Iran and the West: The Outlook for Diplomacy–an EIU Webinar (updated)

On November 13, 2013, the Economist Intelligence Unit sponsored a webinar to discuss the negotiations underway between Iran and the Western powers regarding the future of Iran’s nuclear program.    The presenter was Edward Bell, an Economist correspondent covering Middle East and Asia.  

1.  Change in tone in Iran’s diplomatic posture

Back in July 2012 there was a real prospect of Iran blocking the Straits of Hormuz in response to economic sanctions imposed by the West.  The biggest change came as Hassan Rowhani, who campaigned as the non-hardline conservative candidate, was elected as President of Iran in June 2013.  The supreme leader Ayatollah Ali Khamenei has encouraged Mr. Rowhani to be flexible in his dealing with the West.  Khamenei’s backing has helped to quiet conservative forces at home in Iran during the negotiations.

Rowhani has appointed senior cabinet members with experience in dealing with west.  For example,

  •  Mohammad Javad Zarif, an Iranian diplomat and politician is the current minister of foreign affairs in the Rouhani administration.
  • Ali Akbar Salehi is an Iranian academic who is a graduate of MIT who has been made the head of the Atomic Energy Agency.
  • Bijan Namdar-Zanganeh is the Minister of Petroleum.

The biggest affect on negotiations has been that the negotiators have the full backing of the government.  As opposed to previous negotiations, where any proposal made to the Iranian negotiators would have to be taken back to Iran for discussion within the government, the current negotiators are able to make decisions on behalf of the government, which has meant more rapid progress in the negotiation process.

2.  Recent negotiations

  • In the first round in October, Iran proposes its “end game” for its nuclear capacity.  Both Iran and Western powers reported constructive discussion but no deal was made.
  • Second session in November was attended by US Secretary of State John Kerry.  The reports by the media were that a deal was close, but confusing reports emerged, first blaming the outcome on the French for halting development of Iran’s heavy water reactor.  Then the US blamed the Iranians.
  • However, the Iran and the IAEA issued a joint statement, with Tehran pledging greater transparency, which was joined in by other foreign ministers from Russia and China, and this led to a third round of talks scheduled for the weekend of November 23rd.

Update:   On the weekend of November 23rd, 2013, a tentative agreement was reached between the Western powers and Iran.   The New York Times has put together a graphic which outlines the details of the agreement.

The most important feature of the agreement is that allows enrichment up to 5%, but the current stockpile of uranium enriched to 20% must be diluted.    In exchange, the US will relieve $6-$7 billion in sanctions, $4.2 billion of which is oil revenue frozen in foreign banks.    This is not a “grand bargain resolution”, but a short-term deal that will build trust between both sides.  

Such a trust-building measure is sorely needed, because the Iran and the US have little track record of trust building in the past few decades.  However, Iran has a strategic interest in ensuring the success of the negotiations in that it wants to maintain the right to enrich uranium to provide fuel for a nuclear-power program.

On the West, there is dispute between the Western powers.  Israel will strongly opposed ANY nuclear program.  The French are not opposed to any nuclear power program, but they oppose the heavy water reactor now being build in Arak because of its potential to create plutonium-based weapons. 

3.  Iran-IAEA Joint Statement

After the second round of negotiations, the joint announcement between Iran and the IAEA, UN’s nuclear watchdog, is that IAEA has pledged to protect Iranian security concerns, so that sensitive information is not passed to foreign powers; in exchange, Iran would allow greater transparency, in particular with respect to on-site inspections.

4.  Potential Interim Deal

There could be an easing of sanctions on Iran’s economy.  Iran wants to enrich its uranium to the level of 19.5%, close to the 20% “weapons-usable” threshold.  Perhaps an agreement that would limit Iran to enrichment to 5%, or allow the outsourcing of enrichment, might be a deal that would allow the Iranians the “win” of being able to keep its uranium enrichment program, while at the same time calming some of the fears of Western powers of its ability to convert its nuclear-power program to a nuclear-weapons program.

5.  Regional Winners and Losers

What powers would be the winners if the Iranian nuclear talks reached fruition, and the economic sanctions were lifted?

  • Syria—Iran’s influence couldn’t be ignored in negotiations with the Assad regime
  • Turkey—could reignite its trade with Iran, which has resisted US and EU sanctions on Iran and has only complied under pressure (trade has been down 40% year-on-year in the first eight months of 2013)

What powers would be the losers?

  •  Most obvious loser would be Israel, which has remained steadfast in opposition to any deal with lifts sanctions.  The above-ground heavy water reactor facilities in Arak are most vulnerable to potential Israeli attack.
  • Saudi Arabia would no longer have a weakened adversary in the Middle East “Cold War”, and its Sunni clients would face opposition from Shia militant groups in the region such as Hezbollah.  It would also face increasing competition within OPEC because of increase production of crude oil (see section 6 on Economic Impact of Sanctions).

6.  Economic Impact of Sanctions

The sanctions have caused the economy to shrink, and it will not go back to pre-sanction levels (2011) until 2018.  But if the sanctions are lifted, non-oil exports could be carried out more easily, and this would improve Iran’s foreign currency levels.  The highest profile impact of the sanctions has been the reduction in the production of crude oil.  Back in 2007, Iran was producing 4 million barrels per day, and now it is only producing close to 2.5 million barrels per day.  This means that exports have been cut almost in half, although exports have been rising slowly as Asian economies that deal with Iran find ways to deal in their own currency.  For example, India is paying for oil with rupees.  China is paying for its oil is investing in Iranian petrochemicals in order to get around sanctions.  If sanctions are removed, the oil production could go from its current 2.5 mb/d to 3.5 mb/d by 2018.

There increase in production would lead to tensions in OPEC, which is currently dealing with the increasing production coming from Iraq.  Saudi Arabia is hoping that Iran’s oil production is also curtailed by the continuance of economic sanctions. 

One of the segments most effected by the imposition of sanctions is the currency.  The rial has been devalued twice since sanctions started.  Exchange rate was 12,000 rial to the dollar in 2012, and it is now at 25,000 to the dollar.  Central bank has the ability to maintain the rial at this level for quite some time.  Iran exports a lot besides crude oil.  Weakness of rial makes the non-oil exports more attractive in comparison.  The consumer prices have gone down.  The current 40% inflation will come down as the monetary authorities try to slow the growth in liquidity, and it will end up at 10% by 2018. 

Its market size and relative isolation still makes Iran attractive.  Iran is a solidly middle-class country, with an educated population which is well aware of international trends.  A lot of investment in infrastructure could be lucrative.

Looking outside of Iran, how could a breakthrough in nuclear negotiations impact oil prices?  An ease of tension would help remove the “political risk premium”, which was at evidence last year when there was a potential threat by Iran of a blockade of the Straits of Hormuz in retaliation for a threatened strike by Israel on its nuclear facilities. 

There has been a concern over how well Iranian oil production capacity was shut in by the sanctions.  Iran was holding a lot of its production was in floating storage, and able to maintain stable production levels for a while.  It has since had to shut down production.  If the shut down was done in a relatively clear-cut and professional way, Iran’s production could increase its production smoothly and rapidly if sanctions are lifted.

Oil sanctions have been particularly effective, one of West’s “trump cards.”   Iran hinging its future on gas exports, but it will take time to negotiate deals.   Gas exports are not subject to the same sanctions as oil exports, but Iran is not carrying out a lot of action here except for some deals with Oman.

7.  Questions & Answers

What are the prospects for division within Iran’s leadership on nuclear issue?

This characteristic had effected the relations between Ahmadinejad and Iranian clerics.  The interaction between President Roumani and the Ayatollah Khamenei are more united.  The Iranians don’t have to go back to Tehran to see what they are willing to negotiate at the table, for example. 

What are the regional political implications if Iran’s oil production rises dramatically? 

The effects would not occur in 2014 or 2015, but in the medium term, from 2016-2018.  It would intensify the Iranian-Saudi Arabian “cold war”.  If Iranians could increase oil production from 2.5 to 3.5 mb/d, it would be a significant improvement for them.  It much of this oil were being exported out of the country, the Iranian crude oil would be a viable alternative to Saudi crude oil, and it would set off tension within OPECs.  90 to 100/$ per day is the price which most governments are basing budget forecasts on.

If a nuclear deal is made, infrastructure investment opportunities are significant.  BP estimates that Iran has the world’s largest gas reserves which are not being used at capacity.  Turkey and a few former Soviet republics are places that Iran sells gas to.  If Iran developed LNG capacity, it would increase its export ability.  Patents by US companies would have to be used which would cause delays. 

If Iranians could realize real this oil/gas production potential, then exchanging the buy back system of contracts would offer more attractive terms to investors. 

If sanctions reduction would occur, how would effect Iranian investment abroad?  The Tehran stock exchange is one of best performing stock exchanges in the area because money can’t leave Iran.  The first port of call for investment from Iranians would be UAE (Dubai), other countries like Turkey, and parts of Iraq.  Oil sanctions and banking sanctions keep Iran out of international steering mechanisms.  These banking sanctions would be medium-term sanctions that would need to be relieved in the medium term.

How would the lifting of sanctions effect China and Japan which both rely on Iranian oil? 

Both China and Japan have maintained relations with Tehran.  They have an interest in maintaining good commercial relations with Tehran based on oil trade.  Both China and Japan have infrastructure in place to handle Iranian oil.  They have not put diplomatic pressure on France and US, however.  There is a solid Asian bias in Iranian trade, as China, Japan, India are main consumers of its petroleum products.

How would the lifting of sanctions effect Saudi Arabia?

If Iranian oil could come back out of the country, SA could maintain oil price by cutting down production.  Now that are pumping out as much as they can; if they had to cut down production, it would negatively impact their economy.  In terms of political status in region, if Iran were to engage in short-term negotiations over what’s going on Syria, you could have amplifications of tension in Iraq and Syria because of the “proxy war”.  However, Iran has been moderate in these negotiations.

What do you consider to be the greatest challenge towards potential agreement?

The biggest challenge is the West coming to grips with a nuclear Iran, that is an Iran having nuclear power but not nuclear arms.  Iran having a nuclear capacity that can be contained is something that US has to come to terms with.

More regionally, the biggest factor is there is not going to be any decrease in rhetoric from Israel.  That linkage is going to make it hard for Iranians to believe that threat of military force is gone.


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