The European Union's tough new Iran sanctions, which go into effect today, aim to pinch Iran where it will hurt the most: Iran's oil industry. Oil accounts for roughly 80 percent of Iran's exports, and Tehran derives more than half of its revenue from its energy sector.
Long a major oil and gas supplier, Iran now faces a decline in production, an urgent need to expand its refining capabilities, and a predicted surge in Iraqi oil output – all of which could significantly affect a regime that has become one of the Middle East's most powerful nations.
As Iran begins to feel the squeeze from this third set of sanctions – United Nations' June 9 sanctions were followed by tougher US measures adopted July 1 before the EU weighed in this week – the Monitor examines the status of Iran's oil industry and the challenges facing it.
How robust is Iran's oil sector?
Iran's output is declining because many of its oil fields are aging. Last month, the Paris-based International Energy Agency (IEA) predicted that Iran's production would drop by 18 percent by 2015, to about 3.3 million barrels per day (b.p.d.).
Though Iran is a major oil exporter, it has very limited refining capacity, and therefore imports 30 to 40 percent of its gasoline for domestic use – making it especially vulnerable to sanctions such as those the EU has adopted. It is striving to reduce imports, however, and brought them down by 8 percent last year.
How will sanctions affect it?
The United Nations passed a fourth round of sanctions against Iran in June, but did not include measures the United States sought to dent Iran's oil industry, which accounts for roughly 80 percent of the country's exports.
So the US passed its own sanctions, signed by President Obama on July 1, to penalize companies that invest in Iran's energy sector, export refined petroleum products to Iran, or supply services or technology used for refining petroleum. The law also prevents firms that do business with blacklisted Iranian companies and banks from accessing the US financial system.
The European Union also agreed last month to impose its own sanctions, including bans on new investment; technical assistance; and the transfer of technology, services, and equipment to Iran's energy sector. The EU sanctions were finalized yesterday and go into effect today.
Cliff Kupchan, Eurasia director at the Eurasia Group consultancy, called the sanctions "unprecedentedly strong."
"Heretofore, European IOCs [international oil companies] played a key role in … bringing in advanced technology and keeping production at least on a plateau," he said in an interview before they were finalized. "That golden bullet for the Iranians is about to disappear."
But many large international oil companies have already exited Iran, so the main impact of the EU's move may be in shutting out the smaller companies that help sustain Iran's oil industry. The investment ban could pinch Iran, since its aging oil fields and infrastructure need huge investments just to maintain current output.
"It would be hard for Iran to maintain its current production without a serious influx of foreign investment, and it's hard to imagine that happening under the current circumstances," says Iran expert Suzanne Maloney at the Brookings Institution in Washington.
But Flynt Leverett, director of the New America Foundation's Iran Initiative and the Geopolitics of Energy Institute, says the sanctions will not hugely affect Iran's energy sector because Chinese companies are already filling the void left by Western investors and companies.
They have signed deals worth billions in the past few years to develop Iran's oil and gas fields and infrastructure and, Dr. Leverett says, in most cases have or can develop the technical know-how to help Iran do it. "I wouldn't assume that the Iranians don't have options ... to keep things rolling along," he says.
But Mr. Kupchan disagrees, saying that "a lot of what Iran needs, China cannot provide."
How much influence does Iran have in OPEC and world markets?
As the second-largest producer in the Organization of Petroleum Exporting Countries (OPEC), Iran wields considerable influence, but Kupchan says it is declining.
Saudi Arabia has enough spare capacity that Iran can't manipulate the supply and price the same way it could several years ago, when supply and demand were much tighter. "Iran doesn't have a trump card anymore," he says.
Could Iraq's growing oil industry reduce Iran's influence?
While the IEA predicts Iran's oil will wane, analysts project neighboring Iraq could boost its production to 3 million to 4 million b.p.d. in the next five years. If the IEA's estimates are correct, that could put Iraq slightly ahead of Iran in terms of production.
In addition to 11 deals awarded last year to international oil companies in Iraq, Italian firm Eni SpA is currently assessing bids to open 100 new oil drills in southern Iraq, the Wall Street Journal reported earlier this month. Russian oil giant Lukoil has also said it will invest $5 billion to develop an oil field in the country's south, while Exxon Mobil is spearheading an effort to boost production through a water-injection system, the Journal added.
Will these factors change the dynamics of the Middle East?
Analysts say that even if Iran's oil revenues fall, the country will keep its foreign-policy priority of being a regional heavyweight that funds groups like Lebanon's Hezbollah. "They will jettison lots of things, including social programs, before they give way on geopolitical preeminence, and the nuclear program," says Kupchan.
New sources of friction could arise, however, as Iraq joins the ranks of major regional oil producers. It is unclear how Iran would react to being surpassed in oil production by the nation it has considered its "younger brother," says Kupchan. One possibility is "increasing strains between an aggressive Iran and an already newly assertive Iraq in a context where Iran has ... shown it is not averse to creating trouble on the borders and acting very provocatively in the region."
The potential for conflict also exists over oil and gas fields that Iran shares with Qatar and Iraq.
But as oil prices remain relatively high, sanctions and increased Iraqi production are not likely to produce significant changes in Iran, says Dr. Maloney.
"It's important to recognize that this is a country that has endured gigantic economic hard-ships in the past and has found a way around it," says Maloney. "What is going to change Iran is the internal dynamics."