Bottom Line Up Front:
The Trump administration ended a key waiver on Iran oil sanctions as part of an effort to apply maximum pressure on Iran’s economy and its regime. The end of the waiver program will reduce Iran’s oil exports further but is unlikely to bring them to a halt. Several countries, including China and Turkey, are likely to continue at least some Iranian oil importation, challenging the Trump administration to risk a rift by imposing actual sanctions. The U.S. decision further increases the potential for Iran to exit the 2015 multilateral nuclear deal and even the possibility of increased hostilities between Washington and Tehran.
In 2011, Congress sought to reduce Iran’s exportation of oil by passing a law, which was ultimately enacted, that imposes penalties for transactions with Iran’s Central Bank, the entity in control of Iran’s oil payments. That law, Section 1245 of the FY2012 National Defense Authorization Act (NDAA), requires the President to exclude a foreign bank from the U.S. financial system if that bank conducts a ‘significant financial transaction’ with Iran’s Central Bank or with any sanctioned Iranian bank. The law provided an incentive to cut purchases of Iranian oil by providing for an exception for the banks of any country determined to have ‘significantly reduced’ purchases of Iranian oil. The exception, called the Significant Reduction Exception (SRE) requires countries to reduce their oil purchases from Iran by at least 20% each 180-day evaluation period. The mechanism largely accomplished its objective from the enactment until the lifting of sanctions in early 2016 under the Iran nuclear deal. During that time, Iran’s oil exports fell from 2.5 million barrels per day (mbd) to 1.1 mbd, greatly reducing Iran’s receipts of hard currency. The lifting of U.S. sanctions in January 2016 had a predictable effect: Iran’s oil exports rebounded to the former 2.5 mbd level by the end of that year.
The May 2018 Trump administration decision to exit the nuclear deal, and the resulting re-imposition of U.S. sanctions, shortened the life expectancy for the SRE allowances. Amid a tightening oil market, the administration provided the SRE to eight countries on November 5, 2018: China, India, Turkey, Japan, South Korea, Taiwan, Greece, and Italy. Of those, Taiwan, Greece, and Italy reduced their Iran oil purchases to zero, but the five others – despite reductions – continued to collectively keep Iran’s total oil sales over 1 mbd – a number judged inconsistent with the administration’s ‘maximum pressure’ campaign against the Iranian regime.
On April 22, 2019, the State Department announced that no more SREs would be granted after their expiration on May 2, 2019. China, Turkey, and to a lesser extent India, had strongly urged renewal of the SREs and are likely to try to continue at least some purchases of Iranian oil. Whether they do so will depend on whether the Trump administration imposes any actual sanctions on the banks of these countries, and on the willingness of these countries to risk U.S. sanctions. Japan and South Korea, which typically always cooperate with U.S. laws, will likely cease energy transactions with Iran, as will the other countries that already ceased purchasing Iranian oil. But it is unlikely that, in the aggregate, the U.S. move will drive Iran’s oil exports to zero, as the administration predicts.
The decision will surely reduce Iran’s exports below the approximately 1.2 mbd level they hovered around at the end of March, however.
The U.S. announcement follows by two weeks the U.S. designation of the Islamic Revolutionary Guard Corps (IRGC) as a foreign terrorist organization. Whether the decision about the SREs affects Iran’s oil sales drastically or marginally, the U.S. decision will likely further inflame tensions between Tehran and Washington. Iran’s state news media indicated that Iran would be able to circumvent the decision and to continue exporting oil, suggesting Iran did not want to use the SRE decision to escalate its disputes with the United States. However, the head of the IRGC Navy, Admiral Alireza Tangsiri, reiterated a previous threat to close the Strait of Hormuz if the end of the SRE allowances ‘prevent Iran from using it….’ And, this latest move gives Iran’s hardliners more ammunition to argue that Iran derives no economic benefit from remaining in the nuclear deal and that Iran needs to abandon the agreement once and for all.