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EnergySource August 21, 2019

Sanctions prompt Iran to remain relevant in the global energy calculus

By Sara Bazoobandi

On August 4, the Iranian government announced that the Revolutionary Guard had seized a foreign oil tanker in the Persian Gulf. Iran claimed that the vessel was smuggling diesel fuel to Iraq, but the Iraqi oil ministry denied any connection with the tanker. Global shipping companies had not reported any missing vessels in the Persian Gulf. This is the third seizure of a vessel by Iran in recent weeks. Since US sanctions were reinstated on Iran last year, the Iranian government has struggled to export oil and other hydrocarbon resources. Iranian officials have frequently threatened that, if Iran is prevented from using the Persian Gulf to export oil, they will block the transportation channel for other regional exporters.

The US government’s maximum pressure strategy on Iran has contributed to:

  1. Economic hardship in Iran: The reinstated sanctions have had severe impacts on Iran’s economic growth, inflation, and employment. Moreover, sanctions have significantly contributed to the most recent currency crisis in Iran. Between May 2018 and 2019, the riyal has lost more than 400 percent of its value. As a result, illegal imports of consumer goods, unofficial economic activities, and the smuggling of Iranian products to neighbouring countries has increased. Energy prices in Iran are lower in comparison with some of Iran’s neighbors. This has created an arbitrage for fuel smuggling from Iran. The price of petrol in Iran, based on the average currency exchange rate of the past twelve months, is about 10–12 cents. In Pakistan, Iraq, and Turkey, it is 75, 63, and 150 cents, respectively. According to the Majlis Research Centre, fuel smuggling from Iran is as high as 11.5 million litres per day. The Iranian government has taken various measures to address the issue, such as continued fuel rationing and punishing smugglers.
  2. Escalation of tension in the Persian Gulf: Tehran has been sending a series of mixed signals that indicate both Iran’s desire for a peaceful resolution with the United States, and an increasing risk of a military confrontation. Recent developments in the Persian Gulf include Iran seizing and attacking oil tankers and both Iran and the United States downing drones. Such events undermine the degree of security and stability that is required to allow secure transport of one third of the world’s sea-borne oil. In addition to Iran, Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, and Iraq also rely on oil shipments via the Persian Gulf for their exports, to varying degrees. According to Bloomberg, an increasing number of vessels have recently begun to use a series of new methods, such as turning off their transponders as they pass through the Strait of Hormuz, in order to minimise the risk of seizure by Iranian forces. War-risk insurance has increased for vessels that seek to pass through the Gulf as tensions have risen. In July, the United States announced plans to form a coalition of military allies to ensure freedom of navigation in the Persian Gulf.

The security of energy transports through the Gulf is now linked closely with the future of US sanctions, and Iran is motivated to remain relevant in the global oil marketIran’s crude export has declined dramatically since the sanctions have been reinstated, but the effect on the global price of oil was insignificant. Saudi Arabia and other Gulf producers have reportedly increased production to ensure a steady global supply. As a result, despite the oil sanctions on Iran, crude prices have remained relatively stable. Therefore, not only have the sanctions affected Iran’s market share and export income, but sanctions have also caused Iran to lose its significance in the global energy calculus. Iran’s role in the security of energy transportation via the strait of Hormuz is, therefore, Iran’s only chance to stay relevant in the global energy market.

Moreover, Iran is motivated to maximise its bargaining power. The current tension levels between Iran and the United States could potentially lead to the renegotiation of a new deal, some form of military confrontation, or a long period of instability in Iran. Although renegotiation seems to be the safest option for the Islamic Republic, the establishment is not united over the terms of the negotiations. Delaying the negotiations while gaining more clout is, therefore, the best strategy for Iran. Playing a role in the security structure of the Persian Gulf does indeed help Iran to gain some negotiation power.

All in all, the Islamic Republic is determined to push back against maximum US pressure. Increasing naval activities in the Persian Gulf seems to be the most effective strategy for Tehran. Iran’s actions will not only be disruptive for security of energy transportation through the Gulf but they will also increase the risk of a sudden military escalation. In the short-term, the business of energy transportation through the Gulf is more likely to continue as usual. However, as pressure from sanctions continues to increase, the risk of destabilising actions by Iran will rise.

Dr. Sara Bazoobandi is a senior fellow with the Atlantic Council’s Global Energy Center and Global Business & Economics Program.

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Image: Dust plumes over the Persian Gulf, July 1, 2011 (photo by NASA, MODIS Rapid Response Team, Goddard Space Flight Center).