Congressional Quarterly,
CQ Congressional Testimony
July 25, 2006 Tuesday
COMMITTEE: HOUSE JOINT ECONOMIC
HEADLINE: ENERGY AND THE IRANIAN ECONOMY
TESTIMONY-BY: ILAN BERMAN, VICE PRESIDENT
AFFILIATION: AMERICAN FOREIGN POLICY COUNCIL
Statement Ilan Berman Vice President for Policy American Foreign
Policy Council
Committee on House Joint Economic
July 25, 2006
Chairman Saxton, Vice-Chairman Bennett, distinguished members of the
Committee: It is a privilege to appear before you today to discuss
the subject of the Iranian economy and U.S. policy options.
There is no greater foreign policy challenge facing the United States
today than the one posed by the Islamic Republic of Iran. The Iranian
regime’s persistent work on its nuclear program, and its intransigence
in the face of international demands, has catalyzed a growing crisis
that threatens international peace and security. So far, however,
there has been little public discussion about the economic dimension
of the current crisis, or of the financial levers available to the
United States and its international partners to alter Iranian behavior.
WHAT FUELS IRANIAN INTRANSIGENCE?
More than any other factor, Iran’s defiance in the current stand-
off with the West over its nuclear program has been made possible by
energy. Over the past several years, the Islamic Republic has emerged
as a bona fide energy superpower. Home to approximately 10 percent of
world oil, Iran is the second largest exporter in the Organization
of Petroleum Exporting Countries (OPEC), producing an average of
3.9 million barrels of oil per day. At the same time, Iran sits
atop the world’s second-largest reserves of natural gas (some 940
trillion cubic feet). As a result, Iran’s economy is overwhelmingly
energy-based. Today, the vast majority (80 to 90 percent) of Iran’s
export earnings, as well as about one half of its budget and a quarter
of its gross domestic product, is derived from energy exports to the
international community.
In the past, this energy-dominated economy has led to wild fluctuations
in Iran’s financial fortunes. During the late 1990s, plummeting
world oil prices left the Iranian regime nearly bankrupt.2 Today,
however, quite the opposite is true; the rising price of world oil
generated by political instability associated with the War on Terror
has provided Iran with a staggering fiscal windfall. As of March
2006 (the end of Iranian calendar year 1384), officials in Tehran
were publicly estimating their country’s hard currency reserves at
some $50 billion.3 These added resources and financial cushion can be
expected to dramatically increase the Iranian regime’s willingness to
engage in risky regional behavior, as well as to accelerate the pace
and scope of its strategic programs, in the months and years to come.
Iranian officials have attempted to solidify this economic status
through a major expansion of their country’s international energy
profile. Over the past two years, Iran has signed two massive
exploration and development accords, worth an estimated $100 billion
over the next twenty-five years, with China alone.4 A growing number
of other nations, including France, Malaysia, Japan, Canada, and
Italy, are now engaged in the development of existing oil fields
within the country, and this involvement is expected to increase
as recent discoveries including the Azadegan field and Bangestan
reservoirs in southern Iran, as well as the offshore Dasht-e- Abadan
site near the southwestern port city of Abadan begin to come online.
Iran has also commenced efforts to become a major global exporter
of natural gas. Since 2002, it has supplied Turkey with substantial
natural gas deliveries via a bilateral pipeline link and, according
to official Turkish government statistics, could provide roughly 20
percent of total Turkish natural gas consumption by the end of the
decade.5 A similar arrangement is emerging between Iran and Armenia as
part of a pipeline, currently under construction, that could supply
Armenia with up to 47 billion cubic meters over a period of 20 to 25
years, beginning in 2007.6 Iran has opened similar discussions with
Georgia, and has even taken steps to coordinate natural gas policy
with Moscow as part of a Russia-led natural gas cartel now emerging
in the post-Soviet space.
At the same time, the Iranian regime has dramatically increased its
ability to leverage its strategic location in the Strait of Hormuz,
the principal passageway for roughly two-fifths of world oil trade.
According to U.S. intelligence estimates, a sustained national
military rearmament over the past several years has provided Iran
with the ability to temporarily shut off the flow of oil from the
Persian Gulf, even with a Western military presence in the region.
It is a testament to this energy clout that, as the international
crisis over Iran’s runaway nuclear ambitions has deepened, Iranian
officials have repeatedly raised the specter of a disruption of energy
trade in the Persian Gulf. Regime officials such as Mohammed-Nabi
Rudaki, deputy chairman of the Iranian parliament’s national security
committee, have warned that the Islamic Republic has the power to
"to halt oil supply to the last drop from the shores of the Persian
Gulf via the Straits of Hormuz" should serious measures be undertaken
against the Islamic Republic at the United Nations.9 Similarly, Iranian
president Mahmoud Ahmadinejad has warned the United States and Europe
that the global price of crude has not yet reached its "real value."10
Even Iran’s Supreme Leader, the Ayatollah Ali Khamenei, has threatened
the West with disruptions in fuel shipments from the Persian Gulf in
the event of a "wrong move" against Iran.11 And regime officials have
concretely demonstrated their capacity to do so, holding a week-long
series of aerial, naval and ground maneuvers in the Persian Gulf in
April 2006 to showcase the force-projection capabilities of their
elite clerical army, the Pasdaran.
ASSESSING IRANIAN VULNERABILITIES
Given such posturing, it is not surprising that some analysts have
concluded that energy is Iran’s "trump card" in its dealings with the
West. This economic leverage, however, is a two- way street and on
at least three fronts, Islamic Republic is susceptible to economic
pressure from the international community.
Commodity shortages
Despite massive oil exports of some 2.5 million barrels a day, Iran
currently imports more than a third of its annual consumption of over
64.5 million liters of gasoline from a variety of foreign sources
(among them India, France, Turkey and China) at an estimated cost
of more than $3 billion annually.13 These imports are not surplus;
Iran reportedly maintains just 45 days worth of gasoline domestically,
and requires steady supplies of refined petroleum products from abroad
for the continued functioning of its economy. Mounting international
pressure, moreover, is already raising the costs of these deliveries.
One leading Iranian policymaker has predicted that the regime will
need to spend an extra $5 billion this year alone to maintain its
established policy of deep subsidies on the sales of gasoline and
avoid domestic rationing.15 This suggests that the imposition of an
embargo on foreign gasoline supplies to Iran could achieve rapid
results ranging from the depletion of hard currency reserves to a
work stoppage in many of Iran’s industrial sectors.
Centralized economic hierarchy
Today, the vast majority of regime wealth is concentrated in the
hands of a very small number of people, whose associates and relatives
dominate the Iranian economy. The extended family of former Iranian
president (and current Expediency Council chairman) Ali Akbar Hashemi
Rafsanjani, for example, now virtually controls copper mining in Iran,
the regime’s lucrative pistachio trade, and a number of profitable
industrial and export- import businesses. A related economic
power center is Iran’s bonyads, the sprawling, largely-unregulated
religious/social foundations overseen by Iran’s Supreme Leader, which
account for between 10 and 20 percent of Iranian national GDP. Given
this economic hierarchy, targeted financial measures that restrict the
ability of these individuals and organizations to access international
markets and curtail their capacity to engage in commerce are likely
to have an immediate and pronounced effect on regime decision-making.
Foreign direct investment
The dozens of billions of surplus dollars collected by the Iranian
government over the past two years as a result of the rising price
of world oil have done little to diminish Iran’s need for foreign
direct investment. According to authoritative estimates, Iran’s energy
sector still requires some $1 billion annually to maintain current
production levels, and $1.5 billion a year to increase capacity.
Without such sustained capital, studies say, Iran could revert
from an energy powerhouse to a net energy importer in the span of
very few years.19 Given the scope of current investment in Iran,
it is unrealistic for the U.S. and its allies to expect to be able
to achieve a comprehensive economic isolation. However, if broad and
forceful enough, multilateral sanctions may complicate Iran’s access
to foreign funding, and/or force a depletion of the hard currency
reserves that the regime has amassed over the past several years.
THINKING BEYOND THE UNITED NATIONS
Today, the United States has the ability to capitalize upon these
vulnerabilities. International economic sanctions can help to slow
Iran’s nuclear progress and signal the international community’s
opposition to an Iranian bomb. If coupled with effective public
diplomacy, such measures can also drive a wedge between the Iranian
government and its people over the prudence of nuclear acquisition.
Moreover, history has shown that the effectiveness of sanctions can
be enhanced by the speed and scope with which they are applied.
It is becoming exceedingly clear, however, that the United Nations
is not the optimal vehicle by which to apply such pressure. Already,
protracted diplomatic wrangling has provided Iran with valuable time
to reduce its economic vulnerabilities. In recent months, Iran has
carried out large-scale transfers of assets from Europe to financial
institutions in China and Southeast Asia, as well as initiating a
major privatization of governmental funds. Most recently, Iran’s
parliament has approved a new fiscal budget that calls for a halt to
imports of refined petroleum products and the institution of gasoline
rationing starting this Fall.3 The goal of these efforts is clear:
to limit Western economic leverage over Iranian behavior.
Timing should also be a major consideration. In late May, Secretary
of State Condoleezza Rice signaled a sea change in American policy
toward Iran when she announced that the United States would join
Europe in proffering a "package" of incentives aimed at bringing
the Islamic Republic back to the nuclear negotiating table. Iran,
in turn, has maintained that it is studying the offer and will
provide a formal reply in late August.24 It is unclear whether
the international community will wait until then to seek Security
Council action against Iran, but it is reasonable to expect that
forceful international action still remains some weeks or months
away allowing Iran to continue minimizing economic vulnerabilities
and forging ahead with its nuclear effort. All of this means that,
if and when economic sanctions are again on the table, their stated
task to alter the regime’s behavior with relation to its nuclear
program will be even more difficult to achieve than it is today.
Moreover, if and when United Nations sanctions do materialize, they
are likely to be deeply influenced by politics. Russia and China both
wield veto power over Security Council action against Iran, and while
Moscow and Beijing appear to have endorsed more robust measures against
Iran should the current negotiations fail, any steps taken will need
to be carefully calibrated so as to preserve the support of those
states. As a practical matter, this means that the economic pressure
applied against Iran will be both gradual and limited in scope.
Given these difficulties, Washington would be far better served by
the establishment of an economic coalition outside of the confines
of the United Nations. Through such a construct, the United States
would have far greater ability to control the timing, extent
and application of economic pressure on Iran, without Security
Councilimposed constraints. It would also provide the U.S. and its
coalition partners with greater political flexibility to apply those
specific measures most likely to alter Iranian behavior.
THE LIMITS OF IRANIAN OIL POWER
Today, Iran holds the ability to exert a high price from the world
if it is stymied in its nuclear efforts. But political and economic
realities suggest that Iran’s oil power is far more limited than
commonly understood.
Iran could indeed curb oil exports, as regime officials have repeatedly
threatened. However, if the Islamic Republic withdraws oil from world
markets, it faces the prospect of losing much- needed long-term energy
clients, such as China and India, which can be expected to quickly
seek replacement suppliers. Moreover, the resulting perceptions that
Iran is an "unreliable" energy partner are likely to reduce foreign
direct investment flowing into the country thereby placing Iran’s
current status as a global energy player in jeopardy.
By the same token, a cut-off of oil exports is likely to reverse
Iran’s recent political gains abroad. Simply put, should Iran’s
energy brinksmanship hurt the economies of its political allies,
those countries are far less likely to unconditionally support Iran
on the perceived source of the economic turbulence: Iran’s nuclear
program. This change will be true in spades for major investors into
Iran’s energy sector (such as Japan, China and France).
Most of all, Iranian officials despite official bluster understand that
actual use of the "oil weapon" is likely to carry dire consequences
for their regime. The international community’s current diplomatic
overtures toward Tehran have been generated in no small part by
problems attaining consensus on more robust measures. Substantial
Iranian interference with the global energy market could change all
that, galvanizing a consensus for aggressive containment or even
regime change on the part of numerous energy-hungry nations.
Is there a guarantee that sanctions will succeed in altering Iranian
behavior and curbing its nuclear efforts? The answer is no. On the
contrary, American policymakers should refrain from seeing economic
sanctions as an isolated measure; historically, a strong correlation
exists between the imposition of sanctions and the subsequent
escalation to the use of force (e.g., Panama in 1989, Iraq in 1991,
and the Balkans during the mid-1990s). However, what is clear is that a
failure by the international community to promptly utilize its existing
economic leverage vis- a-vis Iran will make other, less attractive
solutions chief among them the use of force much more likely.
Ultimately, the United States must make a choice. Is it, and the world,
willing to pay the political and economic price associated with a
serious strategy to confront Iran? The alternative is to internalize
a permanent hike in the cost of doing business with a region dominated
by an atomic Islamic Republic.