A month on from the imposition of the last round of economic sanctions on Iran, and Brent crude prices have slipped to under $60 a barrel. It is their lowest level since September of last year, and a clear indicator that the effect of sanctions on global oil supply has been more moderate than the market initially feared.
There are a few reasons why this may be the case. One is that eight countries – including Japan, India, Turkey and South Korea – have been granted exemptions from the sanctions regime, albeit under the proviso that these countries will take steps to reduce the level of oil imports from Iran in six months’ time.
Another reason is that even where enforced, sanctions have at best created a semipermeable seal on exports of Iranian crude. As far back as September, the Financial Times reported on the use of so-called “ghost tankers” to sell oil in secret. The tankers had switched off their GPS transporters to evade detection, making the actual amount of oil leaving Iran difficult to assess.
Thirdly, this time around the US is going it alone. “Unilateral oil sanctions are notoriously difficult to enforce,” says Edward Chow, a Senior Associate at the Center for Strategic & International Studies, and co-author of The Future of Iran’s Oil & Gas Industry. "The previous oil sanctions against Iran worked because they were multilaterally agreed under the auspices of the United Nations. The political objective of the sanctions, forcing Iran to negotiate seriously on its nuclear program, was also well-understood and accepted internationally."
Nonetheless, the impact of sanctions will be significant, both for Iran’s oil & gas industry, and for America’s future ability to exert control through purely economic means. China, which averaged around 650,000 barrels of crude imports a day in 2017, is understandably resistant to any developments that adversely impact a key supplier. Likewise Russia, although it has ruled out acting as a back door for Iranian crude re-exports, is a key ally and a staunch opponent of US sanctions.
The erosion of American soft power
The unpopularity of the Trump administration’s withdrawal from the Joint Comprehensive Plan of Action (JCPOA) – otherwise known as the Iran Nuclear Deal – which counted China, Russia and the European Union as signatories, has meant that even traditional allies are exploring means of circumventing the impact of sanctions. The $1 billion committed to developing Iran’s South Pars gas field by French supermajor Total has made France a particularly vocal critic.
In September, the remaining signatories of the JCPOA announced the creation of a “special purpose vehicle” designed to allow for financial transactions between Iran and its trade partners. The SPV is intended to provide a way around Section 1245 of the National Defense Authorization Act, a sanction reinstated upon the US’s withdrawal from the JCPOA. Under Section 1245, the Secretary of the Treasury is empowered to impose penalties on foreign financial entities deemed to have transacted with Iran’s central bank or financial institutions.
Progress with creating such a vehicle has been “rather halting,” Chow says. “Nevertheless, the direction is clear: the more the US uses unilateral economic sanctions, the greater the incentive for other countries to set up mechanisms to avoid such sanctions’ negative effects on their own interests. The trend is immature right now, but it will not be in ten or twenty years’ time.”
Should this trend continue to develop, the result will be a weakening of the dollar’s efficacy as a tool of political enforcement. That could have dangerous implications for the use of military force as a means of exerting pressure on foreign governments. Alternatively, it could reduce the costs incurred by malicious state actors for human rights violations or the use of prohibited weaponry.
These risks mean that US policy-makers may be hesitant to enforce sanctions to their fullest extent. “ resolve to enforce unilateral actions will be tested,” Chow warns. “The strength of current US sanctions against Iran relies on the reach of the American financial system and the willingness of the American government to apply secondary sanctions against companies from other countries, which it will have to demonstrate.”
An end to cooperation
Whether or not the US chooses to impose secondary sanctions, the prospects for the Iranian oil & gas sector are pretty poor. Even prior to the US’s withdrawal from the JCPOA, when Iran’s massive fossil fuel reserves should have made it a prime target for foreign investment, cooperation between Iran and international oil companies was halting.
In part, uncertainty around the possible reinstatement of sanctions was to blame. But Iran also has serious institutional problems that make it a difficult place for foreign investors to thrive. A factional political system means that new projects often end up treated as bones of contention between combative institutions and regulatory bodies, each pursuant to its own ends.
Another issue was the unattractiveness of the Iran Petroleum Contract, an attempt on the part of the Iranian state to facilitate foreign investment in the country’s energy industry. Introduced in November 2015, the IPC was intended to provide foreign companies with access to Iranian oil and gas fields, while reserving exclusive ownership rights to the National Iranian Oil Company (NIOC). But the final version of the IPC after parliamentary revisions meant that it was no easier for foreign companies to book reserves.
Chow’s opinion is that Iran should have done more to solicit investment while the going was good. The country “made a mistake by not offering much more attractive terms to attract foreign direct investment after the JCPOA was agreed and multilateral sanctions lifted,” he says. The re-imposition of sanctions will of course make further progress much more challenging.
Unfortunately, the Iranian oil & gas sector badly needs both foreign capital and foreign expertise. “The entire sector has been under-invested for forty years due to the lack of capital and access to technology, equipment and modern oil field practices,” Chow explains. The result of under investment is evident in an average recovery rate for Iranian oil fields of below 25%, which compares to a worldwide industry average of 35%.
Chronic under-investment will have implications not just for Iran and its buyers, but also for the climate. Iranian oil production entails handling large quantities of associated natural gas. But with limited ability to bring that gas to foreign markets, and an export strategy centered around oil, Iran consistently ranks among the top three countries in the world for gas flaring. In 2016, after the introduction of the JCPOA, the resulting rise in oil production led to the flaring of 578.92 billion cubic feet of gas.
Solving these types of problems necessitates cooperation. Western oil majors subject to international scrutiny have the experience and equipment needed to reduce the incidence of flaring. Likewise, more involvement from foreign companies could help Iran bring its considerable reserves of associated natural gas to consumers in other markets.
“The environmental case illustrates a much larger point,” Chow sums up. “It is difficult to solve a lot of regional and global problems without involving a nation of 80 million people sitting on the largest combined oil and gas reserves in the world.”
Edward Chow will be speaking at the upcoming Flame conference in Amsterdam. Register now to hear him speak.