18-01-2012 15:09:56

Financial sanctions a better bet than EU oil embargo

Curbing crude exports will provoke a popular backlash against the West and strengthen Ahmadinejad’s hand

(Financial Times, January 18) – In recent weeks there has been intense speculation that in the event of a European Union oil embargo, Iran would try to close the Strait of Hormuz, through which flow 32 per cent of global oil exports and 28 per cent of global liquefied natural gas exports. Such an attempt is unlikely, although, to be clear, history suggests that sanctions would not work in constraining the Iranian regime.

The first reason to believe Iran might stop short of closing the strait is simply because such a move would fail. Cutting off Gulf oil supplies represents an existential threat to the West that it would have to use force to counter.

The response, if transit were seriously threatened, would rapidly degenerate into a shooting war between Iran and the US supported by many of its allies. While oil prices might reach unprecedented new levels, the US Navy would quickly restore access.

The second reason is that a serious threat to close Hormuz is arguably the principal Iranian deterrent against a military attack by the US or Israel on its nuclear facilities. So to use it in response to an EU oil embargo would be using that proverbial sledgehammer to crack a pistachio nut.

Iran does have other options to retaliate. It could intensify pressure on oil prices by contributing to the instability in Iraq that has followed the US troop withdrawal as the Shiite ruling clique has begun a de facto war of attrition against the Sunnis.

Replacements
This could cause problems with Iraqi oil exports. It could also make serious trouble for the Nato alliance in Afghanistan. And it could put huge pressure on the Gulf Cooperation Council (GCC) exporters to be, at the very least, slow in offering replacements to Europe.

At worst it could even threaten GCC export facilities. For example, the Abqaiq processing facility in Saudi Arabia, well within Iranian missile range, processes 5-6 million barrels per day. Some form of retaliatory action against the EU countries of the sort seen when the UK extended its sanctions could also be expected.

Nevertheless, history has shown that since the Iranian nationalisation of 1951 and the events leading to the overthrow of Mossadegh in 1953, oil embargoes simply do not work. The international oil market is too complex, with too many players and too many options to disguise transactions. History is littered with failed oil embargoes, ranging from Cuba, Rhodesia and South Africa to the embargo against Iraq after 1990. It is also worth highlighting that an EU oil embargo would greatly strengthen the regime of Iranian President Mahmoud Ahmadinejad at a time when it is under considerable pressure, especially with the parliamentary elections looming in March.

Unemployment remains high, as does inflation, which has been greatly aggravated by the removal of many price subsidies in the past twelve months. Also in the past few weeks, the value of the Iranian rial against the dollar has fallen dramatically.

Political considerations
At one point, before a recovery, the devaluation reached 30 per cent. This has damaged the credibility of the government and risks aggravating the problem of inflation. Given the crucial role of oil in Iran's deepest political DNA, an EU embargo would put the population solidly behind the current regime.

What would certainly be a more effective means for putting pressure on Iran is if the US can persuade the EU to extend sanctions to financial transactions. At the start of 2012, the US passed legislation imposing sanctions against undertaking financial transactions with the Central Bank of Iran.

Over the past 18 months access to finance for Iran in the EU has also become more constrained. However, using a financial embargo to restrain oil revenues also has problems.

It is possible importers of Iranian oil could resort to barter, thereby avoiding using normal financial instruments. This is clearly an option for China. There are also other financial routes such as banks, which could be used to disguise any financial trail.

While no route to restricting Iranian oil revenues is perfect, at least financial sanctions are not as likely to lead to a popular backlash as an oil embargo, which would be seen as an attack on Iran.

Despite the problems with financial sanctions, at least they have some possibility of pressing Iran in a way that a simple oil embargo cannot. An oil embargo alone cannot succeed.

TAGS: European Union, oil embargo, Iran, Strait of Hormuz, natural gas, Nato alliance, Afghanistan, Gulf Cooperation Council, Iranian nationalization, Mossadegh, Mahmoud Ahmadinejad, Central Bank of Iran