SAVING THE IRAN DEAL: OPPORTUNITY FOR EUROPEAN BUSINESS.
In the four months since President Trump’s announcement of the US withdrawal from the Iran Nuclear Deal, the remaining signatories have been scrambling to save what was a decade-long process to peacefully halt Iran’s nuclear program. Although, the US dollar financial system will prove to be almost insurmountable, what options are being tabled to facilitate continuing trade?
On 26 November 2018 it was reported that France and Germany will take joint-ownership of the Special Purpose Vehicle being built to ensure continued trade with Iran. Pequod Advisory Group views this as a positive development carrying significant weight. As the largest economic and diplomatic powers in Europe this sends a strong message to both the United States and Iran of the EU’s position and commitment to the JCPOA.
An alternate financial channel in order to facilitate trade with Iran has been announced. A Special Purpose Vehicle (“SPV”) – essentially a barter trade account – which would hold Euro-denominated credits from Iranian exports to spend with European suppliers.
European businesses have a new 80-million-strong largely untapped market to enter. Iran is the 26th largest economy in the world (2nd in MENA to Saudi Arabia) with a GDP of USD 440 billion. This ranks on par with Thailand, slightly behind Poland, and ahead of Austria, Norway, and Nigeria.
European small and medium enterprises - those with low- to no exposure to the US market - could benefit from the potential in the Iranian market. It remains to be seen how much, and what type of, support the EU is willing to provide to European SMEs.
For Iran, increased European business offers some hedging against the overwhelming Chinese influence in the economy by diversifying their trading partners.
The Chinese leadership has been taking concrete steps toward internationalising the Yuan - paying for crude oil purchases in their own currency. In March 2018, the Chinese launched crude oil futures on the Shanghai stock exchange, denominated in Yuan.
Energy exports are crucial to the Iranian economy, with crude petroleum accounting for 63 percent of export value in 2016.
The Joint Comprehensive Plan of Action (“JCPOA”) as it is formally known is the culmination of a decade of intensifying economic sanctions, diplomacy, and negotiations. The deal was finally agreed on 14 July 2015 in Vienna between Iran and major world powers; China, France, Germany, Russia, the EU, the UK and the United States. It was adopted unanimously by the United Nations Security Council on 20 July 2015 as Resolution 2231. The deal trades a halt in Iran’s nuclear program, along with verification protocols, for relief from economic sanctions and opening to global trade. The Obama administration never fully relieved all US-imposed sanctions; most of the primary sanctions on Iran’s ballistic missile program and the US trade embargo remained in place.
Fast-forward to 8 May 2018 and President Trump’s announcement that he will not sign the sanctions waiver. The US has decided to unilaterally reimpose economic sanctions on the Islamic Republic to be activated in two tranches, in August and November. The November round will hit Iranian oil exports, the lifeblood of the economy. This would be the second time Iran’s oil exports have been surgically targeted by US sanctions, the first being in 2010 under the Obama Administration, which was cited as a major factor in bringing Iran to the table on the nuclear deal. The reimposition of US sanctions has contributed to a slide in the Iranian rial, which has lost approximately two-thirds of its value against the US dollar this year. Though, there are other domestic factors affecting weakness of the Iranian currency.
At a State Department press conference on 16 August Secretary Mike Pompeo stated “In May of this year, President Trump withdrew from the flawed Iran nuclear deal, which failed to restrain Iran’s nuclear progress or its campaigns of violence abroad.” The Trump administration believes the deal is flawed because it did not address and contain Iran’s ballistic missile program and support for regional Shia groups. The US labels the regime as a state sponsor of terrorism for proving funding to militants fighting proxy-wars across the Middle East, notably in Yemen and Syria. Iran is known to prop up Hezbollah in Lebanon, Hamas in Gaza, and Houthi rebels in Yemen. However, the JCPOA is deliberately specific and limited to the restriction of Iran’s nuclear program. Under the terms of the JCPOA, Iran must allow for inspections by the International Atomic Energy Agency (“IAEA”), which they have passed on all 12 occasions to date. The nuclear deal limits Iran – for 15 years – to uranium enrichment-related activities at the Natanz Enrichment Facility only, and to a maximum enrichment level of 3.67 percent. This is below that even required for nuclear power plants, which typically operate with 5 percent. Weapons-grade uranium is enriched to 90 percent. The enrichment process to weapons-grade, from the 3.67 percent stock would take approximately six months with IR-1 centrifuges.
THE EUROPEAN RESPONSE
As recently as 6 August the European Union Foreign Minister, Federica Mogherini, announced that the EU would update its Blocking Statute to protect European firms engaging in legitimate business with Iran, going as far as to encourage Europe’s small and medium enterprises to “increase business with Iran”, referring to the action as a “security priority”. The Blocking Statute is designed to protect European firms from the effects of extra-territorial sanctions imposed by the United States; that is sanctions the US seeks to impose outside of its jurisdiction. The EU Blocking Statute has yet to be tested. Mogherini further stated that the remaining parties to the deal would commit to maintaining financial channels for the export of Iranian oil and gas. On 23 August, the EU commissioned its first round of financial support for Iran totalling EUR 18 million. This is part of a EUR 50 million package to support private enterprise in the country.
Energy exports are crucial to the Iranian economy, with crude petroleum accounting for 63 percent of export value in 2016. China is the largest buyer of Iranian crude making USD 8.37 billion in purchases in 2016 representing 33 percent of all sales. Other key markets are India, South Korea and Japan. Asia as a whole, accounts for 85 percent of Iranian crude sales worth USD 21.8 billion in 2016. The remaining 15 percent was attributed to sales in Europe led by France, Greece, Spain and Italy. When the Obama administration ratcheted up sanctions in 2010 with the Comprehensive Iran Sanctions, Accountability, and Divestment Act, specifically targeting the Iranian energy sector, Iran had been exporting record amounts – USD 103 billion and USD 145 billion in 2010 and 2011 respectively – mostly to Asia. As the sanctions took hold, Iran’s oil exports declined to a low of USD 18.3 billion in 2015, right before the lifting of sanctions in early 2016.
One of the key problems for the EU and European companies is their exposure to, and dependence on, the US dollar. The global financial system is based on the dollar and those transactions eventually wind up remitting through the US Federal Reserve, which is why the United States can exert extra-territorial leverage. The first option being tabled by Germany, France and the UK, is around establishing an alternate financial channel in order to facilitate trade with Iran. This could take the form of a legal entity, a Special Purpose Vehicle (“SPV”) – essentially a barter trade account – which would hold Euro-denominated credits from Iranian exports to spend with European suppliers. High-level meetings held on the side-lines of the United Nations General Assembly in September 2018 have seen Mogherini and Iran’s Foreign Minister Javad Zarif announce the creation of such an SPV. The final details are yet to be released. This alternate financial channel is the best option for ensuring continued trade and potentially saving the nuclear deal.
With the unique creation of this SPV, European companies can conduct legitimate business with Iran. The SPV has the support of the remaining parties to the Iran Deal; Russia, France, Germany, China, the UK and the EU. The European Union will be in the spotlight as to whether they can stand firm in the face of pressure from the US. It will be a telling moment for the EU leadership, which will have lasting repercussions either way.
IRAN’S POSITION ON THE US WITHDRAWAL
As recently as 27 August, Ayatollah Khamenei indicated that he is in support of Iran leaving the JCPOA if the deal is not going to work for Iran. Noteworthy is Khamenei’s opposition to the nuclear deal in the first place, therefore his current commentary on the issue is not surprising. Khamenei is leaning on European leaders to rapidly salvage a workable solution which provides comparable benefits for Iran to continue complying with IAEA inspections.
Confined narrowly to the nuclear deal and UNSC Resolution 2231 – the Iranian’s can claim the ethical high ground. Unfortunately, Ayatollah Khamenei can be his own worst enemy with his continued vitriol aimed at Israel and the United States. The Iranian leadership should be rallying international support to its cause by focusing communications efforts on the facts – they are complying with and passing the inspections, and the United States is breaking the agreement. In the US there is little support for the withdrawal. Polls conducted in May 2018 indicate that less than a third of Americans support the Trump Administration’s move. Iran can bolster this by highlighting the comments made by the EU, Germany, the UK, Russia, and China; there is vocal displeasure with the US breaking away. At the 73rd United Nations General Assembly, September 2018, Rouhani devoted much of his speech to slamming the US over its decision to “illegally withdraw” from the JCPOA and unilaterally impose sanctions on Iran, terming this “economic terrorism.”
In early October, Tehran scored a diplomatic victory when the International Court of Justice (“ICJ”) upheld their argument that the reimposed US sanctions violate the 1995 Treaty of Amity between Iran and the US. Though, the ICJ ruling will have zero effect given their lack of any enforcement mechanism. The Treaty was immediately terminated by the Trump Administration, as announced by Secretary Pompeo.
The challenge for the Iranian leadership, and Rouhani particularly, is buying enough time internally. Khamenei and other hardliners in the government who were not supportive of the agreement in the first instance are growing more vocal and raising the spectre of an Iranian withdrawal.
THE ROLE OF CHINA
Arguably the most influential partner to the agreement is China, as Iran’s largest trading partner and the biggest export market for Iranian crude. The European Union has in recent years been looking East, cosying up to Beijing as there is a stronger realisation that trade with China is paramount to Europe’s future prosperity. At this stage, the Chinese have indicated they are not going to be cutting crude purchases from Iran. The China-Iran relationship is transactional in nature and Beijing sees Iran as a “valuable non-US-aligned partner in a geostrategic region.”Both countries share “a scepticism of the US-led international order.” China has repeatedly thwarted international (EU and US) pressure to comply with international sanctions regimes imposed on Iran. In 2012 when the Obama Administration again pressured China to cut imports of Iranian oil Beijing voiced its opposition, though ultimately agreed to lower purchases by 20 percent.
The Chinese leadership has been taking concrete steps toward internationalising the Yuan, which importantly means paying for crude oil purchases in their own currency. As the world’s largest importer of crude, this is significant. In March this year, the Chinese launched crude oil futures on the Shanghai stock exchange, denominated in Yuan. As at July, the Yuan-based crude futures contracts already had won a sizeable 14.4 percent market share. China has already tested Yuan-based payments for crude with both Russia and Iran via the Bank of Kunlun, a subsidiary of China National Petroleum Corporation.
Alternate payment channels are now widely being tabled. In addition to the EU proposal for the creation of an SPV, Russia, Turkey, and Iran have been in discussions – as recently as September – about ditching the US dollar in transactions between the three nations. Over the past five years, Iran’s trade with Russia has averaged USD 1.8 billion per annum, and with Turkey USD 6.6 billion. Second, there is the option of utilising a bank with no exposure to US dollars. There is precedent for this in Russia. Rossiya and SMP, both Russian banks with close ties to Putin, have been under US sanctions since 2014. In that time, both banks have seen increases in their assets, primarily based on financing construction projects and establishing retail banking operations in Crimea.
WHAT DOES THIS MEAN FOR EUROPEAN BUSINESSES?
European businesses have a new 80-million-strong largely untapped market to enter. Despite decades of economic sanctions, Iran is the 26th largest economy in the world (2nd in MENA to Saudi Arabia) with a gross domestic product (GDP) of USD 440 billion. This ranks on par with Thailand, slightly behind Poland, and ahead of Austria, Norway, and Nigeria. The Iranian economy grew by 13.4 percent in 2016 and 4.3 percent in 2017. Between 2000 and 2011 the economy averaged over 5 percent growth. However, with crude sales sliding over the past three months and uncertainty over the EU’s financial vehicle, the Iranian economy is forecast to contract by about 1 – 1.5 percent over the next three years.
Iran is a genuinely attractive emerging market. It is no coincidence that European majors rushed into the country after the JCPOA was formalised. Airbus signed an agreement to deliver 100 planes, Daimler had entered into a joint-venture with an Iranian automotive manufacturer to build Mercedes trucks, French oil and gas firm Total earmarked USD 1 billion for Phase-2 of South Pars, and Swiss company Stadler Rail had a USD 1.4 billion deal for the production of railway cars. All of these deals have been withdrawn from or placed ‘on hold’. Large European multinationals face uncertain regulatory risks at present. The threat of secondary sanctions imposed by the US given their large exposure to the US market and US financial system, plus potential global brand reputation risk.
The situation is markedly different for European small and medium enterprises. Those with low- to no exposure to the US market could benefit from the fast-growing Iranian market. The EU is actively encouraging this strategy. It remains to be seen how much, and what type of, support the EU is willing to provide, and the effectiveness and strength of the Blocking Statute. For Iran, increased European business offers some hedging against the overwhelming Chinese influence in the economy by diversifying their trading partners, and also serves to internationalise their position with increased vested interests. That said, the EU is mired with its own contentious issues; the ongoing migrant crisis, surging populist parties including the rise of the Alternative for Germany (“AfD”), Brexit less than six months away, and upcoming European parliament elections in 2019.
Ultimately, international public opinion presently sides with Iran, not the US. There is growing resentment even among Western allies of US unilateral- and extraterritorial sanctions. Beijing’s drive to increase international acceptance of the Renminbi coupled with the EU’s proposal to build a new financial mechanism to evade the US financial system will only serve to strengthen the knowledge base of how global markets will operate in a post-USD dominated system.