Sanctions vs. Energy and Iran

Daniel Altman, International Herald Tribune:

The United States and its allies face a quandary as they confront Iran over its nuclear ambitions. If sanctions are the answer, what economic levers could they safely use against a country that controls a substantial share of the oil supply for Europe and Asia? It's a difficult question to begin with, but it becomes more complex in light of Iran's unique political and economic situation.

At the moment, sanctions are a purely hypothetical topic, given that China or Russia are inclined to veto attempts by the United Nations' security council to impose them on Iran. On Friday, the Bush administration and European officials also said they did not want to take steps toward an oil embargo or other economic penalties that would increase hardships in Iran.

Indeed, such a move would be counterproductive for a number of reasons, experts said. The United States has already tiptoed down this path by banning virtually all commercial and financial transactions with the country. Yet there are very few areas where further sanctions might be effective, experts said.

One reason is that Iran's government has discouraged the formation of an industrial middle class, said Abbas Milani, director of the Iranian studies program at Stanford University, who left Iran in 1987. That would leave 80 percent of the economy essentially in the hands of the state. As a result, there is no solid cadre of business leaders to pressure the government.

Another reason is the difficulty of enforcement. "Sanctions are very, very porous," Askari said. "In the case of Iran, both because of where it is situated and where it can get things from, it can get what it wants."

Even stopping the flow of the high-technology goods mostly manufactured in the United States and Europe could be difficult, said Ali Fatemi, dean of the graduate school of business at the American University of Paris. Fatemi said he left Iran in 1954, returned two years before the revolution of 1978-79 and then left again in the early 1980's. "The only thing that it could do in most cases is it could raise the price, because there are so many loopholes, as we've seen in Iraq," he said.

Iran is more vulnerable, Fatemi said, in its imports of refined petroleum products. Despite its massive oil reserves, the country has very little capacity to produce substances like gasoline and jet fuel. He estimated Iran's imports in this area are at about $10 billion a year, a figure that may represent up to a third of all imports.

Another energy-related area in which Iran's future economic growth could suffer is its natural gas industry. The country has the world's second-largest gas reserves but has yet to become a net exporter of the commodity.

"They know they're sitting on a ton of gas and they're dying to develop it," said Cliff Kupchan, an Iran analyst at the Eurasia Group who was formerly in the U.S. State Department. "They can't do it by themselves, and sanctions that prevented them from doing it would hurt Iran."

The hurt might be especially acute because the domestic economy in a slump.

"Unemployment has increased in Iran in the last six months, despite of absolutely unheard-of revenue for the government," Milani said. "There's a massive flight of capital. No one knows the exact figure, but it is massive."

The government keeps prices for food and other necessities fixed at low levels, so there is little incentive for suppliers to produce more. Yet the oil money is filtering into the economy, leading to "too many dollars chasing too few goods," Milani said. "Inflation is close to 20 percent officially," he added. "Many people think it's much, much higher." READ MORE

In the midst of this general inflation, however, house prices are falling along with the capital flight, eroding average Iranians' wealth. "In real estate, for the first time in recent memory, the prices are going down," Milani said. "There's a glut of properties on the market."

Even under these circumstances, sanctions might be counterproductive if they provoked Iran to turn off its oil taps, said Paul Stevens, a professor of petroleum policy at the University of Dundee who helped Iran to unravel its international legal claims after the revolution. "They're quite capable of doing so," he said. "Cutting off noses despite faces is something that comes to mind."

The prospect of Iran curbing oil supply - and the threat, however remote, of sanctions on Iran's oil exports - has already helped drive the price of crude back toward $70 per barrel in the past week.

Indeed, oil is an obvious focus of any talk of sanctions, as it was in Iraq's case under Saddam Hussein. But several experts cautioned against trying an Iraq-style embargo on Iran.

"If Iran was not allowed to export its oil, probably the price of oil in today's dollars would go over $100 a barrel," said Hossein Askari, who holds the Iran professorship of international business at George Washington University. Aksari said he left Iran in 1954 and that his chair was endowed by the pre-revolutionary government of Shah Reza Pahlavi in 1974.

A high oil price would hurt consumers all over the world but particularly in Iran's major markets, which include China and Japan, said Milani.

Instead of barring Iran from exporting oil, he said, a better approach would be to freeze the assets and confiscate the properties of its leaders. He also suggested freezing the foreign assets of Iran's revolutionary foundations, through which the country's elites control vast business empires.

The foundations, called ponyads, may be the repositories for money skimmed off government oil revenue, Fatemi said.

"They don't give any account to anybody, and they're bigger than the public sector," Fatemi said of the ponyads. "They are basically run for the profit of the ruling mafia."

Fatemi added that billions of dollars in assets owned by Iran's rulers were in Switzerland and the rest of Europe. He also asserted that the regime laundered oil revenue through Dubai and other countries, sometimes for business, sometimes to support militant groups like Hezbollah.

"There's a lot of room there to apply pressure on Dubai to stiffen its anti-money-laundering rules," Fatemi said. "If Dubai wants to be a responsible international financial center, it has to change its methods in terms of giving Iranians a blank check to do whatever they want to do."