Iran, Natural Gas, and EU Sanctions: “Is Europe Shooting Itself in the Foot (to Russia’s Benefit)?”

Earlier this month, after the United Nations Security Council authorized new multilateral sanctions against the Islamic Republic by adopting Resolution 1929, the member states of the European Union (EU) approved guidelines for expanding European sanctions against Iran.  Any new sanctions that the EU might apply against Iran on the basis of the new guidelines must still be drafted and approved by member states, presumably before the EU foreign ministers meet again next month.  The EU guidelines seek to pick up on various sorts of ideas for new sanctions which were suggested or encouraged in Resolution 1929, but not mandated.  (Resolution 1929 defines relatively few new mandatory sanctions, but offers a kind of “menu” of potential additional sanctions, which individual states can chose to pursue.)  The EU guidelines, among other things, envision tighter restrictions on European involvement in the Islamic Republic’s energy sector — including limits on “new investment, technical assistance and transfers of technologies, equipment and services related to these areas, in particular related to refining, liquefaction and LNG technology.”

We have been critical of the new UN sanctions, the new unilateral U.S. sanctions announced by the Obama Administration following the adoption of UN Security Council Resolution 1929, and the new Iran-related secondary sanctions legislation which is now heading to the White House for President Obama’s signature.  We have criticized these measures on diplomatic, economic, political, and strategic grounds.  We are also critical of the EU sanctions effort.  As Flynt told the Washington Post earlier this month, “The net effect of these ‘optional’ sanctions, which will be pursued by the United States and some of its allies, but no one else, will be to reallocate business opportunities in Iran from Western states to China and other non-Western powers.”

But we thought it important to get a more focused look at the European sanctions effort — and, in particular, the relationship between the EU’s Iran policy and its long-term energy strategy — from our colleague Pierre Noël at Cambridge University’s Judge Business School.  We are grateful to Pierre for providing a thoughtful and constructive answer to an important question — “Is Europe shooting itself in the foot (to Russia’s benefit)” with its Iran policy? — and are pleased to publish his assessment below.

Pierre takes on some important pieces of conventional wisdom about Iran and European energy security — e.g., that Europe needs Iranian gas to reduce its dependence on Russian gas and that Iran is waiting to jump on any significant opening to enter the European gas market.  Pierre points out that Iran has become a very large gas consumer, with a high level of exploration and production activity.  But that exploration and production activity is not translating into large-scale gas exports from Iran.  (Even China’s deepening involvement in Iran’s energy sector will not do much to boost the Islamic Republic’s standing as a gas exporter, at least not in the near-to-medium term.)

In this context, Pierre notes that a couple of key variables which will affect the ultimate impact of European sanctions are the level of Iranian dependence on European service companies (e.g., Technop, Schlumberger, Siapem, CGG, Sieme, etc.) and whether European service companies’ contracts to work in Iran will be curtailed by EU action.  The relevant facts on the first point are neither clear nor easy to discern.  We suspect, though, that there is an increasing number of Asian and South American companies that could do most of these jobs if European companies are displaced.

Furthermore, Pierre argues that, while it is unlikely new European sanctions will have much of an impact on Iran’s trajectory as a gas producer over the next several years, such measures do serve perceived political interests in Europe.  In particular, the EU’s Iran policy makes Europe appear relevant without having to pay any real economic cost or take any significant risk.

All in all, we find it hard to avoid the conclusion that Europe has largely taken itself out of the “race for Iran.”  In the end, Europe seems incapable of a genuinely independent strategy toward the Islamic Republic — something that various Iranian interlocutors have been suggesting to us for some time.

Flynt Leverett and Hillary Mann Leverett

* * *

“Is Europe Shooting Itself in the Foot (to Russia’s Benefit)?”
by Pierre Noël

The logic behind the question in the title is straightforward: Iran is a country with very large reserves of natural gas, a lot of it relatively low-cost to produce.  With the right investment, Iran could become a gas exporter of global significance in about a decade.  Europe is one of the largest gas markets in the world.  Its combination of liberalized electricity markets and ambitious environmental policies has the effect of favoring gas as a fuel for power generation, at least in the mid-term.  Russia’s position in the European gas market raises concerns about market power and the politicization of gas supplies from Russia.  The EU supports new gas pipeline projects from Central Asia and the Middle East through Turkey to diversify Europe’s sources of natural gas; the availability of Iranian gas could be essential to the success of this diversification strategy.  Russia, on the other hand, should want to prevent or delay the emergence of Iran as a large gas exporter.

However, there are a number of uncertainties, which, taken together, raise serious questions about the practical validity of these interlinked propositions.  First, at the moment we do not know to what extent the latest EU sanctions will add to the difficulties already experienced by the Iranian oil and gas industry to source technology and finance.  These is a log of oil and gas activity going on in Iran, but large-scale gas export projects combining complex financing and cutting-edge engineering are not part of this activity.  This is certainly the case for LNG projects, an area where the relevant technology is still largely controlled by Western companies; it is unclear to what extent big pipeline export projects could be carried on.

Second — and more fundamentally — it is far from certain that becoming a large gas exporter is a strategic priority for Iran, or even a clearly defined objective.  Iran’s potential to become a large gas exporter has been recognized for decades, but that potential has never materialized.  Iran imports roughly 5 billion cubic meters of gas per year (bcm/y) from Turkmenistan and exports roughly the same amount to Turkey.  The Islamic Republic’s small export contract with Turkey is notoriously unstable and has led to numerous rows over price and delivery.  European majors such as Total and Shell have had a terrible experience negotiating with Iran over LNG projects (and, during the 1990s, over oil projects as well).  When the European companies pulled back from new projects in Iran three years ago, ostensibly because of sanctions, the companies were not in a position to make final investment decisions on these projects for commercial reasons.

Becoming a large gas exporter would require a strategic decision by Iran, based on a wide political consensus — such as the one underpinning the Iranian nuclear program — to open the sector for real to foreign investors.  There is deep opposition to such a move in the Iranian political culture and the culture of its oil and gas bureaucracy, rooted in the memories of the U.S.-sponsored coup of 1953 following the nationalization of British oil concessions by the nationalist Mossadegh government.  If becoming a large gas exporter was a strategic objective for Iran, then the Iranian government would appear hopelessly incompetent at pursuing it.  But geology is not destiny; Iran may not want to be the next Qatar.

Furthermore, Iran is itself a large and fast-growing gas market, now 30% larger than the largest European markets, the UK and Germany.  Iran needs to continue developing some of its reserves simply to supply its domestic market; that is what Iran’s gas-related exploration and production activity has been about for some time and — I would suggest — that is what Iran’s gas-related exploration and production activity will continue to be mainly about.  The existing sanctions have been effective at killing proposed LNG export projects — but these projects might not have gone ahead anyway, in the absence of sanctions, for commercial reasons.  There is no indication that the sanctions have had any impact on the growth of gas production in Iran.  I do not know to what extent the Iranian industry’s exploration and production effort relies on European technology and services that would be made unavailable by new EU sanctions, and would not be replaceable by technology and services from Asian or South American companies.

This does not mean that Iran has no strategic energy policy.  In the context of the standoff with the “international community” over its nuclear program, Iran is obviously trying to use the attractiveness of its energy resources and geographical position to its political benefit.  The growing interest of Chinese oil and gas companies in Iran has been widely documented — but it has not led to any new gas export project.  Turkey’s ambition to increase its access to Turkmen gas via Iran has already been discussed on (see here and here).  Given how strategic Turkmen gas (and the trans-Caspian pipeline) is to Europe’s Nabucco concept, Iran has an option to provide Turkey with both access to gas and leverage on Europe.  The Iran-Pakistan pipeline project, for which the Pakistani government has just reaffirmed its support, is another example where Iran uses its energy assets strategically to raise the cost of the U.S.-EU Iran policy.

The final point is about Europe’s plans for a large pipeline across Turkey that would bring gas from Central Asia and the Middle East to the EU, especially south-east and central Europe.  The noise around the “Nabucco” project, as it is known, is inversely proportional to its commercial and political credibility.  The idea of a multi-billion ‘merchant’ pipeline being built across Turkey in the hope that exporters would then use it to ship gas to Europe is so unrealistic that it should never have been taken seriously outside Brussels.  From high-level conferences to political agreements via feasibility studies, the project is still what it was 10 years ago: an unrealistic concept.  Nabucco is a typical Brussels project with very little real political support from member states outside central Europe.  It certainly is not the cornerstone of a European external energy policy — something which does not exist and that Europe does not need.  European gas supply has been diversifying for four decades and the trend is accelerating sharply; the EU does not need a diversification strategy (though it badly needs an effective gas market, the creation of which is a real job for Brussels).  It is true that Brussels energy bureaucrats have long had dreams of importing Iranian gas by pipeline — but these are just dreams; one cannot conclude from this that European leaders are frustrating Europe’s energy security interests by further isolating Iran.

The bottom line is that European countries have very little to lose materially from being tough on Iran.  The idea that Iran would save Europe from Russia’s gas grip if only we could do business with the Islamic Republic is factually wrong, and the issues around Russian gas are not perceived that way in most of Europe anyway.  European energy companies and key EU member states are actually busy helping Russia bypass Ukraine rather than scrambling to sign contracts east of Turkey.

Thus, the first element of an explanation to why Europe is getting tougher and tougher on Iran — on top of the fact that there is genuine and widely shared concern in Europe about the future of nuclear non-proliferation — is that those sanctions do not have any significant material cost.  But Europe also has a lot to gain politically from being ahead of the pack on sanctioning Iran.  This allows European countries to show complete solidarity with the United States on the top item on Obama’s foreign policy agenda, at a time when Europe is marginalized in U.S. foreign policy and criticized by the Obama administration for not doing enough in Afghanistan.  Furthermore, it helps Europe balance its increasingly critical attitude towards Israel.  Finally, one should keep the wider context in mind: for a Europe that is battling economic dislocation internally and political irrelevance externally, any issue that allows EU member states to present a united front and make Europe exist on the world stage looks like a gift from heaven.  The Iranian nuclear issue is exactly that — at least as long as there is not real risk of a military confrontation.

Flynt Leverett directs the Iran Project at the New America Foundation, where he is also a Senior Research Fellow.  Additionally, he teaches at Pennsylvania State University’s School of International Affairs.  Hillary Mann Leverett is CEO of Strategic Energy and Global Analysis (STRATEGA), a political risk consultancy.  In September 2010, she will also take up an appointment as Senior Lecturer and Senior Research Fellow at Yale University’s Jackson Institute for Global Affairs.  This article was first published in The Race for Iran on 1 July 2010 under a Creative Commons license.

| Print