What Impact Will New U.S. Sanctions Have on Iran?

October 31, 2018

By Elizabeth Rosenberg

Elizabeth Rosenberg held senior roles at the U.S. Department of the Treasury from 2009 to 2013, where she helped oversee the tightening of international sanctions on Iran. She is now a Senior Fellow and Director of the Energy, Economics, and Security Program at the Center for a New American Security.

 

The Trump Administration is imposing new sanctions on Iran’s oil exports on November 5. What impact are sanctions likely to have on Iran? How do these sanctions differ from previous U.S. or international sanctions?

The United States will reimpose scores of sanctions on Iran that it lifted in January 2016 under the terms of the Joint Comprehensive Plan of Action (JCPOA), the Iranian nuclear deal. The targets of the upcoming sanctions will be banks, including Iran’s Central Bank, the Iranian oil company, and many other significant economic actors in Iran. This set of measures follows a set of sanctions that the United States reimposed in August. Both the August measures and the November ones are the direct result of President Donald Trump’s May announcement that the United States would withdraw from the JCPOA. At that time and subsequently the U.S. administration has made clear that it will roll out a campaign of intensive economic pressure on Iran—one that goes far beyond merely the reimposition of the August and November tranches of sanctions. The goal of this pressure campaign, according to U.S. officials, is generating enough leverage to kick-start a fresh diplomatic process with Iran covering nuclear and regional issues.

The November 5 sanctions have already had an economic effect on Iran. Since May, when they were formally previewed by the U.S., many foreign investors have walked away from Iran. All of Iran’s oil buyers have decreased their call for cargoes. The market chill has showed up in dimming Iranian growth prospects and rising inflation and unemployment forecasts. It has moved global oil prices higher in anticipation of the supply choke-off. Iran’s leaders have acknowledged that they are facing challenging circumstances. They vow to fight them head on and have been pressuring the Europeans in particular to maintain economic opportunities for Iran in order for it to stay within the JCPOA.

Iranian tanker
An Iranian oil tanker approaching Rotterdam in the Netherlands in 2007

What is markedly different about this round of sanctions is that this time the United States is going it alone. Between 2012 and 2015, the period of intensive sanctions by the United States and its partners around the world, they acted together to pressure Iran to go to the nuclear negotiating table. None of the other parties to the JCPOA—or the traditional security allies of the United States, or the world’s major economies, or Iran’s biggest oil buyers—have joined with the United States in 2018. Undeniably, the United States has massive global financial leverage to pressure all countries and firms to stay away from Iran. But many companies also have lots of incentives to cheat. The United States will have to embrace a Herculean enforcement posture to beat back would-be evaders all over the world.

 

What is the state of Iran's economy now, especially after the first round of U.S. sanctions in August? How vulnerable is the Iran economically?

Iran’s economy has been weakening over recent months as firms have distanced themselves from Iran to avoid exposure to U.S. sanctions. The biggest economic challenge for Iran is the dipping demand for its oil. Oil sales are Iran’s biggest source of hard currency and are responsible for a significant component of its budget. Oil exports were about 2.3 million barrels per day in September 2017, but fell to 1.7 million barrels per day as of September 2018. The United States is pushing Iran’s oil buyers to stop purchasing altogether. Without that income, Iran will struggle, and growth will certainly contract. The IMF’s most recent World Economic Outlook report foresees Iranian growth contracting 1.5% in 2018 and a further 3.6% in 2019.  

 

But Iran has faced versions of this challenge in recent years yet has avoided state collapse or utter economic free-fall. Indeed, Iran has faced repeated currency and banking crises, and has been struggling with limited foreign investments for decades. The resiliency of coping with a “resistance economy” has conditioned generations of Iranians for living through very difficult times. The current sanctions pressure will provoke difficult circumstances for Iran, but they will not cause the economy to collapse or the political elites to capitulate to U.S. policy demands. 

By comparison to the enormous economic struggles of the 1980s, when Iran was locked into a war with Iraq, the economic fallout from more recent sanctions has been comparatively small. At the outset of the war in 1980, Iran’s GDP contracted by over 27% and, despite some rebounding, further contracted by over 8% in 1984 and over 10% in 1986, according to World Bank data. In comparison, at the peak of sanctions pressure in 2012 and 2013, GDP growth only contracted 7.4% and 0.2%, respectively.

One troublesome fact is that Iran has prioritized spending on war fighting and support for regional terrorist proxies even through the darkest economic periods in recent decades. Iran’s funding of Hezbollah, for example, has been consistent to keep the group lethal and destabilizing in the region. U.S. Treasury officials suggested in June that Iran provides Hezbollah nearly $700 million per year in funding, a substantial increase over estimates prior to the beginning of the Syrian Civil War. 

 

How will the next wave of sanctions impact the global energy market? Are any other oil producers likely to step in and increase their exports to compensate?

The sanctions are pushing global oil prices up, and will continue to do so as the United States pushes Iran’s oil buyers to zero-out purchases altogether. Iranian exports probably won’t drop to zero because such a supply cut-off would push the oil price too high, too fast, and because it will be very difficult for the United States to catch all sanctions evaders and avoiders. 

There are some alternative producers that will add oil to the market, a move that will relieve the high prices somewhat. Saudi Arabia has notably committed to adding an additional 2 million barrels a day to the market, but many analysts doubt that it can achieve that level or sustain it for any length of time. Saudi Arabia is already producing as much as it ever has, and analysts are nervous about execution, given that this would be a first. There are other producers, such as Libya, the UAE, and others (both in and out of OPEC) that will add more oil to temper prices. Eventually producers in the United States will also add more barrels to the market, although of a lighter grade of crude, to help alleviate the price pressure. 

 

What countermeasures is Iran taking to mitigate the impact of U.S. sanctions?

Iran has taken a number of measures to mitigate the impact of U.S. sanctions. Beginning in the spring, the Central Bank of Iran sped up plans to unify the official and unofficial exchange rates to limit the impact of U.S. sanctions on the Iranian rial, although that plan was largely unsuccessful at halting the currency’s depreciation. The Iranian government also limited imports of nearly 1,300 items and switched to reporting currency in Euros, in an effort to preserve hard currency and encourage businesses to move away from denominating trade in dollars. 

 

Iran has also taken steps to preserve oil exports. Iran reactivated its oil bourse, allowing private companies to purchase crude oil for export rather than going through the soon-to-be-sanctioned national oil company. But this has little hope of success. Iran has also attempted to mask oil shipments to allow higher levels of crude exports to a wider variety of destinations than official reporting suggests. There’s a stronger chance that this deceptive practice will meet with some success—as it has in the past. 

 

What countermeasures are the European Union and other key importers of Iranian oil—such as China, India, Japan and South Korea—taking to mitigate the impact of U.S. sanctions?

European leaders have led the public challenge to U.S. sanctions, reviving a 1990s-era blocking statute to support European firms exposed to the sanctions and offer compensation if they are hit with U.S. penalties. The EU, with the notable support of China, is also pioneering a non-bank special purpose vehicle to facilitate payments between Iran and international firms that might be sanctioned. Neither of these mechanisms is expected to be very successful in delivering hard currency to Iran and keeping it connected to the international financial system. Notwithstanding government backing, exceedingly few private firms in Europe and around the world relish the thought of tempting painful and expensive U.S. sanctions enforcement. 

Leading Asian countries are taking other measures to mitigate the impact of U.S. sanctions. In some cases, Asian firms are winding down business, including suspending transactions with Iran. They are seeking official waivers to keep purchasing Iranian oil, although in smaller volumes and turning to Iraq, Saudi Arabia, Kazakhstan, Mexico, and others for alternative cargoes of oil. In other instances, Asian firms are planning to continue business with Iran. For example, Chinese buyers of Iranian oil have been shifting away from international shippers severing ties to Iran to instead contract cargoes from the National Iranian Tanker Company. India allowed Iran’s Bank Pasargard to open a branch in India to shield Indian banks from sanctions. 

 

Photo credits: Dena tanker in 2007 by AlfvanBeem [CC0], from Wikimedia Commons