The Fractured Power
How to Overcome Tribalism
On August 5, the Trump administration reinstated a first set of U.S. sanctions on Iran that had been suspended under the Joint Comprehensive Plan of Action (JCPOA) nuclear deal. But the bulk of U.S. sanctions on Iran will not come back into force until November 5, 180 days after Trump’s initial May 8 announcement that Washington would withdraw from the agreement. On that date, all of the U.S. sanctions suspended by the JCPOA will be reinstated, including the most important of all: the sanctions on Iran’s oil exports.
Sanctions on oil exports have the potential to be economically devastating to Tehran. Iranian Deputy Oil Minister Habibollah Bitaraf said in June that Iran’s government took in an estimated $50 billion from the sale of oil in fiscal year 2017 and that oil and petroleum products made up 70 percent of Iran’s total exports. With the value of Iran’s currency already falling 50 percent since Trump pulled the United States out of the JCPOA and street protests spreading against Iran’s government, cutting off Tehran’s biggest source of cash has the potential to dramatically hit Iran’s already ailing government.
If they play their hand well, Trump officials can secure large reductions in Iran’s oil exports. But doing so requires the administration to navigate both complex global oil markets and a multilevel diplomatic game involving both governments and global companies. Trump will have to manage deft diplomacy with Iran’s largest customer, China, which has made decisions on Iranian oil within the broader context of rising U.S.-Chinese trade tensions. He will have to maintain a relentless campaign against Iranian sanctions evasion. And he will have to deal with the fact that unilateral U.S. sanctions on Iran’s oil purchases may hasten global efforts to build a mechanism that foreign countries can use to conduct trade despite U.S. sanctions in the future.
The first challenge the Trump administration must navigate in reimposing Iran’s oil sanctions is minimizing adverse impacts on global oil supplies. Iran produced approximately four million barrels of oil per day in 2017—roughly four percent of total global production—and exported 2.1 million barrels per day. Taking that much oil off the markets too quickly could have dramatic impacts on global oil prices.
Fortunately, the U.S. oil sanctions were designed with global markets in mind. Instead of forcing countries to immediately eliminate oil imports from Iran, the president can offer countries an exception to continue importing Iranian crude, as long as the countries “significantly” reduce their volumes of Iranian oil imports every six months. The administration of former U.S. President Barack Obama used this flexibility to push for a phased reduction in Iran’s oil exports by one million barrels per day over a period of about 18 months. Trump should adopt a similar approach—even if he sets an even more aggressive target than Obama did for the absolute volume of reductions—and implement oil sanctions on a phased timeline that minimizes impacts on global prices.
With the Brent crude oil benchmark in the mid-$70s, current oil prices are well below the $100 plus that a barrel of oil cost in late 2011 and 2012, when Congress and the Obama administration imposed the first round of oil sanctions on Iran. But prices are up nearly 50 percent over the past 12 months, driven by declines in crude oil output from Venezuela, where the oil industry is collapsing thanks to mismanagement and corruption, and instability in Libya and Iraq that creates intermittent supply disruptions. Markets have proven keenly sensitive to the potential impacts of U.S. sanctions on Iran. After a State Department official told reporters in late June that Washington might require all importers of Iranian crude to eliminate their purchases by November, oil prices quickly jumped by several dollars per barrel, before falling back after the Trump administration indicated it was open to at least some sanctions exceptions and OPEC announced plans to increase production.
The United States has responded to the market challenges by pressing Saudi Arabia to increase production to offset Iranian reductions. At least in the short term, this approach appears to be keeping a lid on further price increases. But if the Trump administration presses to reduce the volume of Iran’s oil exports faster than markets expect, it faces a substantial risk that oil prices will resume their upward climb. Many energy analysts, including the U.S. Energy Information Administration, expect additional oil supplies to come online in late 2018 and the first half of 2019, driven by increasing production in Brazil, Canada, the United States, and elsewhere. This anticipated new production creates some potential future breathing space for reductions in Iran’s oil exports, and the Trump administration should peg the volume of the reductions it seeks in Iranian crude oil exports to the availability of these other projected supplies.
The second challenge Trump faces in reinstating oil sanctions against Iran is convincing Iran’s primary customers to quit—or at least to significantly reduce the volume of their purchases. The United States will need to engage in multidimensional diplomacy that engages both governments and global companies.
The Obama administration’s preferred approach to oil sanctions in 2012 and 2013 was to negotiate with foreign governments to cut their imports. The European Union, for example, agreed to end all imports of Iranian crude, while China, India, Japan, Turkey, and South Korea all agreed to reduce their purchases in exchange for exceptions.
This government-focused approach will probably still prove fruitful with Japan and South Korea, which together imported several hundred thousand barrels per day of Iranian crude in 2017. Neither wants to cut its imports of Iranian crude, and both have asked the Trump administration to let them continue importing at least reduced quantities of oil. But the Trump administration ultimately holds an ace card: both Tokyo and Seoul need Washington’s support to address the North Korean nuclear threat and to counter China’s increasingly assertive posture in Asia. Neither government wants to risk a major rift with Trump over Iran.
The diplomatic situation looks different in Europe, where governments are adamantly opposed to the Trump administration’s withdrawal from the JCPOA and much less willing to negotiate reductions in their countries’ volumes of Iranian imports. Indeed, several European governments will see the very act of sitting down to negotiate over reductions as a concession and may refuse to talk. Government-to-government negotiations over European oil reductions are unlikely to yield much fruit.
Trump officials, however, will find greater success with individual European companies. Major importers of Iranian crude in Europe include Italy’s ENI and Saras, Spain’s Repsol, France’s Total, and Greece’s Hellenic Petroleum. All of these companies depend on access to U.S.-dollar financing, global insurance markets, and U.S. suppliers, and several have significant operations in the United States. None of them want to risk being sanctioned over purchases of Iranian crude. If Trump requires these companies to cut or eliminate their imports, they almost certainly will. Indeed, press reports suggest that several of these companies are already planning to slash their purchases of Iranian oil before the U.S. sanctions come back into force.
The Trump administration can bolster its negotiating position by using sanctions on key chokepoints in the oil business to disrupt shipments of crude to companies that are reluctant to cut their purchases. Many European shippers and importers of Iranian crude rely on British and European insurance companies in order to operate. Ports, for example, will typically not let an oil tanker unload crude oil unless the ship can show that it is insured. Trump can threaten these insurance companies with sanctions as a way of forcing the shippers and refiners to drop plans to keep purchasing Iranian oil. The administration has already made clear that it will sanction the banks that process payments for Iranian oil, complicating Iran’s ability to get paid even by refiners that want to keep purchasing. Taken together, these measures will likely force Europe into cutting its Iranian crude imports despite government objections.
The biggest near-term diplomatic challenge for the Trump administration, however, will be the country that is Iran’s largest customer and whose companies have the greatest capacity to ignore threats of U.S. sanctions: China.
China imports approximately 500,000 barrels per day of Iranian crude, or about a quarter of Iran’s exports, and officials in Beijing have given no indication that they plan to cut those volumes. China, unlike Europe, is also well prepared to resist threats of sanctions against its companies. A number of China’s smaller “teapot” refiners have essentially no business exposure to the United States and could keep importing Iranian oil even if Washington sanctioned them. China also has a number of domestic banks that could process payments for Iranian oil even if sanctioned. (Large Chinese oil companies, on the other hand, do have exposure to the United States and will likely seek to avoid running afoul of U.S. sanctions.) Indeed, Beijing has experience with this model. In 2012, Washington sanctioned China’s Bank of Kunlun for transacting with Iran despite U.S. sanctions. China responded by beginning to route billions of dollars of Iranian oil transactions through the Bank of Kunlun, which had little commercial exposure to the United States. This also meant that other, larger Chinese banks—banks that had significant U.S. exposure—could avoid Iran-related transactions.
Given that China has commercial options to resist U.S. sanctions pressure, the question for Beijing is fundamentally political, not economic. China must decide if it wants to continue importing Iranian oil and fight with the Trump administration over Iran or whether it would prefer to reduce imports and avoid the conflict.
Whatever Beijing decides, Chinese officials will make their call on importing Iranian crude within the context of overall heightened trade and commercial tensions with Washington. If leaders in Beijing decide that cutting imports of Iranian crude offers a low-cost concession to Trump that would win reciprocal U.S. concessions on trade or on regional issues in Asia, China will tell Tehran that it wants to buy less oil. On the other hand, if Beijing decides that cutting imports of Iranian crude would simply send Trump a message of Chinese weakness with little chance of winning reciprocal goodwill in Washington, China will likely continue to take in Iranian tankers.
Even if Iran’s major customers agree to reduce their purchases of Iranian crude, the Trump administration will need to maintain a relentless pressure campaign against evasion techniques by Tehran. Between 2011 and 2015, Iran adopted a number of deceptive tactics to evade sanctions and find illicit markets for its crude. Iranian tankers, for example, would engage in ship-to-ship transfers, offloading crude into smaller tankers that would then falsely market their cargo as originating from someplace other than Iran. Tehran could also smuggle both oil and refined gasoline overland to neighboring countries, including Turkey, Pakistan, and Afghanistan.
Even if Iran’s major customers agree to reduce their purchases of Iranian crude, the Trump administration will need to maintain a relentless pressure campaign against evasion techniques by Tehran.
These evasion tactics suffer from logistic challenges. Iran can’t replace the volumes of oil that sell via large oil tankers simply by sending pickup trucks filled with jerry cans into Pakistan. But it can nonetheless generate tens of millions of dollars in revenue through sanctions evasion.
Limiting Iranian evasion is possible but will require sustained effort. The Trump administration will need to invest significant resources in tracking ships that load oil in Iranian ports and publicizing ship-to-ship transfers, similar to the way the administration has published information on suspected illicit coal shipments shipped out of North Korea. And the Treasury Department will have to rigorously sanction the individuals and companies involved in evasion schemes in order to keep a lid on Iran’s sanctions evasion.
The Trump administration’s diplomacy and the liberal use of sanctions threats against energy companies in Europe are likely to drive a reduction in Iran’s oil exports, at least through 2019. But assuming Trump succeeds in this immediate goal, over the longer term his diplomacy could raise the specter that foreign countries will band together to develop mechanisms to enable trade that is insulated from U.S. sanctions—much as China can already do to some extent.
Former U.S. Treasury Secretary Jack Lew warned in a 2016 speech that there is a “risk that overuse [of sanctions] could ultimately reduce our capability to use sanctions effectively” by driving global financial transactions and business away from the United States. To date, discussions of developing sanctions-resistant trading schemes have been largely confined to rogue regimes, including those of Venezuelan President Nicolás Maduro and Russian President Vladimir Putin, that lack much global economic clout. But the U.S. reinstatement of sanctions on Iran is forcing U.S. allies in Europe to look at ways to fight back.
Europe’s biggest retaliatory step to date has been to update a “blocking regulation” that legally prohibits EU companies from complying with U.S. sanctions on Iran. European companies, however, are still likely to comply in practice, if not in public statements, with U.S. sanctions despite the regulation, given that the penalties for violating U.S. sanctions are far more severe than the expected penalties under the blocking regulation.
A few European governments appear keen on developing a more aggressive approach to resistance. Several European officials have discussed asking the European Central Bank or another European government-controlled bank to start handling payments for Iranian oil. The French government appears to be considering the feasibility of the government itself taking responsibility for importing Iranian oil as a way around U.S. leverage over French companies. France would face severe operational challenges setting up such a scheme before U.S. sanctions come back into force in November, and success in the near term is unlikely. But Trump’s approach to Iran risks spurring serious long-term EU and global discussions about ways to insulate companies from U.S. sanctions pressure over the long term.
These risks are not immediate, and the hypothetical risk of a long-term erosion in the U.S. sanctions tool will not deter Trump from pursuing the priority of slashing Iran’s oil exports. But American diplomatic and sanctions officials looking over the horizon should take the threat seriously. After securing the oil reductions they seek, diplomats will need to work hard to restore frayed relationships, blunt the efforts of allies to insulate themselves from future U.S. pressure, and ensure that U.S. sanctions will remain as sharp a policy tool a decade from now as they are today.