Sanctions on Iran

Western sanctions on Iran are biting. As the nuclear crisis drags on, Iranian oil exports will be lower than last year.

The West is tightening the noose around Iran as the stand-off over the country's nuclear programme continues. On July 12th the US announced that it would seek to close loopholes in existing sanctions that target sales of Iranian oil overseas, and against companies and individuals aiding Iran's nuclear and missile programmes. Washington accused four overseas companies of being a front for Iran's oil trade, for instance, and identified 58 government-owned ships, many of which have reportedly been renamed in order to elude sanctions. This is all part of an effort to force Iran into concessions in its intermittent talks with the five permanent members of the UN Security Council and Germany over its nuclear programme.

Pressure on Iran had been ratcheting up even before the latest US move. The US committed last December to shutting off access to its banking system for financial institutions involved in buying Iranian crude through the central bank in Tehran (although Washington has since granted plentiful waivers). This measure took effect on June 28th. Meanwhile, an EU embargo of Iranian oil imports came into full force on July 1st. So did a ban on European firms insuring tankers shipping Iranian oil. Even as the latest negotiating round (which began in April and convened most recently on July 3rd) stutters onwards, sanctions threaten to have a devastating effect on Iran's oil trade—the lifeblood of the Iranian economy and the source of around half of the government's revenue.

The market has already factored in much of the EU sanctions' impact on European demand for Iranian oil. Refiners in Europe, which bought under 20% of Iran's oil exports in the first half of 2011, have known since January that they would need to find alternative supplies of crude by July 1st. But the new and existing Western measures nevertheless helped to push up the price of Brent crude from US$88/barrel on June 21st to US$101/b by July 12th. The EU insurance sanctions mean that refiners everywhere are now prevented from purchasing protection and indemnity insurance ("P&I") against personal injury and environmental clean-up claims from European firms, which account for 95% of the global reinsurance market. So those still purchasing Iranian oil must either struggle to obtain insurance elsewhere or consider the costly alternative of providing their own.

Asia responds

Most buyers of Iran's crude are in Asia. Pressure on Iran will therefore grow if its Asian customers, who have already cut back on their purchases, keep slashing shipments. Here, the signs are mixed.

In Japan, the third-largest source of demand for Iranian oil, the Diet (parliament) in June passed a bill to provide US$7.6bn of sovereign guarantees for tankers shipping Iranian oil to Japan. But Tokyo's effort to bypass the EU insurance ban set a rare example. Small importers of Iranian oil (Taiwan and Sri Lanka) and larger purchasers (such as South Korea, which bought about 10% of its oil from Iran in the first half of 2011) were believed to be preparing to halt their uptake of new cargoes of Iranian crude by July. Moreover, reports have suggested that from July Indian state-owned firms would have to abandon plans to import 173,000 barrels/day (b/d) from Iran. In recent days it has been reported that state-owned Indian insurers are now allowed to offer cover for tankers carrying Iranian oil, but only up to US$50m. This is far less than the US$1bn typical of P&I policies.

By far the most important player to watch, however, is China. The largest importer of Iranian crude is Tehran's best chance to arrest the decline in its oil exports. Beijing reduced significantly its acquisition of crude oil from Iran in the first few months of 2012, although this seems mainly to have been due to a price dispute between Chinese oil major Sinopec and the National Iranian Oil Company (NIOC). Indeed, China has defended its crude purchases from Iran as "absolutely reasonable and legitimate". Shipments to China rebounded by a third in May, reaching nearly 524,000 b/d (albeit that they were down 12% on a year earlier). Still, it is possible that a last-minute, 180-day exemption from US financial sanctions might encourage Beijing to rein in its imports of Iranian oil in the remainder of the year.

Impacts

Primarily due to the West's sanctions, Iranian oil production (which averaged 3.6m b/d in 2011) and exports (2.3m b/d last year) have already fallen dramatically after beginning to tail off in late 2011. (Even before sanctions were imposed, underinvestment had made it likely Iranian oil production would decline.) Shipping data suggests that Iranian exports will drop to between 1.1m b/d and 1.3m b/d in July, which could correspond to total production of 3m b/d, according to a July 9th report in the Financial Times newspaper.

Both production and exports are likely to fall further. Sanctions' full effects on production will not be seen for several months, when storage capacity will be filled to over-brimming; forward purchases of oil will by then have been delivered. Iran's major Asian customers plus Turkey and South Africa will need to cut back on Iranian oil in order to achieve the "significant reductions" necessary to secure renewal of the six-month waivers granted by the US State Department. Over the course of 2012, the Economist Intelligence Unit forecasts that Iran will export 1.3m b/d, an average of 40% lower than last year. Iran's oil-export revenues will shrink by a comparable amount.

Whether the pain this causes in Tehran will have the effects desired by the West is a separate matter. The Iranian regime shows every sign of being ready to bear the economic costs of pursuing its nuclear ambitions (except, perhaps, in the unlikely event of military strikes against it). If anything, Iran is accelerating its atomic programme in order to deter the West from taking sterner measures. An unaltered Iranian nuclear stance, coupled with an apparent reluctance to compromise on the part of the US, mean that for now sanctions are here to stay.

The author Aniseh Bassiri Tabriziis a Doctoral Research Student in Midde East and Mediterranean Studies at King's College, London

The article was first published in the Economist Intelligence Unit's Energy Briefing & Forecasts