuals linked to Iran's nuclear program. As with most sanctions regimes, such economic policies are not always easy to enforce when political and trade relations with other countries have to be taken into account. No company has ever been officially sanctioned by the United States for dealing with Iran. Foreign investment can still flow into Iran, even though most major foreign investment projects, like the development of South Pars, are stalemated. The closest thing to sanctions enforcement was the not-insignificant $80 million fine that the United States slapped on ABN Amro, a Dutch bank, in 2005 under the Bank Secrecy Act for failing to comply with the U.S. sanctions on Iran and Libya. Though the ABN Amro fine was a clear warning to foreign firms dealing with Iran, more often than not the U.S. executive branch will sign waivers for foreign firms (such as Total [France], Gazprom [Russia] and Petronas [Malaysia]) to avoid a serious spat with a firm's country of origin. But the United States has also grown smarter about sanctions. Under Secretary for Terrorism and Financial Intelligence Stuart Levey, who also served at the Treasury Department under the previous U.S. administration, figured out a more subtle yet effective way to pressure corporations to see eye to eye with U.S. policy. Levey's approach doesn't require formal sanctions legislation or U.N. Security Council resolutions to operate. Instead, the Treasury Department employs its own form of financial strangulation tactics against Iran by zeroing in on foreign banks dealing with Iran and pressuring them to do a cost-benefit analysis of continuing to do business with the West versus risking the consequences for dealing with one of the many Iranian front companies that could also be engaged in illicit activity, such as supporting the Iranian nuclear program. The real boost to this strategy came in late 2007 when the U.S. Congress designated Iran's Islamic Revolutionary Guard Corps (IRGC) as a foreign terrorist organization. Given the IRGC's pervasiveness in the Iranian economy, the risk of getting branded by Washington as a company dealing with a terrorist entity started to be taken much more seriously by foreign financial institutions and companies. The record shows that since 2006, more than 80 banks have allegedly cut ties with Iran.

'Smart Sanctions' on Gasoline

This financial strangulation model is now being applied to the gasoline trade. Gasoline suppliers, shippers and insurers that deal with Iran have been quietly approached by U.S. officials and informed of the risk of dealing with a rogue country heavily engaged in deceptive financial practices. No level of due diligence by these firms is likely to completely absolve them of indirect dealings with a blacklisted entity like the IRGC. The IRGC is deeply entrenched in Iran's economic system and has firm control over Iran's harbors and seaports, providing a substantial financial base for the group's illicit activities. According to STRATFOR sources, the IRGC is known to pocket about 20 percent of gasoline for its own use and as part of its own patronage system. Iran's state-owned National Iranian Oil Company is also known to have a close relationship with the IRGC's main construction arm, Khatam-ol-Anbia (Ghorb), which builds most of Iran's oil and natural gas pipelines. This more subtle approach to gasoline sanctions has been under way for some time, and the results are slowly coming to light. Iran typically gets the bulk of its gasoline from the following five firms: Vitol (Switzerland/Netherlands), Trafigura (Switzerland/Netherlands), Reliance Industries Ltd. (India), Glencore (Switzerland) and Total (France). The United Kingdom's British Petroleum would also be included in this list, but after considering its substantial upstream and downstream investments in the United States (BP's revenues from the U.S. market totaled $130 billion in 2008), the energy giant has not directly shipped gasoline to Iran since November 2008. India's Reliance is another energy firm that appears to be jumping off the Iranian bandwagon — at least for now. Now that its massive 580,000 barrel-per-day (bpd) Jamnagar refinery is online, Reliance is looking to the U.S. market to store and directly sell its fuel. Just in the past month, Reliance ordered storage for 1.3 million barrels of clean product in the New York Harbor area, a clear indicator that the firm's investment strategy for the United States is moving forward. After having been the number-three gasoline supplier to Iran last year, Reliance started cutting down supplies in January 2009. When U.S. President Barack Obama took office and started promoting his path of engagement with Iran, Reliance thought the political temperature had dropped enough for it to resume supplies in March. Over the past three months, however, there are no signs that Reliance has been directly selling gasoline to Iran. Neither would it be a stretch to assume that the issue of Iranian gasoline sales came up when U.S. Secretary of State Hillary Clinton traveled to India in July and had breakfast with Reliance chairman Mukesh Ambani. Total also appears to have recently curtailed its gasoline shipments to Iran, but is already starting to waver in its commitment to Washington on these sanctions. The company — which has millions of dollars worth of exploration and development work in the Gulf of Mexico and Alaska and hundreds of retail stations throughout the United States and owns a 174,000-bpd refinery in Port Arthur, Texas — put a halt to its energy investments in Iran in 2008 but continued trading gasoline. With French President Nicolas Sarkozy aligning himself closely with Washington on the issue of Iran, the U.S. administration has had notable success in its quiet diplomacy with Paris, as evidenced by a recent drop in Total shipments to Iran. However, Russia has been working diligently in softening up Paris's commitment to these sanctions with enticements, such as potential development rights to Russia's massive Yuzhno fields for Total. After a meeting between Russian Prime Minister Vladimir Putin and a French delegation led by Prime Minister Francois Fillon on Sept. 14, Paris has changed its tune on Iran, with French Foreign Minister Bernard Kouchner warning Sept. 21 that gasoline sanctions may not in fact be the best method of pressuring Iran. Total thus remains a wild card in this sanctions regime. The Swiss firms in the list have been less willing to cooperate and have a history of sanctions-busting activities in Serbia, South Africa and, most recently, in Iraq, in the oil-for-food scandal. Vitol, Trafigura and Glencore are currently supplying the bulk of Iran's gasoline shipments, with each shipment averaging between 30,000 and 33,000 bpd. Of the three firms, Vitol has the most U.S. assets at stake should it continue trading with Iran. Vitol, along with Shell, was awarded a $553 million contract in January with the U.S. government to fill the Strategic Petroleum Reserve (SPR) with more than 10 million barrels of crude. In January 2008, Vitol also bought Pacific Fuel Trading Corp., which supplies Los Angeles International Airport with jet fuel, a contract that brought in roughly $540 million for Vitol in 2008. In addition to a number of other smaller energy investments spread throughout the United States, Vitol is expanding its investments in the country to include a storage facility for cruise ships in Florida. Glencore also has a deal, along with Shell, to supply the SPR with another 26,000 bpd of crude from May 2009 through January 2010. The firm specializes in the commodity trade and owns one zinc and two major aluminum facilities in the United States. Trafigura, like Glencore, has considerable assets in Canada, where the government has been increasingly focused on ways to curb business activities with Iran. In spite of its U.S. assets, Glencore may be a tougher nut for the United States to crack. The firm recently merged with United Company RUSAL, a Russian company owned by Russia's formerly wealthiest oligarch, Oleg Deripaska. Despite losing close to 90 percent of his net worth during the global financial crisis and being put in check by the Kremlin, Deripaska maintains close relations with Russian Prime Minister Vladimir Putin, who has a strategic interest in keeping an Iranian thorn in the United States' side. In addition to these top five suppliers, there are newcomers to the Iranian gasoline trade that the United States is starting to eye more closely. As more and more of the energy majors drop out of the race, opportunities open up for other firms to slip in and profit at a time when Iran is desperately trying to stockpile its gasoline supplies. Malaysia's state-owned Petronas, for example, began sending gasoline to Iran in August in three separate shipments totaling 93,000 barrels. Petronas doesn't have significant assets in the United States to concern itself with, but its country of origin, Malaysia, is extremely reliant on U.S. investment to support the country's high-tech industry — about 19 percent of Malaysia's exports go directly to the United States, its largest export market. U.S. companies like Dell, Motorola, Intel, Agilent, General Electric, Mattel and Western Digital all have significant operations in Malaysia. In short, it would not take much for the United States to get the Malaysian government to rein in Petronas through quieter diplomatic means. As in the past, Washington would avoid a trade spat with Kuala Lumpur and simply apply pressure (and provide waivers) without officially sanctioning the energy firm. The majority of Iran's gasoline suppliers have significant interests in the U.S. market and are therefore susceptible to U.S. pressure. As a number of the energy majors reduce their exposure to Iran, the Iranians will have to worry about the long-term consequences of being blacklisted by the energy giants that possess the skills and technology that Tehran so sorely needs to repair its energy industry. As the number of suppliers dwindles, however, the U.S. pressure campaign against Iran's gasoline suppliers has yet to pinch Iran's gasoline supply in any significant way. In fact, Iran is currently importing a surplus of gasoline with help mostly coming from the Swiss firms and opportunity-seekers like Petronas. Clearly, this pressure campaign still has some way to go before real results can be seen. In addition to the gasoline suppliers, the sanctions net includes a number of insurers and tankers involved in the gasoline trade that will be difficult to clamp down on. Most gasoline shipments to Iran have been underwritten by Japanese, Norwegian, German and British firms, including the London Steam-Ship Owners, Lloyd's of London, Munich Re and the Japan Ship Owners' Mutual Protection & Indemnity Association. Some insurance firms are starting to get the message, but unless the United States gets more aggressive in designating Iran's gasoline intermediaries as IRGC entities, these firms are more likely to continue resisting pressure to curtail their dealings with Iran. The tankers are perhaps the most opaque entities to track considering they can operate under a number of different flags and third-party operators. One shipping company that appears to be heavily involved in the Iranian gasoline trade is Sovcomflot, the largest shipping company in Russia. The firm is chaired by Russian presidential chief of staff and former Deputy Prime Minister Sergei Naryshkin, an extremely powerful Kremlin figure who sits in Putin's inner circle. Unsurprisingly, this Russian firm has taken up a substantial portion of Iran's gasoline shipping needs. Pressure is increasing on these shippers, insurers and tankers, but the sanctions regime targeting Iran's gasoline trade is not airtight. Indeed, a number of tankers can be seen daily using the Jebel Ali port in Dubai as a transshipment point to trade gasoline with Iran. The U.S. administration is conscious of this loophole and regularly pays visits to the Emirati royals to discuss the issue of enforcing sanctions with Iran, but the United Arab Emirates' trade links with Iran run deep. Rather than acquiesce to the United States and sever relations with Iran, the UAE government is quite comfortable balancing its security relationship with Washington with its economic relationship with Tehran. Unless the United States goes so far as to enforce a naval blockade on these gasoline shipments — an option that may be under consideration but would require a substantial commitment on the part of the administration — the UAE will continue to be a major loophole in this sanctions regime.

Tightening the Screws

While imperfect, the under-the-table sanctions are proving effective in pressuring major energy firms like BP and Reliance to back off trade with Iran. Moreover, they do not require legislation or U.N. Security Council resolutions to make an impact. Should the U.S. administration decide to follow through with its threat of crippling sanctions, the pending Iran Refined Petroleum Sanctions Act, which has broad political support in Congress, will pass and the president will have a symbolic club to use against Iran. But even if the executive branch doesn't formally act on the sanctions, the pressure campaign against these energy firms, insurers and shippers is already under way to force them to choose between doing business with the West and doing business with Iran. And the sanctions will not be held hostage by the UNSC. Naturally, any hard-hitting sanctions proposal that enters the UNSC forum would immediately get shot down by Russia and China. U.S. President Obama will still pursue this path to portray the sanctions as a multilateral campaign, but the UNSC is mainly for political show. The real thrust of the sanctions lies in the arena of quiet diplomacy. The IRGC — a U.S.-designated foreign terrorist organization — is so heavily entrenched in the Iranian economy that any corporation would be hard-pressed to do business in Iran's energy industry without touching the IRGC. And these corporations could quickly lose confidence in the safety of their investments in the United States, the largest consumer market in the world. As part two of this series will reveal, however, Russia's next moves will likely determine the success or failure of the gasoline sanctions. Even as the energy majors drop out of the Iranian gasoline trade, Russia is preparing contingency plans to cover Iran's gasoline gap. The Iranians are not exactly thrilled to be more reliant on their unfaithful allies in Moscow, but there is a Plan "B" that threatens to blow the sanctions regime apart should Russia and the United States fail to come to an understanding in the near future.

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