x Abu Dhabi, UAEFriday 19 January 2018

Iran's threats are real but so too is its dependence on oil

Iran has no real interest in closing the Strait of Hormuz, because its own oil exports, mostly using the Strait, are so essential to keeping the government there going.

Chest-thumping threats by senior Iranian officials in recent days to close down the Strait of Hormuz sound like the proverbial cutting off one's nose to spite one's face. Iran's economy is overwhelmingly dependent on oil sales, most of which moves through the Strait to markets in Asia and Europe. A shut-down of the Strait would largely close the taps on Iran's own oil sales.

But it's far more serious than that. We need a new metaphor. An Iranian attempt to shut down the Strait of Hormuz would be akin to a man purposely blocking a coronary artery, preventing blood and oxygen from reaching his heart. Such a man would immediately experience myocardial infarction - a heart attack - and die. Without oil sales, Iran, too would experience a heart attack. Its government would become insolvent, and possibly face a chaotic and ugly collapse with regional destabilising effects.

Oil accounts for some 80 per cent of Iran's hard currency earnings and some 60 per cent of fiscal revenues. Oil lubricates Iran's economy, masks structural distortions, creates oil "rent" competition among political elites, and pays for the security apparatus that keeps the increasingly restive and frustrated Iranians in check. Iran's balance sheet is literally smothered in crude oil.

Thus, Iranian threats must be taken in their proper context. Even in the height of the tanker war of the 1980s during the brutal Iran-Iraq war, Tehran never tried to shutter the Strait. It mined the Strait and harassed ships and took some heavy casualties of its own, but it never made an effort at closure. It did not want a heart attack.

This is important to remember as we enter the most critical phase of Iran's showdown with the United States, the European Union, and several Arab states over its nuclear programme. In 2012, Washington and Brussels are taking aim at Iran's oil sales through a series of measures that include banning the purchase of Iranian oil, sanctioning Iran's Central Bank (which processes oil payments), penalising companies that buy Iranian oil, and possibly even a European embargo of Iranian crude.

The targeting of Iran's oil sales represents the most serious escalation of a growing tide of multilateral and bilateral sanctions squeezing the Islamic Republic's economy. The squeeze is biting. Last week, the Iranian currency, the rial, went into a free-fall before the Central Bank intervened. Capital is fleeing. Investment is down. Unemployment is up. Factories are shuttered or shuttering. Banks have been effectively isolated from world credit markets. Corruption - always a mainstay of the Islamic Republic - has taken on a shocking air: one embezzlement ring is accused of stealing $3 billion (Dh11 billion).

Still, despite all of these problems, there is always oil. One Iranian economist once described the Islamic Republic's economy as a garden full of excrement (though he used a more colourful term). "Oil is the water hose that cleans (it) but it stays in the soil, only to creep up again, covering the flowers, until the oil hose comes in and cleans it up again."

Iranian President Mahmoud Ahmadinejad has had quite a hose at his disposal. In his first four years in office, Iran earned more in oil sales than the previous 16 years combined. Rising oil prices provided a boom to a badly mismanaged and structurally distorted economy.

The first quarter of 2012 will be telling. China has already cut its purchases of Iranian oil by half. Japan is looking for other suppliers. South Korea has sanctioned Iran's banks and might also be looking for other suppliers. And India has been talking with Saudi Arabia about increasing its purchases of Saudi crude.

Between them, those four countries account for six out of every 10 barrels of Iranian oil sold on the market.

Most of the other four barrels go to Europe, including Turkey. New EU sanctions on the horizon, however, are even more draconian than US congressional legislation. The EU move could effectively bar all oil purchases from Iran. More oil will thus flow East, and Iran will be forced to offer discounts to Asian buyers.

Yes, the oil price will go up, and this has a short-term benefit for Iran, but this largely benefits other producers; Iran is often forced to offer discounts and it has a hard time getting paid for its oil owing to US Treasury sanctions that have effectively isolated Iranian banks.

Often, policy-makers wonder if sanctions work. This depends on your definition of "work." If "work" means that sanctions make Iran's government and its economy pay a heavy price for their nuclear program, then it is clear: sanctions are working. If by "work" we mean sanctions will get Iran to halt its nuclear programme, that answer is still in the negative.

By going for the jugular, Washington and Brussels are forcing an answer to that question about sanctions. In the end, Iran could always survive financial and trade sanctions, but oil sanctions are a different matter. By attempting to cut off Iran's oxygen, the US and the EU are pushing Iran deeper into a corner, which could result in three scenarios: tactical retreat, reckless defiance or something in between.

It's the "something in between" that Iran often chooses at moments of crisis, offering neither resolution nor reconciliation, but doing enough to, as one Iranian Foreign Ministry official once put it, "avoid getting our skirts caught in the fire." That is not much of a foreign policy doctrine. It favours tactics over strategy and puts Iran in a weak long-term position. It's also a dangerous game, but one that the Islamic Republic has played without any fatal burns for 33 years.

Still, the embers simmer, the fires are gathering, and "the something in between" strategy might not suffice in a year that could be fateful for Iran and the region's future.


Afshin Molavi is a senior fellow at the New America Foundation and senior adviser at Oxford Analytica