New Sanctions Against Iran Up the Pressure

This is the fifth in a six-part series explaining why the United States should continue to pursue an integrated strategy of diplomacy and tough economic sanctions to prevent Iran from obtaining nuclear weapons. It builds on the recent Center for American Progress report, “Strengthening America’s Options on Iran.” Each piece in the series looks at reasons why diplomacy is an effective approach to achieving this end.

This week we look at new sanctions against Iran agreed upon by the United States and its allies last week.

After negotiators from Iran and the P5+1—the five permanent members of the U.N. Security Council and Germany—failed to produce a meaningful agreement on Iran’s nuclear program at talks in Moscow last week, both the Obama administration and its EU counterparts agreed to move forward with a new wave of sanctions that will further limit Iran’s ability to export crude oil to potential buyers. The sanctions are two separate policies by the United States and Europe, but they share a common goal: isolating Iran for not living up to its international commitments on its nuclear program.

The U.S. sanctions

The new U.S. sanctions, initially detailed in the National Defense Authorization Act of 2012, (see text box) target foreign financial institutions that continue to make significant transactions on Iranian petroleum products, and they authorize the president to penalize these institutions by cutting them off from the U.S. banking system and financial institutions.

The United States already targets private financial institutions for such activities through the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010. But beginning on June 28, state-owned and operated banks and financial institutions will be subject to the same penalties.

For the vast majority of state-owned financial institutions, their business in the United States is overwhelmingly more important than their economic transactions with Iran. They have responded to the upcoming sanctions by significantly reducing their imports of Iranian crude oil. The United States is exempting 18 countries, including Japan, Germany, and the United Kingdom, from the new sanctions in recognition of their continuing “significant reductions” in oil imports from Iran.

These sanctions—combined with the ongoing diplomacy with countries around the world tied to their implementation—all serve to send Iran the message that it continues to isolate itself by not coming clean on its nuclear program.

As of right now, China has not received an exemption from these sanctions despite a 30 percent reduction in its imports of Iranian crude oil during the first quarter of 2012. Secretary of State Hillary Clinton said last week that China is moving in the right direction away from Iranian oil imports, which implies that an exemption may indeed be forthcoming.

The EU sanctions

Separate from the new U.S. sanctions, the European Union will begin enforcing a complete embargo of all Iranian petroleum products beginning July 1. (see text box) Businesses that continue to transport, purchase, or import Iranian oil products will face a fine determined separately by each member state. The loss of the European market, which was the destination for 18 percent of Iranian oil exports last year, could be devastating to Iran’s oil sector.

The impact of the new EU embargo reaches far beyond the continent’s borders, however. The council decision also bans European companies from reinsuring tankers carrying Iranian oil. The London-based reinsurance market currently covers 95 percent of the world’s tanker shipments, and few companies around the world are in a position to offer multibillion insurance on an oil tanker if it runs aground and causes the next Exxon Valdez.

Countries and businesses that continue to import Iranian oil are left with few available options to reinsure the shipments without the London market and they are more likely to find alternative suppliers than risk using uninsured oil tankers. The results can already be seen in South Korea, Iran’s fifth-largest crude oil customer last year, which announced that it will indefinitely suspend all Iranian oil imports because of the European insurance ban.

Current and expected effects of the sanctions

The United States and its allies have had the most success targeting Iranian assets and financial transactions through narrow avenues of disproportionate influence, such as the reinsurance market. Other such initiatives—including the Obama administration’s efforts to expel Iranian banks from SWIFT, a critical financial messaging service for international transactions, and limiting Iranian access to world reserve currencies—severely constraining Iran’s international transactions, have heavily damaged the Iranian economy. Some economists estimate that international sanctions have pushed annual inflation in Iran as high as 60 percent.

Officially, U.S. sanctions on Iran’s oil sector are designed to remove an important source of capital for Iran’s nuclear program. Indeed, Iranian oil exports accounted for roughly half of government revenue and almost 80 percent of total exports last year, serving as an important stream of money for a government funding a capital-intensive nuclear program.

But more than simply slowing down the pace of the Iranian nuclear program, the sanctions against Iran’s oil sector and the Central Bank of Iran increase political pressure on Ayatollah Ali Khamenei, the Supreme Leader of Iran and final authority on the country’s nuclear program. Key constituencies of domestic support, such as the Iranian Revolutionary Guard Corps and the merchant class, are being hit particularly hard by the economic toll of the sanctions and blaming the regime in Tehran, according to most anecdotal evidence. Additionally, Iranians recently responded to the country’s growing inflation by launching a three-day boycott of milk and bread purchases, a sign of growing domestic frustration with the country’s economic isolation.

The unified international diplomatic coalition built by the Obama administration hasn’t tangibly changed Iran’s stance on its nuclear program yet. But as Obama administration officials have repeatedly stated, the United States has many more tools and avenues to reshape Iran’s cost-benefit analysis of its nuclear program. The new U.S. and EU sanctions are the next step in that effort.

Next week we’ll close out the series by looking at the policy choices available for the United States and the international community to address the potential threat posed by Iran’s nuclear program.