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Iran Adapts to Economic Pressure
Oil Market Could Help It Weather U.S. Sanctions

By Steven Mufson and Robin Wright
Washington Post Staff Writers
Monday, October 29, 2007

Confronted by mounting U.S. and U.N. pressure, Iran has been steadily shifting its trade from West to East and, with the benefit of record high oil prices, is likely to be able to withstand the new U.S. sanctions, according to U.S., European and Iranian analysts.

China, a permanent member of the Security Council that can veto any U.N. resolution, is expected to overtake Germany as Iran's biggest trading partner this year. Germany and other European countries had consistently been Iran's largest trading partners for more than a decade, according to the Iran Investment Monthly.

The U.S. Treasury said that more than 40 banks, mostly in Europe, have curbed business with Iran as a result of U.S. pressure, but smaller banks, Islamic financial institutions and Asian banks are likely to step in and replace the Western financial institutions through which Iran has long sold oil on the international market. Oil traders said that Iran does an increasing portion of its petroleum sales in euros and yen, instead of U.S. dollars, and often through third parties, to help its customers circumvent U.S. financial sanctions.

"Given particularly the price and demand for oil, Iran clearly has leverage with countries that need Iran's oil," said Shaul Bakhash, a George Mason University historian and author of "The Reign of the Ayatollahs." In addition, he said, "Iran has a huge cushion of foreign-exchange reserves."

Iran's oil revenue this year will far exceed the government's budget forecasts, which had assumed an average oil price of $60 a barrel. On Friday, oil settled above $90. The extra revenue will make it easier for the government to maintain social-services payments designed to bolster its popularity amid economic problems.

Iran has also moved to protect what Leo Drollas, chief economist of the Center for Global Energy Studies in London, calls its Achilles' heel -- gasoline imports. Because of its limited refining capacity, Iran last year imported 200,000 barrels a day of gasoline, about a third of its consumption. But the government has trimmed gasoline subsidies, which has curtailed consumption and smuggling, cutting imports of gasoline in half.

Nonetheless, U.S. efforts to exert financial pressure on Iran were having some impact, even before the new measures taken last week against firms linked to Iran's Revolutionary Guard Corps.

Lukoil, a Russian company with an extensive gasoline marketing network in the United States, announced last Monday that its exploration work in Iran's big Anaran oil field "is currently impeded because of the U.S. sanctions," which bar investments of more than $20 million in Iran.

The U.S. sanctions, announced Thursday, complicate new oil projects by targeting Iran's main oil-field engineering firms. The firms are controlled by the Revolutionary Guard, which the Bush administration has accused of supporting terrorism and aiding nuclear proliferation. One of the firms sanctioned Thursday, Khatam al-Anbiya, is the rough equivalent of the Army Corps of Engineers, according to Karim Sadjadpour, an associate at the Carnegie Endowment for International Peace. The Treasury Department said the firm had $7 billion of contracts in the oil, natural gas and transportation sectors.

European oil companies are holding off on exploration and production deals in Iran. Royal Dutch Shell, Total of France and Italy's ENI have held talks or reached preliminary agreements for new oil and gas projects in Iran in recent years. But now they say they are unlikely to move ahead, in large part because of the commercial terms Iran is offering.

Chinese oil companies have not signed contracts yet for commercial reasons, according to Julia Nanay, a Caspian region expert at PFC Energy, a Washington consulting firm.

The picture on the financial front is similar. The United Arab Emirates, a key transit point for Iranian imports and a major financial center for Iran, had closed 42 firms doing business with Iran before the new sanctions list, said an official there.

He said it remained unclear how the new U.S. measures would affect Iran's Bank Melli, targeted by Treasury for allegedly facilitating ballistic and nuclear equipment purchases. The bank, Iran's largest, had nearly $1.4 billion in assets in its U.A.E. branches at the end of 2005, according to its Web site. Bank Melli also has branches in London, Paris and Hamburg.

Even if Iran finds ways around U.S. financial sanctions, U.S. pressure could increase the costs of Iran's international banking transactions. European and Japanese banks have made it more difficult for Iran to arrange letters of credit, Drollas said.

"Most of Kuwait's banks have stopped dealing with Iranian accounts," said Abdul Majeed al-Shatti, chairman of Commercial Bank of Kuwait. "There are opportunities in Iran. Unfortunately, we need to be part of the international system," he said. "We have a lot of dealings with the United States." He said his bank had not issued any letters of credit for transactions with Iran in more than a year.

"It raises the cost of operation for all Iranian banks," said Jahangir Amuzegar, a former Iranian finance minister and representative to the World Bank before Iran's Islamic revolution. "But whether sanctions are going to cripple banking operations, I don't think so. Sanctions are effective only if they are comprehensive and universal."

Germany and France have been slowly reducing banking exposure and government credit guarantees for exports to Iran, thus shrinking potential for losses in the event of a confrontation with Tehran. Germany issued about $2 billion of credit guarantees for trade with Iran in 2005, helping companies do business that might otherwise be too risky. This year, the government said, the guarantees will drop to about $715 million. France's embassy in Washington said French banks reduced their exposure to Iran from $5.7 billion in December 2005 to $3.8 billion a year by the end of 2006.

Both countries still buy oil from Iran.

The most important question may be what political and psychological impact the sanctions will have on Iran, especially with parliamentary elections next spring and presidential elections in 2009. Iranian President Mahmoud Ahmadinejad has faced growing internal rumblings over his erratic economic policies.

A few critics of the regime inside Iran have gone public. "Are we to endure the hardship of sanctions and other harsh measures on our nation as a result of our illogical and unreal glorification?" Mohsen Mirdamadi, former chairman of parliament's foreign relations committee, said at a reformist conference Friday.

But other observers said that sanctions had little political effect in places like Cuba, Rhodesia (now Zimbabwe), South Africa and North Korea. "Iranians have a strong sense of themselves," said J. Robinson West, chairman of PFC Energy. "If these new sanctions create internal problems and cause the people to unify, then they won't work. But if the sanctions can drive a wedge" between the regime and its constituents, they have a chance to work.

Sanctions could even generate greater resistance. "This is a regime that hates to be seen to be backing off under international and U.S. pressure, so it seems unlikely that the threat of international sanctions alone will cause the Iranians to back off on the nuclear issue," said Bakhash, the George Mason historian.

Carnegie's Sadjadpour said: "These sanctions are not negligible, and they're not going to be pain-free for Iran. The question is: Will they be substantial and painful enough to change Iranian behavior? No, I don't think they will be."

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