x Abu Dhabi, UAETuesday 25 July 2017

US sanctions on Iranian oil work slowly, if at all

The 20th anniversary of the fall of the Soviet Union approaches, a totalitarian state brought down by its own internal weaknesses. Now, the US seeks to use economic pressure against Iran. Will it succeed?

The Iranian leadership introduced petrol rationing after major oil traders withdrew from the country.
The Iranian leadership introduced petrol rationing after major oil traders withdrew from the country.

We are approaching the 20th anniversary of the fall of the Soviet Union, a totalitarian state brought down by its own internal weaknesses, hastened by falling oil prices. Now, the US seeks to use economic pressure against Iran, but is this likely to succeed? In 1986, the Saudis increased oil production and prices crashed. Just five years later, the Soviet Union had disappeared, a link brilliantly explained by Yegor Gaidar, a former Russian prime minister. The accession of a reform-minded leader, Mikhail Gorbachev, and the withdrawal of support for communist regimes in eastern Europe were, of course, key factors. The sclerotic Soviet economy had forced a slow realisation that things had to change.

Though the parallels should not be overstated, the Iranian economy certainly suffers from some of the same glaring flaws as the USSR did. It is even more dependent on oil as a source of export earnings and government finance, and the state and military dominate the economy. Energy consumption is high and inefficient, corruption and mismanagement rife. The US has long sought to use sanctions to pressure the Islamic Republic, dating back to the 1979 revolution. The nuclear dispute has brought a further raft of measures, targeting areas such as banking, investments by the Revolutionary Guards and the financing of energy projects.

But this demands the calculation of which measures are likely to work and which can be countered by Iran. And what is the aim of the sanctions? Is it to cause a collapse of the economy and hence threaten the regime's survival? Or just to make key figures in the leadership conclude that the costs of maintaining certain policies is too high? Against a factionalised state, much less monolithic than the Soviet Union, different economic pressures target different constituencies.

Last week, two more major oil traders, Shell and Vitol, withdrew under US pressure from selling petrol to Iran. The US has identified petrol imports as an Achilles heel, since Iranian refineries cannot keep pace with Iran's swelling consumption, encouraged by extravagant subsidies. But the idea of a total petrol embargo is something of a red herring. The US cannot feasibly enforce a blockade and Iran has many neighbours who would be happy to continue supplying them.

The Iranian leadership has introduced petrol rationing and plans to reduce subsidies. These are huge drains on the state coffers, accounting for a quarter of government spending. A US embargo, ironically, would enable price rises to be spun as patriotic emergency measures. Iran's main vulnerability lies not in its imports, but in exports. With half of government revenues coming from oil, Iran's budget this year assumes an oil price of US$65 per barrel, giving little room for error. Mahmoud Ahmadinejad, the president, has raided the stabilisation fund, filled with excess oil revenues, to support his social programmes.

Iran has done surprisingly well over the past few years to keep oil production creeping up, but growing domestic consumption means that exports are falling. Iran's ability to maintain oil output is hampered by lack of finance, outdated technology and corruption, including the pervasive influence of Revolutionary Guards subsidiaries. Western companies have for now entirely given up on Iran's petroleum sector. Chinese and Russian firms, keen to press ahead with developing new fields, have been frustrated by Iran's tortuous negotiation tactics. The recent big contract awards in Iraq may convince them that there is a better place to do business, while the US has sought to persuade China that Saudi Arabia would help make up any shortfall if Iranian oil supplies were interrupted.

Remarkably, Iran has long been a net natural gas importer despite holding the world's second-largest reserves. It is also the third-largest consumer, behind only the US and Russia, despite a much smaller economy. Again, subsidies and inefficient use are major factors, while the ageing oilfields require large amounts of gas injection to maintain production. In this context, a peaceful nuclear energy programme, such as the UAE's, would actually be a sensible policy.

But Iran's failure to develop gas exports is mainly down to its own political indecision and an inability to agree reasonable commercial terms. Long negotiations with Turkey, Pakistan, Kuwait, Bahrain, Sharjah and Oman have yielded little. Frustrating oil and gas development slowly chokes this crucial part of the Iranian economy. The key US aim, though, should be to bring oil prices down. Expansion in Iraq may help, but the US has done little to implement the other key part of such a policy, reducing oil demand. This would weaken not only Iran but also another US adversary, Russia, as well as meeting climate-change objectives.

There is little sign that the Iranian leadership has the vision or authority to start a successful Chinese-style programme of economic reform without political liberalisation. The Iranian economy will continue to stagnate, partly due to US measures, but mostly because of its own mismanagement. But the situation will not become desperate unless oil prices crash, an outcome much harder to engineer now than it was in 1986. Eventually, life for ordinary Iranians may become so intolerable that the Islamic Republic fears loss of popular support and more pragmatic politicians take charge, as happened in the USSR.

But as Cuba and Iraq show, sanctions work slowly, if at all. They are only one element of US tactics against Iran, and at the moment, the political process seems to be running ahead of the economic one. Robin Mills is a Dubai-based energy economist and author of The Myth of the Oil Crisis.