[Senate Hearing 109-720]
[From the U.S. Government Publishing Office]
S. Hrg. 109-720
ENERGY AND THE IRANIAN ECONOMY
=======================================================================
HEARING
before the
JOINT ECONOMIC COMMITTEE
CONGRESS OF THE UNITED STATES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
JULY 25, 2006
__________
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JOINT ECONOMIC COMMITTEE
[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]
HOUSE OF REPRESENTATIVES SENATE
Jim Saxton, New Jersey, Chairman Robert F. Bennett, Utah, Vice
Paul Ryan, Wisconsin Chairman
Phil English, Pennsylvania Sam Brownback, Kansas
Ron Paul, Texas John Sununu, New Hampshire
Kevin Brady, Texas Jim DeMint, South Carolina
Thaddeus G. McCotter, Michigan Jeff Sessions, Alabama
Carolyn B. Maloney, New York John Cornyn, Texas
Maurice D. Hinchey, New York Jack Reed, Rhode Island
Loretta Sanchez, California Edward M. Kennedy, Massachusetts
Elijah Cummings, Maryland Paul S. Sarbanes, Maryland
Jeff Bingaman, New Mexico
Christopher J. Frenze, Executive Director
Chad Stone, Minority Staff Director
C O N T E N T S
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Opening Statement of Members
Hon. Jim Saxton, Chairman, a U.S. Representative from New Jersey. 1
Hon. Jack Reed, Ranking Minority, a U.S. Senator from Rhode
Island......................................................... 2
Witnesses
Statement of Hon. Paul E. Simons, Deputy Assistant Secretary for
Economic and Business Affairs, Department of State............. 3
Statement of Dr. Kenneth Katzman, Specialist in Middle Eastern
Affairs, Congressional Research Service, Library of Congress... 16
Statement of Ilan Berman, Vice President for Policy, American
Foreign Policy Council......................................... 19
Statement of Dr. Andrew K. Davenport, Vice President, Conflict
Securities Advisory Group, Inc................................. 21
Statement of Dr. Jeffrey J. Schott, Senior Fellow, Institute for
International Economics........................................ 24
Submissions for the Record
Prepared statement of Representative Jim Saxton, Chairman........ 36
Joint Economic Committee's Research Report No. 109-31
entitled, ``Iran's Oil and Gas Wealth,'' March 2006........ 37
Prepared statement of Senator Jack Reed, Ranking Minority........ 41
Prepared statement of Hon. Paul E. Simons, Deputy Assistant
Secretary for Economic and Business Affairs, Department of
State.......................................................... 43
Prepared statement of Dr. Kenneth Katzman, Specialist in Middle
Eastern Affairs, Congressional Research Service, Library of
Congress....................................................... 45
Prepared statement of Ilan Berman, Vice President for Policy,
American Foreign Policy Council................................ 50
Prepared statement of Dr. Andrew K. Davenport, Vice President,
Conflict Securities Advisory Group, Inc........................ 54
Prepared statement of Dr. Jeffrey J. Schott, Senior Fellow,
Institute for International Economics.......................... 58
ENERGY AND THE IRANIAN ECONOMY
----------
TUESDAY, JULY 25, 2006
Congress of the United States,
Joint Economic Committee,
Washington, DC.
The Committee met, pursuant to notice, at 10 a.m., in room
210, Cannon House Office Building, Hon. Jim Saxton (Chairman of
the Committee) presiding.
Representatives present: Saxton, English, Hinchey, Sanchez,
and Cummings.
Senators present: Reed.
Staff present: Chris Frenze, Ted Boll, Colleen Healy, Katie
Jones, Chad Stone, and Kasia Murray.
OPENING STATEMENT OF HON. JIM SAXTON, CHAIRMAN, A U.S.
REPRESENTATIVE FROM NEW JERSEY
Representative Saxton. Good morning. It is a pleasure to
welcome Mr. Simons, and the members of the second panel of
witnesses before the Committee today. Given the course of
events in the Middle East, this hearing on energy and the
Iranian economy is very timely. Iran is a country with immense
wealth in the form of oil and gas reserves. Iran has the third
largest oil reserves and the second largest national gas
reserves in the world.
Unfortunately, despite the country's great economic
potential, the government of Iran has adopted policies that
have undermined the country's economic development and standard
of living. Despite Iran's huge oil and gas reserves, the
Iranian regime is intent on extending its nuclear program,
supposedly for peaceful purposes. However, the regime's
deception regarding the nuclear program, its aggressive
promotion of terrorism, and its President's recent statements
concerning Israel obviously constitute a grave threat to world
peace.
The facts before us today concerning Iran's large energy
reserves undercut assertions by the Iranian regime that the
nuclear program is needed for peaceful nuclear power
generation.
Iran's leaders have also sought to intimidate oil-consuming
nations by threatening to cut off Iranian oil. However, Iranian
oil exports generate a high percentage of Iranian export
earnings and finance a significant portion of government
spending. In short, the Iranian Government and economy are
highly dependent on oil exports and threats to cut off these
oil exports do not seem credible.
The Iranian economy labors under a heavy burden of
government mismanagement, cronyism and corruption, facilitated
by government-affiliated foundations and enterprises. The
Iranian people pay a high price for the failures of the
regime's economic policies, but the prospects for reform of
these policies are bleak in the near term.
In view of the Iranian regime's aggressive behavior, the
feasibility of sanctions against the regime must be considered.
Iran's reliance on imported gasoline is one potential pressure
point. However, the effectiveness of sanctions would depend on
the willingness of a much broader group of nations acting in
concert with the United States to contain Iran's threats. The
coming weeks and months will reveal whether a broader attempt
to impose sanctions will be tried and produce positive results.
At this point I would like to yield to Senator Reed for any
comments he may have.
[The prepared statement of Representative Saxton appears in
the Submissions for the Record on page 36.]
OPENING STATEMENT OF HON. JACK REED, RANKING MINORITY, A U.S.
SENATOR FROM RHODE ISLAND
Senator Reed. Thank you very much, Mr. Chairman. I think
this is a very timely and important hearing and I commend you
for calling it. As we monitor diplomatic developments
surrounding the nuclear standoff with Iran and as the current
conflict between Israel and Hezbollah continues to destabilize
the region, this hearing on energy and the Iranian economy is
very important and very timely.
Iran has recently enjoyed strong economic growth primarily
due to high oil prices. Despite some progress in reforming
certain aspects of the economy, the Iranian economy continues
to suffer some significant structural weaknesses. First, its
heavy reliance on oil revenues makes it extremely vulnerable to
oil price shocks. Second, entrenched political interests impede
substantive economic reform. Last, the country continues to
rank poorly on various indicators of foreign investment risk.
Such vulnerabilities lead some observers to conclude that
the United States and its allies may have some leverage
primarily through sanctions, possibly backed up by the threat
of military action, in convincing Iran to abandon any nuclear
weapons ambitions. However, oil prices are expected to remain
high at least through 2007, and with the global oil market Iran
will always find alternative customers in countries that are
willing to violate sanctions to advance their own interest.
Even if Iranian oil exports were to slow somewhat, the
higher prices that result would at least temporarily cushion
the revenue impact. Iran's vast energy reserves promise that
the country will remain attractive to foreign investors.
Russia and China recently signed on with the United States
and its European partners in seeking a United Nations Security
Council resolution ordering Iran to freeze its nuclear program
or face possible sanctions.
To be truly effective on their own, sanctions must target
the oil exports that are central to the Iranian economy. Given
tight oil supplies, however, it is highly unlikely that all six
negotiating partners would ultimately agree to such
comprehensive economic sanctions. In fact, a decade's worth of
experience with the Iran-Libya Sanctions Act, or ILSA, which
was implemented during a period when oil was relatively cheap
and plentiful, suggests our allies' reluctance to further
rattle the global oil market. Further, both Russia and China
have indicated that they will not support military action
against Iran.
The experience with the United States sanctions against
Iran suggests that a unilateral approach simply will not work.
U.S. sanctions have not prevented Iran from developing what
International Atomic Energy Agency inspectors believe to be a
potential military dimension to its clandestine nuclear program
or from continuing to sponsor terrorist organizations such as
Hezbollah and Hamas.
Some analysts believe that U.S. sanctions have done more to
isolate the United States than to isolate Iran. Rather than
taking a unilateral approach, the United States must continue
to work with the United Nations community. If universal
comprehensive economic sanctions are not feasible, we must
focus on a more effective mix of targeted sanctions that our
negotiating partners can agree to. Targeted sanctions may not
cripple the Iranian economy to the point where it is
financially incapable of developing a nuclear weapon; however,
coupled with concerted diplomatic efforts, the right mix of
sanctions has the potential to convince Iran to abandon any
nuclear weapons ambitions it may harbor.
I look forward to the testimony of our witnesses here
today. In addition to hearing about the state of the Iranian
economy and energy sector, I hope to discuss ways in which
sanctions could be effectively applied, preferably as part of a
multilateral diplomatic effort.
Thank you very much, Mr. Chairman.
[The prepared statement of Senator Reed appears in the
Submissions for the Record on page 41.]
Representative Saxton. Thank you, Senator Reed.
I am very pleased to be able to welcome the Honorable Paul
E. Simons, Deputy Assistant Secretary for Energy, Sanctions and
Commodities at the U.S. State Department's Bureau of Economic
and Business Affairs. Mr. Simons, thank you for being with us.
STATEMENT OF HON. PAUL E. SIMONS, DEPUTY ASSISTANT SECRETARY
FOR ECONOMIC AND BUSINESS AFFAIRS,
DEPARTMENT OF STATE
Mr. Simons. Thank you, Mr. Chairman, Members of the
Committee. Thank you for your initiative in calling this
hearing on this important issue. Let me also congratulate the
staff for the preparation of an excellent Committee report on
Iranian energy that I think helped us get prepared for the
hearing this morning.
Iran, as you have noted in your report and as we have noted
in our written testimony, does play a significant role in
international oil and gas, but Iran is also a country whose
policies and actions have long been cause for deep concern to
the United States and our international partners. Given its
pursuit of weapons of mass destruction and missile delivery
system, its place as the leading state-sponsor of terrorism,
its support for violent opposition to the Middle East peace,
its unhelpful role in Iraq, and its oppression of its own
citizens, as well as its abysmal human rights record, Iran does
pose, as Under Secretary of State Burns recently said, a
profound threat to U.S. interests.
Iran's concerted effort to develop a nuclear weapons
capability has become the focus of particular concern not only
for the United States, but also for the broader international
community, as reflected in the resolution adopted in February
by the International Atomic Energy Agency Board of Governors
and in the March statement by the U.N. Security Council.
On June 6th, the governments of the United States, the
United Kingdom, France, Russia, China and Germany, referred to
as the P5+1 countries, offered Iran a set of far-reaching
proposals that presented that country with a clear choice
between two paths.
One path would lead to important benefits for the Iranian
people if Iran suspends all its enrichment-related and
reprocessing activities and enters into negotiations on the
basis of the P5+1 offer. Secretary Rice has made clear that the
United States would be willing to join the negotiations if Iran
fully and verifiably suspends its enrichment program.
However, if Iran chooses the other path and continues on
its current course, it will face greater international
isolation and strong U.N. Security Council action.
Iran has failed to take the steps needed to allow
negotiations to begin, specifically the suspension of all its
enrichment-related and reprocessing activities. Absent such a
positive, concrete response from the Iranian government, we and
our international partners really have no other choice but to
return to the Security Council to adopt a resolution that would
make that suspension mandatory.
Let me turn now briefly to the issue of energy. And I would
ask that my full statement be admitted to the record, and I
will make some brief comments.
On the energy issue, as you have noted in your opening
statement and in the report, Iran is the world's second-largest
holder of natural gas reserves, and it ranks second or third in
conventional oil reserves. It does have a current oil
production capacity of just over 4 million barrels a day,
making it OPEC's second-largest oil producer and its second-
largest oil exporter, at about 2.6 million barrels per day.
What is striking, though, and as you have noted in your
report--and a view that is endorsed as well by the State
Department--is that Iran is not as prominent a player in the
international oil and gas scene as its geological potential
would suggest. So despite its huge gas reserves, Iran basically
has a very limited gas export potential at present.
It also hasn't really moved very intensively toward
developing a liquefied natural gas export capability, and as we
note in our statement, this contrasts with the situation in
Qatar, Iran's small neighbor just across the Gulf which has
moved very aggressively, has attracted massive foreign
investment, and is very actively developing LNG and other gas
projects with the assistance of the international investment
community.
Iran has expressed its intention to expand its production
of both oil and gas. There have been various notional targets
put out, but its efforts to attract foreign investment through
buy-back arrangements--which are explained in some detail in
your report--which were initiated in 1995, have met with only
limited success. Foreign investment in this sector does appear
to be slowing. There are a combination of factors. Certainly
one factor is a strong perception of heightened political and
financial risk due to Iran's own behavior.
In addition to the discouraging impacts of Iran's
problematic policies, its pursuit of nuclear weapons has raised
the possibility of international sanctions, which several of
the Members have noted here. And as a result, international
companies have found it difficult to reach agreement with
Iranian negotiators on terms that would essentially offset this
high level of political risk.
Iranian oil refining capacity is also inadequate to meet
demands. There has been inadequate investment in the downstream
sector. So this is also an issue.
Let me just conclude briefly with a couple of remarks about
the nuclear side. The P5+1 package that I mentioned earlier in
my statement, and which was put forward in May, reaffirms
Iran's right to nuclear energy for peaceful purposes in
conformity with Iran's obligations under the Non-Proliferation
Treaty, the NPT. And both the President and the Secretary have
made that point quite clear. We are not seeking to deny
peaceful nuclear energy to the Iranians.
However, Iran's long history of deception and noncompliance
with its NPT commitments and its IAEA safeguard obligations
have created something of a loss of confidence in Iran's
intentions. So, as the President has said, civilian nuclear
energy is a legitimate desire. We do believe the Iranian people
should enjoy the benefits of a truly peaceful program to use
nuclear reactors to generate electric power. As the President
noted, America does support the Iranian people's right to
develop nuclear energy peacefully, but with proper
international safeguards. This is the important point.
Let me conclude by stating that with its enormous natural
resource endowments and its very talented people, Iran really
ought to be among the more prosperous countries in the world. I
think this point is also reinforced in the Committee report.
But counterproductive economic policies, mismanagement,
corruption, and misguided goals, such as the dangerous request
for nuclear weaponry, have in fact dimmed Iran's economic
prospects.
Iran's economic problems reflect in some ways its negative
political culture with all the problematic manifestations which
were outlined earlier in my statement. But as President Bush
recently noted, Americans do admire the rich history, the
vibrant culture of Iran, and its many contributions to
civilization. The President recently said that the people of
Iran, the people everywhere, also want and deserve an
opportunity to determine their own future, an economy that
rewards their intelligence and talents, and a society that
allows them to pursue their dreams. Thus far, these dreams have
been sadly thwarted.
Thank you, Mr. Chairman.
[The prepared statement of Mr. Simons appears in the
Submissions for the Record on page 43.]
Representative Saxton. Thank you, Mr. Simons.
Let me get right to the matter that is of concern to us.
You said in your testimony that Iran is richly endowed with the
second or third largest oil reserves and the second-largest
natural gas reserves, and that this becomes an extremely
important economic factor to that country.
As a matter of fact, Iran's revenues from oil exports were
about $47 billion in 2004 and 2005, and that its oil therefore
accounts for about 80 percent of Iran's export revenues. In
addition, the central government's revenue is accounted for by
oil exports to the extent of about 50 or 60 percent, according
to indications that we have, and oil and gas exports amount to
about 20 percent of GDP.
With oil supplying such a high percentage of revenue to
support the Iranian government's budget and military spending,
how credible do you think are their threats to cut off the oil
supply?
Mr. Simons. Clearly I think you have outlined the
importance of oil and energy to the Iranian economy and to the
Iranian economic engine. I don't think I can really speculate
here in an open session about the motivations behind a
potential unilateral shutoff of oil by Iran. There has been
extensive press speculation on this.
Perhaps we could have a closed session where we could get
into a little bit more detail.
But I would just like to make a couple of points here.
First, Iran is an important contributor to global energy
stability, and it does export about 2\1/2\ million barrels a
day. We do have capabilities in place to handle a potential
shutoff of these flows were that to occur. So the United States
and other members of the global energy community are certainly
prepared if the situation goes that way.
But beyond that, I really wouldn't want to speculate in
this setting behind the possibility that Iran might take a
unilateral step in this direction.
Representative Saxton. I appreciate that, but I guess maybe
these facts kind of speak for themselves: $47 billion in 2004
and 2005 in exports, which amounts to 80 percent of Iranian
exports, not just oil exports, but all exports. And the central
government depends on these oil exports for something like 50
or 60 percent of its resources, and that oil and gas exports
amount to about 20 percent of GDP.
That means that exporting oil is a critical factor in the
Iranian economy, and the reason that I emphasize this point is
that every time the Iranian leadership rattles its oil drum,
the price goes up here at the pump. Perhaps that is not a
necessary reaction.
So, I just wanted to make this point. Wouldn't Iran's
economy and government be crippled without the revenues
produced by oil exports?
Mr. Simons. Once again, there is no question that oil and
gas are the centerpiece of the Iranian economy and that were
there to be some type of interruption in Iranian oil
production, there would be a significant impact on the Iranian
economy.
As I mentioned, the impact on global oil economy could be
accommodated by various measures that we could put into place.
But certainly for the Iranians, there would be a significant
impact.
Representative Saxton. Thank you. I think one would
conclude that this is a very strong suggestion that Iran's
threats to cut off oil exports from time to time are mostly, if
not entirely, empty in my view.
I think this is an extremely important point, because in
the past they have been able to affect Western economies by
issuing threats from time to time. When we understand the
nature of and importance of petroleum exports to their country,
it appears to me at least that Western investors and Western
business people and Western governments have not put it in the
right context to the extent that we might have.
With its immense and undeveloped resources in oil and
natural gas, do you believe there is a compelling need for Iran
to develop nuclear power and a nuclear power industry for
peaceful energy production?
Mr. Simons. Mr. Chairman, I think the Committee has done
good work laying out the scope of potential that Iran has were
they to fully develop their oil and natural gas reserves. As
Secretary Rice recently pointed out, we fundamentally don't
understand why Iran has to have a civilian nuclear power
capability. From an economic standpoint they would be able to
develop--they could develop, on the electricity side,
sufficient gas power generation to meet their needs.
However, as the Secretary also pointed out, nuclear power
is part of an energy strategy for many countries that seek to
decrease their exclusive dependence on hydrocarbons. So, we
have been pursuing in this country a diversification strategy
where we look to different elements of the technology basket to
meet portions of our electricity needs, and many other
countries around the world do this. So, I think what we have
really been stressing is that in order for this civilian
nuclear program to be acceptable, it has to contain the
proliferation risk, and this is really what our focus has been.
Both the Secretary and the President have noted that we are
not seeking to deny the Iranians access to civilian nuclear
technology, or not necessarily either to particularly second-
guess how they define their desirable mix in terms of how they
define their energy security. So it is an option that is out
there and we just want to make sure it is made available in
ways that protect global nonproliferation concerns.
Representative Saxton. Let me turn for just a couple of
minutes to the issue of potential economic sanctions which,
incidentally, Senator Reed and I both agree have to be
international and multifaceted in nature. The economic
incentives offered Iran from refraining from uranium enrichment
are quite substantial, as I believe you mentioned in your
testimony. Can you comment on them and why Iran has not
accepted them?
Mr. Simons. My understanding, Mr. Chairman, is that the
Iranians have indicated that they will respond later in August
to the package that has been put forward. As I mentioned in my
opening statement, we do think they have a fairly stark choice
in front of them. They can choose a path of cooperation, which
would create a series of incentives for them to work with the
international community to develop a civilian nuclear
capability, if they so choose, and to afford them these rights
which are part of their membership in the NPT.
So these are options that are out there that fulfill some
of their economic and political aspirations and some of the
aspirations of their people in terms of putting Iran on the
global stage.
On the other hand, if they choose the other route, we do
feel that we have a group of countries, probably for the first
time in many years, a strong multilateral coalition that would
take this issue to the Security Council and seek to more
actively deny Iran some of those same options.
Representative Saxton. Does the fact that Iran imports
refined gasoline create a vulnerability that could be used to
pressure the regime?
Mr. Simons. I think you have pointed out in your statement,
Mr. Chairman, and in your report that Iran does import
something on the order of 170,000 barrels a day of gasoline.
Over the last couple of months there have been some internal
discussions inside Iran of ways in which they could reduce that
dependency by initiating conservation measures, and by boosting
local refined product capability.
But for the time being, I think the point you make is
basically correct: Iran is an extensive exporter of crude
petroleum and imports a large chunk of its refined products.
Again, in open session, I wouldn't want to get into a detailed
discussion of how these tradeoffs might play when one takes a
look at sanctions options, but perhaps, again, we could discuss
that in a closed session.
Representative Saxton. Let me just ask one final question;
then we will go to Mr. Hinchey. How vulnerable is Iran to the
loss of other products, specifically agricultural products, and
what other economic pressure points or vulnerability might Iran
have?
Mr. Simons. If I could ask you to clarify; loss of access
on the import side or export?
Representative Saxton. Import.
Mr. Simons. Well, Iran is a significant agricultural
importer. U.S. law and policy exempts agricultural products,
certain kinds of agricultural products, from our sanctions
regime; so we are able to export certain types of agricultural
products to Iran and to other countries that are under
sanctions.
So, generally speaking, again, I wouldn't want to speak for
the Congress, but in terms of the sanctions world, the trend
has been to focus our attention away from the food side and the
medicine side of the equation. That has generally been the
focus of the Administration, as well as successive Congresses.
Representative Saxton. Other than gasoline, are there other
elements of the economy of Iran that would be affected by
sanctions--or could be?
Mr. Simons. Well, it all depends on what you decide to
target. I think the scope is rather large, but as I think
Senator Reed mentioned when he was here, we have found that
sanctions that are applied multilaterally and that are targeted
not at the broader population, but more at the portions of the
regime that are responsible for the undesirable behavior tend
to be more effective.
So, I think when you take a look at some of these broader-
brush types of sanctions options, you do have to keep in mind
what type of impact that you might have, and I think you want
to make sure when you design these programs that the impact is
focused in on the group whose behavior you want to affect.
Representative Saxton. I apologize to Mr. Hinchey. Every
time you give an answer it raises another question in my mind.
Many of the businesses, particularly which are involved in
import, export, and development of energy, and perhaps even
nuclear pursuits, are very closely related to the government,
aren't they? They are not businesses as we think of them; they
are either owned by or very closely associated with or
controlled by the regime. Is that right? Those are the elements
of the economy that we would want to perhaps target.
Mr. Simons. Well, again, I would prefer to get into the
details of any kind of targeting discussion in another session.
Representative Saxton. Just being able to ask the question
makes the point.
Mr. Simons. One way to look at it would be to focus on
government-owned companies in the energy sector; but another
way of looking at it, which is the way the Administration has
focused initially, has been taking a look at those companies
that are directly participating in Iran's weapons of mass
destruction-related activities and trying to pinpoint those
companies and to shut down their operations and their ability
to function.
So I think there is a subset of these government-owned
companies that are more directly related to the
nonproliferation stream that has been our initial focus, and we
have an Executive order and we have designated certain
companies under that Executive order for sanctions.
Representative Saxton. Thank you very much, Mr. Simons.
Mr. Hinchey, please feel free to take as much time as you
need.
Representative Hinchey. Well, thank you very much, Mr.
Chairman. I appreciate your holding this hearing and giving us
this opportunity to learn more about what the State Department
in this particular case is doing in this situation. I very much
appreciate your testimony and your response to our Chairman's
questions, Mr. Simons. Thank very much for being here.
The Middle East is of course, as we know, the most volatile
and dangerous part of the world and Iran is one of the most
significant countries in the Middle East, even if you were to
just limit that to the possession of huge amounts of oil and
natural gas. But they are significant for other reasons,
including a very large population and a very strong country,
even considering the context in which they operate.
The sanctions that were imposed by the United States, even
though those sanctions have not really been carried out, I
believe date back to the 1980s. Am I mistaken about that, or
can you give us the exact date?
Mr. Simons. Well, the principal set of U.S. unilateral
sanctions were put into place in 1995 and 1997.
Representative Hinchey. Aren't there sanctions that go
back, however, to the 1980s? Weren't there some actions taken
back in the 1980s at the same time that Iran Contra was of
great controversy here?
Mr. Simons. There were some financial-related sanctions,
some asset freezes, but the broad prohibitions on U.S. business
involvement in Iran actually date to the Clinton
administration.
Representative Hinchey. What took place back in the early
1980s, specifically? Can you tell us what happened?
Mr. Simons. Going back to November 1979, President Carter
issued an Executive Order freezing Iranian assets and banning
imports from Iran, in response to the takeover of the U.S.
Embassy in Tehran. In April 1980, the President banned all
commerce and travel between the United States and Iran, because
of the continuing hostage crisis. However, these measures were
subsequently lifted pursuant to the Algiers Accords, under
which the U.S. hostages were freed. In January 1984, Iran was
designated a state-sponsor of terrorism, which resulted in the
application of specific statutory restrictions incident to that
status. In October 1987, most imports from Iran were prohibited
because of its support for terrorism. Broader prohibitions,
including on U.S. exports and investment, were imposed in 1995.
Representative Hinchey. The relationship that Iran has with
other countries is seemingly much more normal. They have good
relations with China, with Russia, and with a number of
European countries, if not most or all of the European
countries, particularly mainland Europe. So it would seem that
any attempt that we might take to impose some economic problems
on that country by initiating sanctions would have a good deal
of difficulty in succeeding, given the fact that other
countries are very likely to step in and increase their
economic relationships with Iran. Don't you believe that that
is the case?
Mr. Simons. I think we are really in a fundamentally
different situation than we were back in the 1990s. When we
imposed the unilateral sanctions back in the mid-nineties the
United States was seeking to move ahead the Middle East peace
process, and I believe, Congressman, you played a role in that.
If I am not mistaken, we had some contact on this back in the
nineties. I think you came out to Israel when I was out there.
So you are very familiar with the issue.
Iran was a major obstacle to forward movement in the peace
process and also we saw a number of demonstrations of Iranian
support for international terrorism that were very troublesome,
and this is what led the Clinton administration to impose at
that point the unilateral sanctions. I would agree with you, at
that point, many of our partners around the world were not
choosing to go this route and were pursuing greater economic
ties with Iran.
But what has happened in the last couple of years and I
think what represents something of a sea change is that today
in 2006, we have been able to mobilize a fairly robust
international partnership and coalition of countries that are
prepared to take a tough look at Iran and that have been
speaking with one voice to the Iranians and that culminated in
the package that was put forward at the end of May, and the two
choices that I outlined earlier.
And the difference this time around is that we do have the
international community speaking with one voice on Iran,
probably for the first time in many, many years, and we have
been able to work this diplomacy effectively. I think it is one
of the signature achievements of this Administration that for
the first time we have been able to have a common multilateral
definition of the Iranian problem and of a possible solution.
Representative Hinchey. I think it is true that anyone who
thinks about it would much prefer that the Iranians, and a
great many other people, other countries around the world, were
not developing nuclear weapons; because the more nuclear
weapons there are in the world, the more likelihood is that one
of them is going to go off someplace and cause some serious
problems, including the possibility of one going off here in
the United States.
So it is pretty evident that most people are concerned
about the proliferation of nuclear weapons, and I think in a
country like Iran that makes some sense. But in terms of the
way in which we are dealing with Iran and the imposition of
sanctions--and those sanctions which were imposed during the
1990s have never really taken place. Nothing really has ever
been done to implement those sanctions; is that correct?
Mr. Simons. No, I don't think that is correct. Certainly,
U.S. businesses are not active in Iran currently and have not
been active for the past decade. We would also argue from the
Administration's perspective that there has been a lot less
involvement by the rest of the world than there otherwise would
have been if we had not gone down this road.
So, a lot of the conclusions I think that the Committee
report came to in terms of the rather slow development of the
Iranian oil and gas sector, there were many reasons for this;
and certainly you can't put the entire monkey on the back of
sanctions, but the sanctions regime played some role in slowing
the development of Iran's oil and gas sector.
Representative Hinchey. In the context of the discussions
within the Department of State with regard to this situation,
to what extent do you regard the reaction of Iran to the United
States to be a result of the President's inclusion of Iran in
the so-called axis of evil with Iraq and then having attacked
Iraq?
Mr. Simons. I think the President's statement stands for
itself and is an accurate description of the threats that Iran
does pose, which I outlined as well in my opening statement. So
this Administration and previous Administrations have had very,
very significant concerns with Iranian behavior. This is really
what motivated the Clinton administration to put in place the
sanctions back in the nineties. So there has been a history of
U.S. Executive Branch as well as congressional concern with a
wide range of Iranian behaviors: the terrorism issue, human
rights, peace process, and now the proliferation issue.
So I think the President's statement was quite consistent
with policies that have been adopted before and after.
Representative Hinchey. When did Iran sign the Nuclear Non-
Proliferation Treaty?
Mr. Simons. I am sorry, I don't have the exact date that
they signed, but they have been a member for many years.
Representative Hinchey. Are we aware of significant
violations of the NPT by Iran?
Mr. Simons. I think what we are trying to do here is to
construct a set of incentives that would oblige Iran to carry
out its civilian nuclear responsibilities in ways that are
consistent with the NPT and that would draw the International
Atomic Energy Agency into a supervisory role to ensure that
Iran does abide by its NPT obligations.
Representative Hinchey. Thank very much, Mr. Simons. Thank
you, Mr. Chairman.
Representative Saxton. Mr. English.
Representative English. Thank you, Mr. Chairman.
Mr. Simons, we have seen an international effort to engage
Iran that has included, I think, a powerful set of economic
incentives that have been offered to Iran to refrain from
uranium enrichment. I guess, looking at this, I have seen very
little evidence that Iran has responded to those incentives.
Do we have any reason to believe that Iran would respond
differently to other economic incentives, including sanctions,
and can you detail for us any change in Iranian behavior that
have resulted so far from the sanctions that have been included
in ILSA?
Mr. Simons. Thank you, Congressman English. I believe that
the discussion of sanctions and the fact that the international
community has stood with a united front over the last 6 months
in keeping a sanctions option available has had a lot of impact
and has affected thinking around the world, including in Iran.
I think it is a little difficult to point to any specific
evidence of this, but certainly going back to Mr. Hinchey's
observation, we had a situation for the past decade in which
European countries were pursuing economic engagement with Iran
and not really availing themselves of a sanctions option. Now
the sanctions option is very much front and center as the
consequence of Iran choosing not to cooperate with the
international community.
So I do think that that has had a significant impact on
thinking. I think it has to some extent--and the Secretary has
made this observation as well--it has affected the political
risk calculus of businesses and banks that might otherwise be
thinking of expanding or continuing their involvement with
Iran.
We have seen some evidence of a slowdown in investment, we
have seen Iran's credit rating being downgraded, for example,
in the OECD, and we have seen some other evidence that by
stoking up the level of political risk and by not offering
economic incentives to offset that political risk, that Iran
already, even before sanctions are imposed, is becoming a less
desirable place to do business. So I do think that having the
sanctions option in full view has been very important.
You raised a second question about ILSA, and in this regard
the Administration did send a midterm report up to Congress
last year in which we detailed what we believed to have been
the impact of ILSA in terms of investment. And here too, as I
mentioned earlier, we do believe that ILSA has played some role
in terms of slowing the pace of investment in Iran's oil and
gas sector.
Representative English. In other words, you are suggesting
that ILSA has had an effect on the international business
community's interactions with Iran. Have you seen any change of
behavior on Iran's part, either at the government level, or has
this had any impact on economic players below the government
level, within the country and its economy?
Mr. Simons. I think I might defer to some of our following
witnesses who might follow this a little more carefully. But I
would just note that in looking at some of the Iranian
government statements that have been made since the sanctions
option has been out there, the Iranian government appears to
have been making a lot of efforts to suggest that all is well
on the investment front and has been seeking out opportunities
to present a normal face, a kind of positive face in terms of
investment. And I think the fact that they are engaging in that
type of campaign suggests perhaps that all is not so well.
Representative English. I appreciate that, Mr. Simons. I
realize the questions I have raised here are very difficult
because this is a very difficult area of policy, but I am
grateful to the Administration for pursuing the aggressive
course it has and the diplomacy it has in dealing with the
thorny issue of Iranian enrichment. And I am grateful to you,
Mr. Chairman, for giving us an opportunity in this hearing to
fine-tune how we approach engaging Iran and encouraging them to
play a more active and positive role in the international
community.
So I thank you and I yield my time.
Representative Saxton. Thank you very much, Mr. English. I
move now to Ms. Sanchez.
Representative Sanchez. Thank you, Mr. Chairman, and thank
you, Mr. Simons, for testifying before us.
Do you really believe that--what do you think the real
impact would be, if we do have a stand-off and we are not able
to come to an agreement with respect to the enrichment issue in
Iran, if the world powers got together and say we are going to
have sanctions against this country?
First of all, do you really believe places like China and
Russia would actually follow that, or their business interests
would follow that? And, second, what would be the impact if
there was leakage in particular from--let's say from those two
areas?
Mr. Simons. Thank you, Congresswoman Sanchez. It is a
little difficult for me to get into a speculative realm here. I
would just note, though, that China, Russia and other countries
did stand up with us in the IEAE votes; two very important IEAE
votes over the past 6 months they stood with us and the rest
the international community in terms of insisting that Iran
meet its commitments. And the Secretary and Under Secretary
Burns have made it their highest priority to work with this
P5+1 group that I described in my opening statement, and it is
one of the highest priorities for this Administration's
diplomacy.
So I do think that the fact that we have assigned this
priority and that we have been able to speak with one voice to
this point is a very important achievement.
Representative Sanchez. With respect to China and the fact
that if you take a look at what it has been doing in the last
few years and having long-term contracts for energy
availability, have you seen them have any interaction with
respect to Iran in that situation?
Mr. Simons. That is a good question. I actually was in
Beijing last week for some discussions on energy issues, and
there is no question that China faces daunting challenges
meeting its future energy requirements, given the projections
of explosive economic growth. You can just see it all around.
They are looking abroad, they are launching upstream
investment activities in many parts of the world. But at the
same time, as former Deputy Secretary Zoellick pointed out in a
speech that he gave, we are seeking to work with the Chinese to
develop a responsible stakeholder role for China whereby they
would take a close look at the political and security
consequences of their energy policies.
Representative Sanchez. That sounds nice, but my question
was have you seen any contract, any deals going on with Iran
with respect to securing energy for the future, from China?
Mr. Simons. I think many countries around the world, China,
India, others, are engaging in discussions----
Representative Sanchez. But we haven't seen anything.
Mr. Simons [continuing]. Discussions. Let me continue for a
minute. As with many of these discussions, they go on for many
years. And as the Chairman has pointed out, Iran is the second-
largest holder of gas reserves, second-largest, third-largest
oil reserves in the country. So you will not be able to shut
off this process of discussion that goes on and of keeping
doors open, and so our job in the Executive Branch is to ensure
that some of these other factors that you point out are brought
to the attention of the Chinese authorities and other
authorities.
Representative Sanchez. I am going to cut you short because
you are running through my time on answering--of giving me
answers to questions I didn't ask.
With respect to any economic reforms, have you seen any
going on in the economy for Iran? I ask that from the whole
sense that there are a lot of people that believe that the most
moderate people in that region would be the Iranians, the
people--I am not talking about who controls the government.
Have you seen--what type of economic reforms, if any, have
you seen in that country? And the second question with respect
to the rise of price in gas, in getting that money back into
the economy, what has the government or the Iranians done with
those moneys? Has it gone to military spending; has it gone
into infrastructure building; what have you seen?
Mr. Simons. As to your first question, we have not seen
much evidence of economic reform, but countries that receive
surges of oil income rarely have the incentives to undertake
economic reform, so it is not unexpected that the Iranians
would not push ahead on reforms.
With respect to the use of funds, some of the petroleum
reserves go back into the general budget and they finance a
variety of development expenditures, security expenditures,
everything that would go into a general purpose budget. So
there has been some focus, additional focus on development
issues, because there has been a budgetary surplus as a result
of the oil revenues. This is consistent with revenues that
would come from tax or other sources.
Representative Saxton. Thank you very much.
Mr. Cummings.
Representative Cummings. Thank you very much, Mr. Chairman.
Iran said that it will respond on August 22nd to the incentives
being offered by the United States and our allies to entice it
to give up its nuclear weapons program. If Iran responds by
withdrawing from the Nuclear Non-Proliferation Treaty, what
leverage would be available to the United States and/or the
United Nations to try to slow the Iranian nuclear program,
particularly if countries like Russia and China remain opposed
to sanctions and to other measures that they consider to be
provocative?
Mr. Simons. Thank you, Congressman. I am afraid that
question is a little bit out of my area of expertise, which
tends to be more on the oil and energy side. But I would just
note that we have given the Iranians a choice of paths that
they can follow, and it has been fairly clearly enunciated, and
we do have all the major powers of the world aligning
themselves, the P5+1, in the direction of a path of cooperation
which would enable the Iranians to access civilian nuclear
technology, admittedly under safeguards.
But this is something that the Iranians will need to take,
obviously, a close look at. But these are the choices that are
ahead.
So either they can pursue the path or they can pursue the
path of isolation. On July 12, the Permanent Members of the
U.N. Security Council, plus Germany (the P5+1), noting that
Iran had given no indication that it was ready to engage
seriously on the substance of the proposals presented on June
6, agreed to seek a Security Council Resolution that would make
mandatory Iran's suspension of all uranium enrichment and
reprocessing activities. The
P5+1 also agreed that should Iran fail to comply with such a
Resolution, we would work for the adoption of measures under
Article 41 of Chapter VII of the U.N. Charter, which provides
for sanctions.
Representative Cummings. I appreciate that. Particularly as
the United States has virtually no contact with Iran now and
has imposed unilateral sanctions since the 1980s, could
additional sanctions even be imposed against Iran if they were
not fully supported by the U.N. and by countries like Russia
and China?
Mr. Simons. I think you make a good point, Congressman
Cummings, in the sense that the U.S. sanctions are already
quite comprehensive, so the approach the Administration has
followed is to take a look at how other countries around the
world could basically look at those kinds of options and could
to some extent associate themselves with some of the things
that we have already had on the table for some time.
Representative Cummings. Well, I mean when you consider
Iran's role with regard to terrorism, have you seen any effect
with regard to Iran's behavior since we have been imposing
sanctions since the 1980s? Have you seen any effect on those
sanctions?
Mr. Simons. As I mentioned in my opening statement, we
still have very, very significant concerns with Iranian support
for terrorist organizations, up until the events in the past
few weeks, and clearly the Iranian supply of Hezbollah has been
a huge problem. I think this is an issue we continue to work on
and it is a concern. And it is a concern now that we have--I
think the important factor now is that we have a broader
coalition of countries that look at the issue the same way that
we do, which is a significant advance over where we had been
for the prior decade.
Representative Cummings. Thank you, Mr. Chairman.
Representative Saxton. Thank you, Mr. Cummings.
Mr. Simons, thank you for being with us this morning. I
would like to conclude with one thought and that is that you
just mentioned the events of the last few weeks, and one of the
outcomes of the events of the last few weeks that has been
noted is a different attitude toward Iran even among or maybe
particularly among Middle Eastern governments. I am thinking of
Saudi Arabia and Egypt and Morocco, of course, and Northern
Africa who have, I believe, in each case failed to condemn the
actions of Israel, which is unusual, against the Hezbollah, the
Iranian backed Hezbollah, and I find that as a very interesting
development subsequent to the actions in Israel and Lebanon.
So thank you for being with us. We appreciate it very much.
Your perspectives are very valuable to us, and thank you for
what you do and keep up the good work.
We are now going to move to introduce our second panel. Dr.
Kenneth Katzman, a specialist in Middle Eastern Affairs,
Congressional Research Service and the Library of Congress.
Second, Mr. Ilan Berman, Vice President for Policy of the
American Foreign Policy Council. Third, Mr. Andrew Davenport,
Vice President, Conflict Securities Advisory Group, here in
Washington, DC. And Mr. Jeffrey J. Schott, Senior Fellow for
the Institute for International Economics.
Thank you for being with us. And why don't we start with
Mr. Katzman and we will kind of move across the dais here.
Dr. Katzman, the floor is yours.
STATEMENT OF DR. KENNETH KATZMAN, SPECIALIST IN
MIDDLE EASTERN AFFAIRS, CONGRESSIONAL RESEARCH
SERVICE, LIBRARY OF CONGRESS
Dr. Katzman. Thank you, Mr. Chairman. Thank you for asking
me to appear at today's hearing. I will summarize my remarks
and request the full statement be placed in the record.
To summarize, I am going to focus today primarily on the
politics of Iran's economy rather than the hard facts of Iran's
economy. Iran's economy is highly resistant to reform because
it is in the interests of those governing the regime to keep
the economy exactly the way it is.
Iran's leaders are able to steer the proceeds or parts of
the economy to provide patronage, build their constituencies,
particularly among the lower classes.
Because Iran's political leaders benefit from the structure
of Iran's economy, there is little chance under the current
system of major structural economic reform.
What I would like to talk about is the engine of this
system that the clerics run are the quasi-state, the state
funded, state directed foundations called bonyads, a Persian
word meaning ``foundation.'' These are informal networks. They
are controlled by key clerics or former or current government
officials. They are technically not under the authority of the
Ministry of Welfare and Social Security, and they do play a
role in social welfare. However, their criteria are arbitrary,
which in many ways explains the conclusions of the World Bank,
which said that Iran's system of social welfare is inefficient
and in fact many Iranians receive benefits from the system who
are in fact not even below the poverty line because the
bonyads, the foundations, their criteria are arbitrary and in
many cases they reward with social welfare families who are
politically loyal to the regime rather than hard facts of
demonstration of actual economic need or poverty.
The bonyads, these foundations, actually account for about
an estimated one-third of Iran's GDP, and I would argue that
they distort normal market forces in Iran.
In many cases, they have these bonyads that because they
are so politically well connected have cornered entire segments
of the market for import or export of certain goods and have
developed monopolies in some of these goods, trading in some of
these goods.
Iran's economy fundamentally is a trading economy. Iran
really doesn't manufacture really anything, much of anything.
Except maybe carpets. It runs on trading, buying, selling,
markup discount. That is Iran's economy essentially.
The most controversial allegations about these bonyads is
whether or not their funds have been used, because they are not
really under any ministry, as a sort of a circuitous way to
generate extra funds to procure weapons of mass destruction
technology and other technology.
This allegation has long surrounded the largest foundation,
the Foundation for the Oppressed and Disabled, which has
constantly been run by hardliners and former officials of the
Revolutionary Guard, including Mohsen RafiqDust, who was the
first minister of the Revolutionary Guard. It is now run by a
former chief of the Revolutionary Guard, Mohammad Forouzandeh.
The Foundation for the Opressed is so large it manages broad
assets, 400 companies and factories, with a total estimated
asset value of about $12 billion, and it is considered the
largest single economic entity after the government itself.
It is active in the following sectors: Food and beverages,
chemicals, shipping. The bonyads shipping company, metals,
petrochemicals, construction, dams, tours, farming,
horticulture, animal husbandry, tourism, transportation,
hotels, two major hotels in Tehran, commercial services,
financing. It produces the best selling soft drink in Iran
called Zam Zam. It uses profits--it does, however, provide
social welfare. It helps about 120,000 poor families and
veterans of the Iran-Iraq war.
Another foundation based in Mashhad in northeastern Iran is
the Shrine of Imam Reza Foundation. It uses donations from 8
billion pilgrims to the shrine--it has used that to buy up to
90 percent of the arable land in its area. The estimated value
of this land could be as much as $20 billion, and it is the
largest employer in Khorasan province. It runs 56 companies,
including a Coca-Cola factory and two universities and is now
getting into automobile manufacturing.
It is headed by Ayatollah Abbas Vaez-Tabasi, who is on the
powerful Expediency Council that is headed by former President
Akbar Hashemi-Rafsanjani, who lost the Presidential election in
2005. His son is married to a daughter of the Supreme Leader
Ayatollah Khamenei.
The Noor Foundation imports sugar, pharmaceuticals and
construction equipment and has substantial real estate
holdings. It is headed by Mohsen RafiqDust, who was the first
Minister of the Revolutionary Guard and who later was head of
the Foundation of the Oppressed. RafiqDust is on the Expediency
Council.
The last foundation I would like to mention is the 15
Khordad Foundation. It is the bonyad, the foundation, that
offered the $1 million to anyone who would kill author Salman
Rushdie, and the bonyad has not--although the government has
said they have no issue with Rushdie any more, the 15 Khordad
Foundation has not actually rescinded that offer for the
killing of Rushdie.
A few other elements of the economy, the political economy,
I want to mention. The cooperatives, another sector of the
economy. The most well known is the Rafsanjani Pistachio
Growers Cooperative run by the cousin of Mr. Rafsanjani, again,
who is chairman of the Expediency Council. The cooperative
represents about 70,000 pistachio farmers and has a large
estimated value of $746 million. Many believe it was
Rafsanjani's wealth from the Rafsanjani cooperative that has
led him to prominence and has allowed him to pay off supporters
although it did not carry him to victory in the 2005 election.
He still lost to Mahmoud Ahmadinejad.
The Revolutionary Guard. I have done a lot of work on the
Revolutionary Guard in my career. Very loyal to the leadership.
Increasingly playing an economic role. As we have seen, it is
getting its tentacles into the economy, and in fact a firm
owned by the Revolutionary Guard called Ghorb is being awarded
a $2.3 billion a year deal to develop two phases of the large
South Pars gas field, which is Iran's large natural gas
project. That project was going to be awarded to Norway's Aker
Kvaerner, but the Guard, using its political influence,
overturned that. It was retendered and it was won by this arm
of the Revolutionary Guard. Again, and certainly Ghorb is much
less capable of developing the South Pars gas fields than
Norway's Aker Kvaerner. So this is another way of how the Guard
and the regime have basically captured, cornered large parts of
the economy.
The implications for reform are clear. There is a big
debate in Iran over reform because the conservatives are very
divided. I will conclude with that. Ahmadinejad really
represents the lower class. He believes in state control of the
economy, that the state should drive employment. Other
conservatives such as Rafsanjani, they represent the bazaaris,
the traders. They are really almost in many ways pure
capitalists. They want very few restrictions. They want to be
able to trade in and out freely and mark up their goods. They
don't want state control of the economy. And they don't want
really foreign investment in the economy because if foreign
investment comes in the investor from a multinational company
will probably make a better product than they do or do a better
job than they do and will displace their monopoly. So the
bazaaris want to keep out foreign investment.
So in many ways, considering sanctions on investing in Iran
outside the energy sector may not necessarily be unpopular in
major segments of the Iranian leadership because, as I said,
the bazaaris don't want this investment anyway because it will
hurt them.
So in summary, I see very little prospects for political
reform. I think the structure of the system is the way it is.
It allows the clerics to build patronage to control their
supporters, to keep people loyal. And I think the system serves
that interest, and repeated efforts to reform have been
thwarted.
Thank you.
[The prepared statement of Mr. Katzman appears in the
Submissions for the Record on page 45.]
Representative Saxton. Thank you very much, Mr. Katzman,
for those important perspectives. We appreciate it.
Mr. Berman.
STATEMENT OF ILAN BERMAN, VICE PRESIDENT FOR POLICY, AMERICAN
FOREIGN POLICY COUNCIL
Mr. Berman. Thank you very much, Mr. Chairman. Dr. Katzman
spoke about the Islamic Republic's political economy and I
would like to talk about economic avenues that are available
for the United States and its allies in confronting Iran. Let
me focus my oral remarks on three vulnerabilities or, if you
will, points of entry into the Iranian economy by which we can
exert pressure. And I do this in order of escalating
effectiveness, at least in my opinion.
The first is foreign direct investment. Iran today produces
3.9 million barrels of oil a day, and exports 60 percent of
that, approximately 2.5 million. In order to maintain this
level of production, it requires approximately $1 billion of
FDI, foreign direct investment, annually. In order to increase
that capacity, Iran requires approximately $1.5 billion. In
context, though, this is not a lot of money. Iran has signed
contracts worth dozens of billions of dollars with foreign
powers over the past several years.
China alone has signed at least two massive exploration and
development deals with Iran worth a cumulative $100 billion
over 25 years since 2004.
As a result of this trend, Iran is no longer an economic
pariah the way it was in the mid to late 1990s. It now has very
vibrant economic ties with a number of foreign countries. And
Iran has amassed huge amounts of money as a result of the high
price of oil. The average cited in the Iranian press is that
Iran has approximately $50 billion in hard currency reserves as
of March of 2006, the end of the Iranian calendar year.
What does this mean? This means that legislation such as
the Iran-Libya Sanctions Act which we have in force and is
coming up for renewal next week, even if there are a political
will to implement it more fully, will not be able to alter
Iranian behavior by itself. There is simply too much hard
currency that the regime could tap into and there are too many
foreign factors who are invested who would act. Iran will find
a billion dollars, or a billion and a half, somewhere. What the
United States can do is try to complicate where Iran gets its
foreign direct investment from, and force them to draw from
their hard foreign currency reserves. I would argue that is a
worthwhile effort, because if Iran has less money available for
its nuclear program, for terrorism, or for interference in
Iraq, that is an aggregate benefit for American foreign policy.
However, this is not by itself a solution to the nuclear issue.
We should not rely just on curbing FDI.
The second weakness is the economic hierarchy that exists
in Iran today. The vast majority of regime wealth is
concentrated in a small number of people. For example, as Dr.
Katzman alluded to, the extended family of former Iranian
President Ali Akbar Hashemi Rafsanjani virtually controls
copper mining, pistachio trade, and a number of profitable
export and import businesses. And parallel to that you have the
bonyads, the regime's sprawling charitable foundations. They
are largely unregulated, accountable only to Iran's Supreme
Leader. And they account for 20 percent or more of Iranian
national GDP, and as much as two-thirds of the country's non-
oil GDP.
So there is a substantial financial base that can be
targeted which has very deep ties to the regime. Targeted
financial measures that restrict the ability of these
individuals and organizations to access international markets
and curtail their ability to engage in international commerce
are likely to have an immediate and pronounced effect on regime
decisionmaking. This is a large domestic constituency and there
is likely to be a lot of domestic pressure exerted on the
Iranian government if these people can no longer live in the
manner to which they have become accustomed.
But the most solid point of entry, in my opinion, is
commodities. Iran maintains a socialist energy sector. Gasoline
is sold for pennies on the dollar. It costs approximately 40
cents to buy a gallon of gas in Tehran today. Iran consumes
64.5 million liters of gasoline a year and it imports close to
40 percent of that. More importantly, it does not have the
equivalent of a strategic gas reserve. There have been studies
out of Iran that suggest Iran only has a 45-day supply of
gasoline ``in country,'' after which there will be shortages at
the pump in a very destabilizing manner.
So on this issue, it is my opinion that economic pressure
can work. We are already beginning to see this. Sanctions have
not yet been applied in any way, but leading parliamentarians
in Iran have already told the government it needs to spend an
extra $5 billion this year alone to maintain its established
policy of deep subsidies and avoid rationing. It is quite clear
that this international climate is creating additional fiscal
requirements for the regime to maintain state subsidies, and we
can exploit that. That is a point of entry for us.
But none of this is occurring in a vacuum. Iran is already
making very substantial economic countermoves.
First, Iran has carried out large scale transfers of
financial assets from Europe to institutions in China and
Southeast Asia, where the belief is they will be less likely to
be exposed if sanctions are applied.
Second, the regime has begun the initiation of a large
scale privatization of government funds, transferring to
offshore accounts, transferring into private hands, selling off
gold reserves, things like that.
And most importantly, and I think this needs to be
emphasized, the regime about a month ago passed a new budget
which goes into effect over the next several months which calls
for a halt to imports of refined petroleum projects and
gasoline rationing beginning this fall.
These are all efforts to minimize economic vulnerabilities
on the part of the Islamic Republic, and they are an attempt by
Iranian leadership to deny the West the ability to influence
Iranian behavior, specifically on the nuclear issue.
Therefore, and I say this advisedly, the sanctions track
that we are currently pursuing at the United Nations is likely
to be ineffective. First of all, we have a problem with timing.
The delays that we have experienced so far--and are likely to
experience moving forward--allow the regime time to make these
economic countermoves that will make sanctions, when they are
applied, likely to be less effective than they are today.
And the second is a problem with scope. There is a need to
appease the stragglers in our economic coalition. The Russians
and the Chinese have made no secret of the fact that they are
very hesitant to apply economic sanctions. Therefore, any
measures that emerge as a result of the U.N. track will need to
be tailored to make sure that they don't warrant a Chinese or a
Russian veto. It means they are going to be narrow in scope.
My conclusion here is that, unfortunately, the way the
Administration is currently pursuing economic policy toward
Iran will virtually guarantee that sanctions will fail. In my
opinion, what the Administration needs to do, and needs to do
in short order, is to create a ``coalition of the willing''
with which it can go outside the confines of the U.N. and focus
on those measures that will be most effective in changing
Iranian behavior.
I say all of this advisedly because it is not guaranteed at
all that sanctions will work. In fact, the political will of
the regime to acquire a nuclear capability is very strong and
historically, sanctions are not an isolated event. They tend to
have a very strong positive correlation with escalation to the
use of force. But I think sanctions are a step that should be
attempted because if we don't, and we acquiesce to the current
U.N. track, this will make other options, chief among them the
eventual use of force, either by us or another country, all the
more likely.
Right now, we still have the ability to attempt to use
economic pressure on Iran to slow down and to curb Iran's
atomic ambitions. A year from now, it is not at all clear that
we will have that opportunity.
Thank you.
[The prepared statement of Mr. Berman appears in the
Submissions for the Record on page 50.]
Representative Saxton. Thank you very much, Mr. Berman. We
move now to Mr. Davenport.
STATEMENT OF DR. ANDREW DAVENPORT, VICE PRESIDENT, CONFLICT
SECURITIES ADVISORY GROUP, INC.
Dr. Davenport. Mr. Chairman, thank you for the privilege of
appearing before this Committee. I would like to speak first
about the central role that Iran's oil and gas industries play
in supporting all facets of Iran's government and then focus my
time on the company specific dimensions of that equation. I
will also touch on the impact of U.S. policy on corporate
decisionmaking regarding the pursuit of these business
opportunities.
In our view, three central issues define Iran's oil
industry today. First, it is clear that Iran's oil exports play
a key role in underwriting that country's government. As oil
prices increase, Tehran experiences economic windfalls that
have a direct impact on the government's discretionary spending
across the board.
Second, despite the lucrative nature of Iran's oil exports,
its energy industry as a whole has distinct weaknesses that
have prevented it from reaching its full potential. Iran's oil
industry is state controlled, aging, inefficient and in need of
significant upgrades that only foreign companies with their
access to large-scale capital and advanced equipment technology
are capable of providing. These upgrades and foreign
investments are essential for Iran to cushion the blow of
increasing domestic oil consumption and aging oil fields that,
together, are putting downward pressure on the country's oil
exports.
Third, the country's gasoline related expenditures have put
added strain on Iran's budget. Despite booming revenues, Iran's
lack of refining capacity has forced the country to spend
billions of dollars importing gasoline. Moreover, the decision
by Iran's parliament to lock domestic gas prices at 2003 levels
has led to billions more dollars in state subsidies.
Over the coming years, the intersection of these three
industry pressures will put the Iranian government and the
companies that do business there at a crossroads. With Iran
almost completely dependent on its energy exports for its
revenues and in desperate need of foreign investment to keep
these revenues flowing, foreign companies will become even more
central to the prosperity of Tehran than they are today.
The summary statistics regarding the role of oil in the
Iranian economy tell the story. Iran holds an estimated 10
percent of the world's proven oil reserves. Its oil exports
generate 80 to 90 percent of the country's total export
earnings and 40 to 50 percent of its total government budget.
Although the state-owned National Iranian Oil Company
largely runs the country's oil industry, we understand that oil
export revenues are effectively funneled straight to the
country's central bank. As might be expected, oil related
revenues quite literally equate to discretionary funds for
Tehran. Although Iran's military and nuclear spending is
largely unknown, it can be reasonably expected that both are
benefiting directly from recent oil windfalls.
To maintain these high revenue flows, however, not only
will oil revenues need to remain high, but Iran will need to
invest heavily in its existing and prospective energy projects.
Most would agree that the future success of Iran's oil fields
requires billions of dollars in foreign investment capital and
technology in the coming years.
Our research shows that there is no shortage of
corporations currently working in Iran's oil industry. In our
view, even considering the outrageous pronouncements of Iran's
new President, short of international sanctions, no significant
number of companies will forgo the country's business
opportunities. History has shown time and again that companies
will do what the law allows. As long as operating in Iran is
legal, the draw of a growing economy and the country's vast oil
and gas resources will lure them in.
There are a few important exceptions. A number of companies
have correctly identified a growing sensitivity in the U.S.
investor community to business associations with Iran. The
prospect of being labeled as, quote, ``doing business with the
enemy,'' unquote, the title of a 60 Minutes segment that has
aired twice over the past 2 years, has influenced the behavior
of some companies. For most companies, however, this
calculation is still in flux.
For at least five prominent U.S. companies, Comptroller
William Thompson of New York City made this calculation a good
deal easier by registering public shareholder resolutions with
the SEC on behalf of the city's fire and police pension funds
calling for a board level review of their corporate ties to
Iran and other terrorist sponsoring states.
After some wrangling, these companies made adjustments to
corporate policies and in certain cases renounced any future
business ties to Iran whatsoever.
The impact of corporate reputational concerns and market
forces, however, should not only be measured by whether or not
a company chooses to exit completely from Iran. One positive
development stimulated by these concerns and increased
attention to this issue from investors, the government and the
media in the U.S. has been a new sensitivity to the structure
of their corporate ties to Iran.
Some non-U.S. companies have begun to self-police their
operations at standards above and beyond the requirements of
their national laws to protect their reputations from potential
Iran-related harm. For example, companies are substituting
equipment and technology to minimize dual use concerns and in
some cases posing questions regarding certain local partners.
In fact, our firm is witnessing corporations insisting on
certain contract terms with Iran rather than vice versa.
While this may be short of what some policymakers prefer,
it demonstrates an innovative market oriented reaction that has
a high likelihood of reducing the security risks that these
corporate ties can represent. In our view, this increased
security consciousness, when it occurs voluntarily, should be
viewed as a good thing.
Given recent events and the importance of foreign companies
to the Iranian economy, one might ask: What role does U.S.
policy play in the considerations of these companies operating
in Iran? For a long time, the answer for non-U.S. companies has
been very little. President Clinton's 1995 Executive Order
banned U.S. involvement in Iran's energy sector, but had little
to no impact on foreign companies.
Congress then passed the 1996 Iran-Libya Sanctions Act, or
ILSA, which sought to sanction non-U.S. companies investing
more than $20 million annually in Iran's oil and gas industries
by restricting their access to the U.S. economy. ILSA, however,
was never enforced. Soon after the act was passed, several
large companies, including France's Total and Russia's Gazprom,
violated its provisions and following an official review went
unpunished. These early precedents cleared the way for other
companies to do the same and, today, there are over 20
companies in technical violation of ILSA.
With U.S. sanctions policy toward Iran remaining fairly
consistent since the mid-1990s, one might further ask: What has
changed over the past few years causing changes to corporate
behavior that we have been witnessing?
Our findings demonstrate that after September 11th the
stigma associated with corporate ties to terrorist sponsoring
states increased significantly. This stigma reverberated in the
local and national press. State and municipal governments began
analyzing how their retirement and other public investment
funds were invested in these companies. Grassroots attention to
state sponsors of terrorism raised substantially the
reputational risk of these corporate ties.
This grassroots movement continues today. For example, in
Missouri, an investment trust just recently became the first
public fund in the country to institute a policy that, after
careful review, screens out certain companies with business in
Iran and other terrorist sponsoring states. A so-called terror
free mutual fund, the Abacus Bull Moose Growth Fund, has
likewise been created in response to market demand. As a result
of this trend, some companies are rightfully seeking to
safeguard their corporate operations from these types of
associations. To be clear, this is market oriented cause and
effect.
According to our Global Security Risk Monitor online
research product, over 300 public companies have carried out
business with Iran during the past 3 years.
As stated, short of strong multilateral sanctions, there
will continue to be companies looking to enter the Iranian
market or expand their corporate presence. As reputational risk
increases, so too will corporate self-policing. Such new
corporate governance guidelines and due diligence measures will
not be lost on the state-owned companies that will have to
learn to be responsive to the reputational burden that they
bring to each of their prospective and existing business
partners.
Thank you.
[The prepared statement of Dr. Davenport appears in the
Submissions for the Record on page 54.]
Representative Saxton. Thank you very much, Dr. Davenport.
Mr. Schott.
STATEMENT OF DR. JEFFREY J. SCHOTT, SENIOR FELLOW, INSTITUTE
FOR INTERNATIONAL ECONOMICS
Dr. Schott. Thank you very much, Mr. Chairman. I appreciate
the opportunity to testify before this Committee.
My testimony today draws on my personal experience as a
U.S. Government official involved in the formulation and
implementation of sanctions policy back in the late 1970s and
early 1980s and since then also as a researcher who has spent
25 years documenting the use of economic sanctions around the
world with my colleagues Gary Hufbauer and Kimberly Elliott. We
have probably produced the most extensive study of the use of
economic sanctions, analyzing where they can be successful and
their limitations. I hope that that analysis will help the
Committee in its deliberations and the Congress as it pursues
legislation in the coming weeks.
There has already been very extensive discussion of Iran
and sanctions and petrodollars. The questions that were raised
by you and the other Members of the Committee in the first
panel were very insightful, and I will try not to duplicate
that discussion.
But there is an important point to bear in mind. Iran now
pockets about an extra $30 billion of oil export revenues
annually compared to a decade ago. And these oil profits, as
has been said in this panel, fuel the Iranian economy. They
also finance Iranian investment in weapons development and
support for terrorism.
What is good news for the ayatollahs is not good news for
the United States. We are paying for these developments and not
just at the pump. Petrodollars make Iran more capable of
pursuing its nuclear ambitions and funding Hezbollah and other
terrorist organizations and, importantly, it makes Iran more
immune to U.S. economic coercion. I have some differences with
comments that have been made about the effectiveness of
expanded sanctions, in part because I have concerns about the
viability of stronger multilateral support for our initiatives.
We have had sanctions for several decades, as Mr. Hinchey
implied in his question in the opening panel. Fortunately, one
only has to look back 22 years to the bombing of the Marine
Corps barracks in Lebanon and the sad fact that our Marines had
to return to Lebanon for the first time in 22 years just the
past week or so to help the evacuation of U.S. citizens.
That led to sanctions against Iran for the first time since
the hostage crisis of 1979 to 1981; it put Iran on the list of
state sponsors of terrorism where it belongs and where it has
remained for the past 22 years. We have had extensive
unilateral sanctions. We have had very modest international
support for those sanctions. And as a result, we have not
achieved the very ambitious, difficult objectives that our
sanctions policy has sought.
Now the question is, what more can be done? I think that
question makes this hearing very timely, very important. But
there is no easy answer to the questions that you have raised
this morning.
In the interest of time, I will just note that in terms of
our past sanctions policy I have appended to my statement a
chronology of key events in the decades long sanctions efforts.
If you read that, it will be troubling, because it goes back
over many events that now resonate in the headlines of the
newspapers that we read everyday. It is like Yogi Berra said,
it's like deja vu all over again. The same problems confronting
U.S. policy two decades ago now dominate the headlines.
Funding of terrorists in Lebanon. Testing North Korean
missiles and Iran's pursuit of nuclear weapons. Economic
sanctions have not blunted Iran's foreign adventurism in these
two decades although they have undoubtedly inhibited the task
and made it more costly to pursue.
Now the Congress is considering the extension or expansion
of the ILSA sanctions against Iran. I think that law should be
extended, renewed as is. But we should be careful to assess
what can be done through the use of sanctions.
Can sanctions stop Iran from eventually developing a
nuclear weapon? I don't think so. We have let the cat out of
the bag in our reactions to developments in India and Pakistan.
I fear any Iranian government would follow similar nuclear
ambitions because--for them--the issue is one of nationalism.
Even if the ayatollahs were not in power, leaders in Iran would
feel that nuclear weapons will bring them regional dominance
and that, just like with India and Pakistan, the West will
accept their accession to the nuclear club without significant
retribution.
Nonetheless, history shows that targeted sanctions can push
back that day of reckoning. India, Pakistan and North Korea
have all been subject to very extensive sanctions and some
multilateral measures. The sanctions did not prevent
proliferation but collective denial by Western powers of key
ingredients of the bomb maker's art--the reprocessing
technology, centrifuges and the like--substantially slowed the
process.
I have studied a lot of sanctions, and I know that there
are lots of ways you get around sanctions. Sanctions will not
prevent a determined and a well financed country from
eventually crossing the nuclear threshold. Even the tightest
sanction regime can be evaded with sufficient incentive.
Saddam Hussein showed that during his reign when billions
of dollars were smuggled into Iraq, sometimes with the
complicity of Iran. Land borders are porous, especially in the
Middle East, and sea and air freight are difficult to monitor
effectively without intense military operations. With Iran's
petrodollar bonanza, it will be able, over time, to procure the
necessary material and technology to achieve its nuclear
ambitions. This is a sad reflection and we ought to be planning
how to deal with this.
The comments that were raised earlier that we should
ratchet up the sanctions cause me some concerns, because this
is not the same situation we had back in the 1990s when ILSA
entered into force. Given tight global supplies, Iran has
greater leverage to counter sanctions from major oil consuming
nations and it can counter sanctions in several ways. One is by
cutting back its level of oil exports. It doesn't have to cut
them off. It can just reduce a bit. It can do non-oil related
measures by racheting up tensions in the Middle East, as it is
now doing in Lebanon, and it can also do the same in Iraq and
perhaps they are doing it at the same time.
Few producing nations have the spare capacity to offset
potential Iranian cutbacks, so prices would likely rise
sharply. Now, as you implied, Mr. Chairman, and Mr. Simons
implied in his answer to you, you could utilize release from
the Strategic Petroleum Reserve. It is not an automatic
process, especially if you want an internationally coordinated
action using the IEA's emergency sharing plan. I sat on the
governing board of the IEA as part of the U.S. delegation
trying to do that in 1980, 1981, and it was a difficult
process. We ended up doing nothing. The crisis was over before
there was international agreement to take action. Prices went
up and then they went down as a result of the global recession.
That may be a satisfactory response, but in the short term
certainly Iran will sell less and earn more. For that reason,
there are a lot of politicians who find it hard to stomach the
idea of more comprehensive sanctions, because of its short-term
impact on prices, and because it would undoubtedly trigger at
least in the short term a global recession.
Europe, China, and Japan have similar concerns and are
likely only to follow a very modest path of sanctions
escalation. Russia will be even more ambivalent and so will
China. The Russians have gained a lot from the oil price spikes
that have already been generated by Mideast tensions. They are
one of the world's major oil producers and indeed they
increased their production over the last decade, and they also
want to continue to cultivate Tehran as its best foothold in
the Middle East. I would be very wary of thinking we will get
strong support in multilateral actions from the Russians.
So what should we do? Let me conclude with a brief
commentary.
I think the most immediate and obvious task is continued
denial of critical components for Iran's nuclear industry. The
policy already receives support from major powers, but there is
a lot of leakage that comes in from second tier powers and we
ought to be concentrating our diplomacy on getting those states
to try to join in the broader sanctions effort.
Other targeted sanctions against Iran's ruling class should
also be considered. I think these are more for annoyance--
measures such as travel restrictions and overseas asset
freezes--but Dr. Katzman perhaps can comment more on the impact
that they would have on domestic Iranian politics.
But the strategy of limited sanctions accompanied by
coordinated diplomacy is not going to achieve the result of
denying Iran eventually its objectives. It will only delay the
process. Hopefully, over time, that delay will mellow Tehran's
nuclear ambitions. This is less than a satisfying result, but
effectively what we can achieve given current conditions in
world energy markets.
Thank you very much, sir.
[The prepared statement of Dr. Schott appears in the
Submissions for the Record on page 58.]
Representative Saxton. Thank you very much, Dr. Schott.
That was a very good statement and we appreciate it very much.
You each heard Dr. Schott, other panelists, obviously heard Dr.
Schott talk about the effectiveness or potential effects of
sanctions. Within the context of what Dr. Schott had to say,
Mr. Davenport and Mr. Berman and Mr. Katzman, would you just
kind of respond and give us your thoughts relative to the
context within which Dr. Schott put the subject?
Dr. Davenport. I will do my best. I would have to say that
from our perspective, we spend a lot of our time, the company
that I represent, researching which companies from around the
world are doing business in Iran and what they are doing there
and hence the focus of my testimony on the importance of those
companies to the country's economy. And I think it has been
supported really in the testimony of some of the other
witnesses that, at present and for the future, the Iranian oil
economy is going to be highly dependent on the investments of
foreign companies. That is really how they are going to keep up
their current level of revenues and how they are going to keep
producing more and more oil in order to compensate for
currently aging oil fields and their increasing domestic
consumption. As long as that is happening, I think you are
going to see Iran's economy, short of oil prices falling,
continuing along apace even with U.S. sanctions in place.
So I believe that what would affect Iran's economy most
substantially would be international sanctions, if they were to
occur, or a severe drop in the price of oil. I think these
vulnerabilities show increasingly as Iran ramps up its budget
and gets rather spendy with the current oil-related revenues
that they are experiencing. I believe they have a budget
deficit currently, even given the enormous windfalls that they
are experiencing from today's oil prices. So I think either oil
prices fall or international sanctions are put into place and
those are the two biggest things that I see having a negative
impact or significant impact on Iran's current economic
situation.
Representative Saxton. Thank you.
Mr. Berman.
Mr. Berman. Thank you very much. I tend to agree about 50
percent with Mr. Schott, and let me explain why. He is exactly
right in terms of goals. Economic sanctions cannot change the
calculus of the Iranian leadership. It is very clear that
Iranian officials have made a strategic choice in favor of
nuclear possession, and they also have made clear that they are
willing to stomach very painful economic measures inflicted
upon them from the international community in order to achieve
their goals, in order to perpetuate policy. But let me draw in
something that hasn't been mentioned so far yet today.
The goal of sanctions should not be to stop the nuclear
program. If that is the goal, then we have already failed. We
have failed before we started. The goal, rather, should be to
impress upon the Iranian people, the 85 to 90 percent of the
Iranian people that are disenfranchised from the government,
that their ruling regime's goals have concrete economic
consequences, because the one thing that is very important here
is the degree to which economic measures are not done in
isolation. They have a diplomatic component. The most important
component here is in order to accentuate the effectiveness of
sanctions is to deny the regime the ability to rally the people
around the flag, and that means that any economic measures have
to be coupled with very robust public diplomacy that talks
about the concrete consequences of their regime's adventurism.
The second point is on Iranian oil power, and about what
can Iran do. Is it likely to expect an oil trade disruption? I
think there are a couple of factors that mitigate strongly
against that. The Iranian regime has blustered very publicly
that it will reduce the flow of oil from the Persian Gulf. That
they will cutoff the flow of oil from the Strait of Hormuz. And
they have the capability to do that, certainly, but it is
useful to remember here that Iran is dependent on less than
savory countries, which are its primary customer base for
energy. And it is very clear that if Iran is no longer on the
table, countries like China and countries like India will waste
no time in finding other, more stable suppliers.
The second point is that if Iran begins fiddling with the
``oil tap,'' this will do something that so far American
strategy has not been able to: to galvanize an international
consensus about the need for a fundamental change in Iran. Many
countries that are very dependent on Iran for oil will simply
not stomach someone tinkering with a passageway through which
two-fifths of the world's oil trade passes. I think the goal of
their bluster is to have us self-censor, to have us think about
what the costs are. But it is a very far cry for them to be
able to do that. In fact, I think they understand that doing so
in a very robust fashion might actually be regime threatening.
Representative Saxton. Mr. Katzman.
Dr. Katzman. My view is that Iran is single mindedly
determined to achieve a nuclear capability and they will not be
deterred by economic measures. In the Iranian view of Iranian
strategists all across the spectrum, the reformists, the
hardliners, every type of hardliners, Iran has been humiliated
by outside powers throughout its history. It has been criss-
crossed by every invader imaginable. The only way to reverse
this sense of vulnerability is to achieve a nuclear capability,
in which case they would no longer be vulnerable in their
perceptions to this type of manipulation, in their view, by
outside powers. I believe they can endure substantial economic
privation.
Remember, Iran I think--I believe there is a perception in
Washington, popularly here in America, that the Tehran elites
are Iran. That is not Iran. Iran is rural villages, very poor.
It is not a rich country. It is not a really well educated
country. In Tehran there are very well educated elites who
would be quite harmed and quite injured by economic privation.
But the vast majority of Iranians are used to economic
privation their entire lives, and I don't personally believe
that any sanction will deter them from this course of pursuit.
Thank you.
Representative Saxton. Thank you.
Mr. Hinchey.
Representative Hinchey. Thank you, Mr. Chairman. Gentlemen,
I want to thank you very much. I think your insight today that
you provided us is very valuable and I wish the entire number
of the Members of the House of Representatives could have been
here to hear you. I think it would have been very beneficial.
Have any of you been to Iran recently? Not recently. Any of
you been to Iran at all? I think that is a major problem, and I
don't say that in any way to diminish what you just said. I
think what you just said is very, very valuable and I don't
mean to diminish it at all. But I just ask that question
inquisitively because there is very little contact between our
countries, any real, any meaningful contact between our
countries, and the situation has gotten worse over the course
of the last 25, now almost 30 years.
Mr. Schott, you said that a lot of people, politicians
particularly, have a difficult time stomaching sanctions. I
think that is right. I have a hard time rationalizing when you
look--when you look back on the history of our involvement with
this country, it seems to have been deplorably unsuccessful,
and it is because the relationship has been a very aggressive
one and the aggression has been primarily from our side. I can
remember, you know, when I was a very, very young man watching
television news programs over the weekend where the Shah of
Iran was the principal guest and at that time Iran was a major
ally and close friend of the United States through the Shah.
But the Shah, over time, became less and less popular within
his own country and when that happened back in the Carter
administration, we reacted in a favorable way toward the Shah
and an unfavorable way to the people who opposed him, and that
was really the beginning of the decline of this relationship.
And it is an unfortunate situation, because I think that
the people who are making policy could very much benefit from
the insights that you provide. I don't know what kinds of
opportunity you have to talk to this Administration or
particularly to the State Department. I hope it is--I hope that
you do have the opportunity because I think that there could be
a great benefit from that kind of interaction.
But I would just like to ask you ask one question
basically. The approach that we have taken to Iran has been
very unsuccessful, seems to me completely unsuccessful. The
likelihood of the situation improving under the present set of
circumstances I think is remote. The response of the Iranian
people to the actions that we have taken with regard to their
country has been very reactionary. They have increasingly
elected more and more reactionary leaders who are increasingly
hostile to the United States and to other countries,
particularly Israel. So the circumstances that prevail today
are worse than they were 10 years ago, substantially worse than
they were 30 years ago.
Everything that we have done has made the situation worse.
Well, I don't know about everything, but most of the things
that we have done has made the situation worse. What is it that
we should be doing to make the situation better?
I think it was Mr. Berman who said he didn't have an
opportunity to talk about diplomacy in his opening remarks.
Seems to me that that is exactly the problem we all have. None
of us have had an opportunity to talk very much about
diplomacy, let alone to engage in a serious diplomatic
initiative with this very significant country. So I would
appreciate anything that you might care to respond to that. Dr.
Katzman, if you would like to begin.
Dr. Katzman. Well, I would just begin by saying there has
been engagements and actually in the last 4 years there has
been substantially more engagement with Iran than ever before.
Actually in 2003 for the first time the two countries
acknowledged that they were conducting an open dialog. During
the Clinton administration there had been talk about what the
conditions might be for entering a dialog with Iran. But the
last 4 years we have actually had a dialog with Iran, starting
with Afghanistan, and Iran was extremely helpful in putting
together the Karzai Government at the Bonn conference in late
2001. And then there were talks with Iran on Iraq and how Iran
might be helpful.
Representative Hinchey. What you have just said is
absolutely true. Iran was very helpful with regard to
Afghanistan and that was very important to us because
Afghanistan was the appropriate focus of our attention at that
particular moment. What strikes me as--what is difficult for me
to understand is why we allowed our relationship to deteriorate
with them after they had been so helpful to us in Afghanistan.
I was in Afghanistan in December of 2001. I had a chance to see
what was going on there. I understand the kind of things that
Iran and other countries did working closely with us. Why then
did the President say, for example, in his speech just a couple
of months later, a month later, that Iran was part of the axis
of evil?
Dr. Katzman. Well, the Iranians point to that as something
that bothers them greatly. But I would also say the dialog was
suspended in May of 2003 when al-Qaeda activists who were in
Iran were responsible for the bombing of a big housing complex
in Riyadh, Saudi Arabia. Sayf al-Adel and bin Laden were
believed to be in Iran possibly under Iranian protection there.
Representative Hinchey. You take a big jump in time between
2001 to 2003. The curious question is what did we allow to
happen or what did happen in that intervening period that
caused the situation to deteriorate, sir?
Dr. Katzman. There were--what I understand is there was
consideration of building on the Afghan initiative, the Iraq
initiative. But there was a sense that Iran was still doing
things we found objectionable such as the nuclear. Remember in
2002, late 2002, the evolution of the major nuclear sites was
unveiled. So while Iran may have been helpful on Afghanistan
and Iraq, we had this other track happening where it suddenly
became apparent that Iran was much more advanced in its nuclear
program than we had previously thought, and that might have
factored in to why this dialog was not built on.
Mr. Berman. A couple of points. You made the case that our
approach has been spectacularly unsuccessful. I would argue
that in fact we haven't had much of an approach at all for the
last 8 years, 10 years. What you have actually had in
Washington is two competing camps. One thought that we could do
business with the Iranian government. On the other side, you
have people that said this is a government that is unreformable
and we simply can't talk to them. And the result of that clash,
predictably, has been policy inertia. I think that it has
actually affected some of the things that this Administration
has done. The legacy is still there.
So I would say that your point is well taken, but I think
it might not be because we have tried everything at our
disposal. It might be because we are butting heads with
ourselves.
The second point: You made reference to the election of
Ahmadinejad, and I think the more appropriate term here is
selection. What is important to remember is that there were two
Presidential run-offs, one in June and one in July. But 3
months before that, in March, the Iranian government's vetting
authority excluded more than a thousand potential candidates
for President. The eight that remained, who participated in the
first round, might have talked a different talk, but they all
walked the same walk. None of them were going to pursue
policies that were going to be threatening to the Islamic
Republic. And in the final stage in the run-off between former
President Rafsranjami and Ahmadinejad, it is important to
understand why the latter won. He won on a campaign that was
populist. It was against corruption, basically pointing to his
people and saying, ``These people have robbed you, the Iranian
people, of your deserved wealth. Stick with me and I will make
it better.'' He hasn't, and this is where there is an
opportunity for the United States. Ahmadinejad for the last
year has had the opportunity to pursue very populist policies.
And he has done some of that tinkering on the margins of
agrarian reform, etc. But what he hasn't done is reconstruct,
as he promised to do, the relationship between the government
and the people in terms of trickle-down economics, if you will.
That is an opportunity for the United States, because if
Iranians substantively are still economically disenfranchised
from the government. But that doesn't mean they will be in the
future. If the Iranian regime begins implementing some of these
policies, you will see a fracturing of that base of Iranians
that right now does not see any economic opportunity for them
in the perpetuation of the Islamic Republic. But so far, this
hasn't happened.
Dr. Davenport. I will have to defer to some extent to other
witnesses here since the company that I represent is impartial
and doesn't take policy positions on the research we perform.
But what I would like to say is whether or not you would
agree with the current track of the Government here with
respect to Iran, what we are witnessing in the private sector
is a number of Americans at the local level, and most notably
in the investment community taking, matters to some extent into
their own hands via a form of what has been called, in the
past, socially responsible investing, also termed values-based
investing, based on their own opinions of what is going on in
the world. In some cases, where American policy and regulatory
regimes can't reach, these investors are taking actions with
respect to U.S. and foreign companies doing business in Iran,
taking a look at exactly what they are doing there and deciding
for themselves whether or not they want a part of it. And in
some cases, they are screening out these companies altogether.
And I think that is becoming an element in the international
dynamic as that community grows.
Dr. Schott. As in the first panel, Mr. Hinchey, you have
put your finger on the key question: Is U.S. policy making
things better or moving us toward meeting U.S. objectives, or
is it making things worse? And I strongly disagree with some of
the commentary on this panel that we haven't had a policy. We
have had a very clear policy dealing with a very difficult and
volatile situation.
The policy started, as you rightly mentioned, back in the
1970s when we played Iranian politics the wrong way, ended up
in the hostage crisis, and we used economic sanctions very
intensively and ultimately somewhat successfully to provide
bargaining chips to get our people home after 440 days.
But that created a sense of tension and animosity that
carried over. Clearly, the Iranians had the capability to
export their adventurism, and they did so, and that led to the
sanctions regime starting in 1984.
That was manageable. We followed a policy of containment as
opposed to a policy of military response. And given the
situation in the Middle East, given the lack of strong
multilateral support back in the 1980s and the 1990s, and even
today, it probably was the best of a bad set of options to
follow.
Any containment policy is going to have tensions among
domestic groups. There is going to be cheating. There is going
to be those who say, well, we have military means, let's use
them, though it is hard to figure out what the next step will
be after you begin a military response, even if it is a limited
bombing raid.
And so the policy of containment in the 1980s--and
essentially that has been the policy under ILSA, to limit the
growth of the Iranian industry--has been successful. Iran still
produces about the same amount of oil, but it hasn't been able
to take further advantage of its natural resources.
We now have a much more difficult international environment
in which to pursue our policy. The global oil supply demand
balance is very tight, and that has contributed to the
financial windfall that the Iranians now benefit from that
gives them a lot more margin of flexibility for pursuing
domestic and international policies.
It also, as I said in my statement, ends up constraining
the impact of economic coercion against them. That is why I
think we have to continue a policy of containment. I think we
can try to sharpen it in some areas, the narrowly targeted
areas of componentry and technology useful for the nuclear
industry, so that we lengthen the period of time, and hopefully
the global environment both economically and politically will
allow us to begin to work more closely with the future Iranian
government, as the policy dialog began to improve a few years
ago, as Dr. Katzman said.
But sanctions are not going to be a magic bullet to solve
our problems. There is a wide range of problems in the Middle
East related to economics and politics that pull against a
coordinated international action and I don't think we are going
to see that from the Russians, the Chinese, or the Japanese in
the future. They will help us a little, but you will get the
type of bland statements you got out of St. Petersburg 2 weeks
ago.
Representative Saxton. Thank you very much.
Mr. Hinchey, thank you for hanging in here with us.
Representative Hinchey. I thank you, Mr. Chairman, for
holding this hearing, and thank these gentlemen. The insight
that you all provided I find very, very valuable.
If I could just ask one last brief question, Mr. Chairman.
Representative Saxton. If it is very brief.
Representative Hinchey. Could you supply me a list of those
20 companies that violated the ILSA?
Dr. Davenport. I will do my best. I will be in touch with
your office and talk with my guys.
Representative Saxton. In wrapping up here, we started this
discussion a couple of hours ago to focus on the economics of
the oil industry and Iran and what we can do to influence
policy there, and perhaps it was a natural thing that we didn't
focus on the ideology that is driving all of this. It just
seems to me that a mention of that at this point might be
worthwhile. It is obviously an ideology which the regime is
intent on spreading. From my point of view, much of what is
going on in Iraq today has directly to do with this. Much of
what is going on in Syria today has a lot to do with this. Much
of what is going on in Lebanon and northern Israel today is
directly influenced by the policies of the Iranian regime and
the other parts of the world as well.
The second thing I would just like to point out is, as I
briefly mentioned earlier, it seems to me that there is a new
or different attitude being expressed by various governments in
the Middle East, including and perhaps not limited to Saudi
Arabia and Egypt and Oman and Qatar and Bahrain and other
countries that are less than anxious to be influenced by this
ideology. And that perhaps as much as anything else that I have
heard here today should be viewed by us and our Government as
an opportunity to build with our friends, with moderate Middle
Eastern countries, if you will, to try to counteract what we
have been here talking about for the last 2 hours or so.
So thank you for sharing these perspectives with us. I
think it has been extremely helpful to those of us who have
attended today.
[Whereupon, at 12:05 p.m., the Committee was adjourned.]
Submissions for the Record
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Prepared Statement of Hon. Paul Simons, Deputy Assistant Secretary for
Economic and Business Affairs, Department of State
Mr. Chairman, distinguished Committee members, I am pleased to be
here today to testify on ``Energy and the Iranian Economy.''
Iran is an important country from a number of perspectives, and has
a particularly significant place in the international oil and gas
domain. But Iran is also a country whose policies and actions have long
been cause for deep concern. Given its pursuit of weapons of mass
destruction and missile delivery systems, its place as the leading
state-sponsor of terrorism, its support for violent opposition to
Middle East peace, its unhelpful role in Iraq, its oppression of its
own citizens and abysmal human rights record, Iran poses, as Under
Secretary Burns recently said, a profound threat to US interests.
Iran's concerted effort to develop a nuclear weapons capability has
become the focus of particular concern, not only for the US but for the
international community, as reflected in the resolution adopted in
February by the International Atomic Energy Agency (IAEA) Board of
Governors, and in the March statement by the United Nations Security
Council (UNSC). On June 6, the governments of the US, UK, France,
Russia, China, and Germany--referred to as the P5+1--offered Iran a set
of far-reaching proposals that presented Iran with a clear choice
between two paths: One path leads to important benefits for the Iranian
people, if Iran suspends all enrichment-related and reprocessing
activities and enters into negotiations on the basis of the P5+1 offer.
The Secretary has made clear that the United States would be willing to
join the negotiations if Iran fully and verifiably suspends its
enrichment program.
If Iran chooses the other path and continues on its current course,
it will face greater international isolation and strong U.N. Security
Council action. Iran has failed to take the steps needed to allow
negotiations to begin, specifically the suspension of all enrichment-
related and reprocessing activities. Absent such a positive, concrete
response from the Iranian government, we and our international partners
have no other choice than to return to the U.N. Security Council to
adopt a resolution which would make suspension mandatory.
THE IMPORTANCE OF ENERGY
Let me turn to energy matters. Iran is the world's second largest
holder of natural gas reserves (after Russia), with an estimated 940
trillion cubic feet of gas available, and it ranks second or third (the
Iranians claim 132 billion barrels) in conventional oil reserves.
(While there is no doubt that Iran's oil and gas reserves are
substantial, the opaque nature of the Iranian energy sector makes it
difficult if not impossible to independently verify the figures it
claims.) With a capacity of just over 4 million barrels per day (bpd),
Iran is OPEC's second largest oil producer and second largest exporter
(about 2.6 million bpd).
What is striking, however, is the fact that Iran is not as
prominent a player on the international oil and gas scene as its
geological potential would suggest. Despite its huge gas reserves, Iran
is actually a gas importer (from Turkmenistan). At present, it exports
gas only to Turkey and to the small Azerbaijani exclave of Nakhichevan,
with imports and exports roughly balancing. A project for a gas
pipeline to Pakistan and India has long been a subject of study and
discussion, but thus far of little concrete action. Notwithstanding its
central location, Iran has not developed into a hub for international
oil or gas pipeline development.
LNG has also been a focus of discussion and negotiation, but at
present, no LNG facilities exist and none are under construction. This
contrasts with the situation in Qatar, Iran's small neighbor on the
other side of the Gulf, whose North Field shares a reservoir with
Iran's South Pars field. Qatar's liberal investment regime, secure
political climate, and strong relationship with the US have attracted
massive foreign investment and enabled Qatar to leap far ahead of Iran
in developing LNG and other gas projects. At just above 4 million bpd,
current oil output in Iran is significantly less than the approximately
6 million bpd Iran produced prior to the 1979 revolution; production
has increased in recent years, but not by a great deal (it was about
3.8 million bpd in the mid-90s). New production has been largely offset
by the natural decline (estimated at 8 to 13 percent per year) in the
output of older fields, while rising consumption squeezes exports.
ENERGY POLICY
Iran has expressed its intention to expand its production of both
oil and gas. Plans have been announced to increase oil production to 5
million bpd in 2010 and 8 million bpd in 2015. But Iran's efforts to
attract foreign investment through ``buy-back'' deals, initiated in
1995 in a reversal of post-Revolution policy, have met with only
limited success. Foreign investment in this sector appears to be
slowing, due in part to a strong perception of heightened political and
financial risk in dealing with Iran. In addition to the discouraging
impact of Iran's problematic policies, including its pursuit of nuclear
weapons which has raised the possibility of international sanctions,
international companies have found it increasingly difficult to reach
agreement with Iranian negotiators on project terms that are
economically attractive. US measures and policies, including ILSA (the
Iran and Libya Sanctions Act), have also contributed to the negative
business and investment climate that prevails today for Iran. Foreign
involvement in the oil and gas sector also remains a politically
charged issue in Iran. Most current oil production in Iran comes from
fields developed and operated by Iranian entities;
Iranian refining capacity is inadequate to meet the demand for most
petroleum products, particularly gasoline, and the Energy Information
Administration (EIA) estimates that Iran will spend more than $4
billion on product imports this year. Prices are fixed well below
international market levels (gasoline costs about 9 cents per liter),
which inevitably spurs demand and makes smuggling to other countries
profitable. Price increases have proven politically unacceptable, and
proposals for rationing are meeting opposition.
THE IRANIAN ECONOMY
There are some positive indicators in the Iranian economy: recent
IMF estimates for fiscal year 2005 put GDP growth at 6 percent. Iran's
foreign exchange reserves are estimated at $47 billion, excluding
gold--about 10 months worth of imports at the 2005 level. The IMF also
estimates a budget surplus for 2005/2006.
But despite the advantage of recent high oil prices, there are also
very significant negatives in the economic picture, including high
rates of inflation and unemployment. For 2005, official inflation and
unemployment rates were both in the double digits at 13 percent and 11
percent respectively. Iran's stock market dropped sharply in 2005/06,
losing 20 percent of its value (though the stock market is not a major
factor in Iran's overall economy). The Iranian economy also remains
heavily dependent on the output of a single sector, with petroleum
export revenues, estimated at nearly $45 billion last year accounting
for 80 to 90 percent of Iran's foreign exchange earnings and more than
10 percent of GDP. According to the EIA's January 2006 report, Iran's
major customers for oil are Japan, China, South Korea, Taiwan, and
Europe.
NUCLEAR PROGRAM
Iran's formerly secret efforts to develop a complete nuclear fuel
cycle included uranium mining and milling, uranium conversion, gas
centrifuge enrichment, laser enrichment, construction of a heavy water
production plant, a heavy water reactor, and plutonium separation
experiments. Iran claims it is seeking an indigenous nuclear fuel
cycle, including the capability to make fissile material, for nuclear
energy purposes only. Iran has also claimed that its nuclear activities
will provide energy security and independence. However, Iran's limited
uranium reserves would not give Iran nuclear energy independence and
the costs to Iran of manufacturing fuel indigenously would far exceed
the price at which fuel could be purchased on the international market.
As noted, Iran also has huge reserves of natural gas, which if
developed would represent a significant energy resource. If recovered,
flared natural gas in Iran would be sufficient to generate over 4000
megawatts of electricity, equal to four Bushehr-capacity power plants.
Bushehr is the only power reactor under construction in Iran.
Bushehr, a VVER (from the Russian acronym for water-cooled, water-
moderated) 1000, 1000 megawatt light water reactor, is nearing
completion. Iran still lacks the know-how and facilities to manufacture
the requisite reactor fuel for Bushehr. Russia has agreed to supply
fuel for this reactor, and to take back the spent fuel, but has not
delivered fuel.
The August 2005 offer from the EU-3 (the UK, France, Germany)--
which Iran rejected--included future European assistance to support an
expanded, safe, safeguarded nuclear power program. The June 6, 2006
package of incentives offered by the P5+1 governments includes an offer
to cooperate with Iran in the development of a civilian nuclear power
program.
The P5+1 package reaffirms Iran's right to nuclear energy for
peaceful purposes in conformity with Iran's obligations under the
Nuclear Nonproliferation Treaty. The President and the Secretary have
made clear that we do not seek to deny peaceful nuclear energy.
However, Iran's long history of deception and noncompliance with its
NPT (nonproliferation treaty) and IAEA safeguards obligations have
created a loss of confidence in Iran's intentions.
As the President has said, civilian nuclear energy ``is a
legitimate desire. We believe the Iranian people should enjoy the
benefits of a truly peaceful program to use nuclear reactors to
generate electric power. So America supports the Iranian people's
rights to develop nuclear energy peacefully, with proper international
safeguards.''
LOST OPPORTUNITIES
With its enormous natural resource endowments and talented people,
Iran should be among the most prosperous countries in the world. But
counterproductive economic policies, mismanagement, widespread
corruption, and misguided goals such as the dangerous quest for nuclear
weaponry, have dimmed Iran's economic prospects. Iran's economic
problems reflect in some ways its negative political culture, with all
the problematic manifestations I outlined earlier. As President Bush
recently noted, Americans admire the rich history and vibrant culture
of Iran, and its many contributions to civilization. ``The people of
Iran'', the President has said, ``like people everywhere, also want and
deserve an opportunity to determine their own future, an economy that
rewards their intelligence and talents, and a society that allows them
to pursue their dreams.'' Thus far, those dreams have been sadly
thwarted.
__________
Prepared Statement of Dr. Kenneth Katzman, Specialist in Middle Eastern
Affairs, Congressional Research Service, Library of Congress
Thank you, Mr. Chairman, for inviting me to appear at today's
hearing. I request that the full statement be placed in the record, and
I will summarize my remarks.
OVERVIEW OF IRAN'S POLITICAL ECONOMY
As a longtime analyst of the politics of Iran, I will primarily
focus on the politics of Iran's economy. I want to preface my remarks
by saying how difficult it is to obtain authoritative information on
Iran's political economy. Iran is not an isolated country--it has
relatively open trade with U.S. allies. However, Iran's economy is not
transparent and there is no U.S. Embassy in Iran to follow Iran's
economy and obtain authoritative information. The Iranian government
has not, to date, allowed a CRS visit to Iran on the grounds that CRS
is part of the U.S. Government.
In particular, I will discuss how key leaders and factions have
gained a substantial measure of control over major segments of the
Iranian economy, avoiding virtually any official transparency or
accountability. Iran's leaders are able to steer the proceeds of parts
of the economy to provide patronage and build their constituencies,
particularly among the lower classes. Because Iran's political leaders
benefit from the structure of the economy as it is, there is little
chance under the current system of major, structural economic reform.
The consensus of experts is that Iran's economy has improved
substantially over the past 2 years, but that is primarily the result
of increased oil prices and masks underlying weaknesses that would
likely be revealed were oil prices to fall significantly. Oil revenues
account for about 80-90 percent of Iran's export earnings and almost 50
percent of the government budget. The IMF, the World Bank, and outside
experts say that Iran has pursued only limited structural economic
reform and that Iran needs to reform its financial sector and privatize
state-owned industries, and further liberalize trade regulations. As is
also true of other countries in the region and throughout the
developing world, some reforms are blocked by powerful political
interests, and others are not implemented because of fear of mass
unrest. In the case of Iran, some of its economic difficulties have
been caused by the ideology of the Islamic revolution of 1979, which
propounded self-sufficiency and an end to Iran's dependence on and
perceived manipulation by great powers.
Energy Subsidies. As one example of Iranian mismanagement of its
energy sector, Iran heavily subsidizes gasoline costs to consumers.
Gasoline costs only about 40 cents per gallon in Iran, and the Majles
(290-seat elected parliament) has consistently rejected proposed
legislation to reduce the gasoline subsidy because doing so would
result in higher prices, which could spark unrest. Iran's refining
capacity is sufficient to fulfill only about 60 percent of the gasoline
consumption of Iranian consumers, and the remainder is purchased from
nearby sources (including India and Kuwait) on the open market. As a
result, Iran's government is currently spending an estimated $5 billion
per year to import refined gasoline, and the funds have been derived by
drawing down on Iran's foreign exchange reserve fund. It is a large
increase over the amounts spent in previous years--about $1.5 billion
per year. Most experts believe that Iran should eliminate the gasoline
subsidy in order to reduce domestic demand, in part by encouraging use
of public transportation. In addition, according to press accounts,
Iran's per-vehicle gasoline consumption is relatively high because many
of its vehicles are older-model and not fuel efficient.
Inefficient Social Welfare Policies. A 2003 World Bank assessment
notes that the Islamic regime has pursued a ``social justice'' policy
since it took power in 1979.\1\ The official welfare effort has
succeeded in reducing the proportion of the population below the
poverty line from 47 percent in 1978 to 19 percent in 2003. The regime
has also closed a gender gap in education (even though the regime is
perceived as repressive of women), and it has instituted universal
education and extensive health care coverage.
---------------------------------------------------------------------------
\1\ World Bank Report No. 25848-IRN. Iran: Medium Term Framework
for Transition. April 30, 2003.
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Over 7 million Iranians (about 10 percent of the population)
benefit from the government's officially sanctioned social welfare
network. The main official relief agencies are the Welfare Organization
and the Imam Khomeini Relief Committee. They are overseen by the
Ministry of Welfare and Social Security. The Imam Khomeini Relief
Committee is said to assist as many as 7 million Iranians with basic
foods. The Welfare Organization, as well as the Committee, provides
social welfare services to women-headed households as well as other
recipients. The Ministry of Welfare and Social Security has set up some
7,000 job centers for women heads of households, providing vocational
training among other services. Other ministries that oversee or give
out social welfare benefits are: the Ministry of Housing and Urban
Development; the Ministry of Agricultural Jihad; and the Ministry of
Labor and Social Affairs.
However, the government's social welfare strategy includes the
provision of implicit subsidies, not only for gasoline but also for
medicines, bread, and other goods. The World Bank calls these subsidies
``untargeted and ineffective'' and not disproportionately benefiting
the poor. Much of the benefit of subsidies goes to Iranians who are
middle class or even affluent. For example, the Imam Khomeini Relief
Committee also provides marriage dowries, as well as education
assistance to about 600,000 students, including university
scholarships. These benefits do not necessarily go to Iranians who are
below the poverty line. In addition, according to critics, the
government is trying to eliminate poverty through handouts and
charitable transfers rather than by generating employment. The Bank
recommends that Iran should shift away from untargeted subsidies to
more targeted subsidies that benefit the genuinely poor.
Quasi-State Foundations (Bonyads). Part of this inefficiency might
be a result of the politics of Iran's social welfare system. As
discussed below, many Iranians receive benefits not only from the
``official'' social welfare network but also from an informal
charitable network. The core of the informal network is the quasi-
official ``foundations'' (bonyads) described below. These organizations
are controlled by key clerics and other former or current government
officials. The bonyads are technically not under the authority of the
Ministry of Welfare and Social Security, and therefore the bonyads'
criteria for deciding who should receive social welfare is often
arbitrary, according to many observers, explaining why some Iranians
who are not truly needy receive benefits. Those needy Iranians who are
not well-connected or who are perceived as unsympathetic to the regime
might often not receive social welfare benefits. By contrast, the
official social welfare system overseen by the Ministry of Welfare and
Social Security do have clear criteria and clearly stipulated benefits,
for example for unemployment compensation, old age pensions, disability
pensions, survivor benefits, and medical benefits.
The bonyads, which are said to account for an estimated 33-40
percent of Iran's total GDP, also distort normal market forces in Iran.
Some of them have existed for centuries as custodians of Shiite holy
sites in Iran, and, since the 1979 revolution, have come to enjoy
significant economic and political privileges. Several of the bonyads,
the heads of which are appointed by Supreme Leader Khamene'i, control
vast assets given to them by the state. Combined, they are said to
employ as many as 5 million Iranians and give social welfare to perhaps
several million more. These figures indicate that the bonyads have a
large constituency and are able to build support for the regime among
the working and lower classes.
Their privileges are vast, by all accounts. According to the World
Bank study in 2001, the bonyads enjoy virtual tax exemption and customs
privileges, preferential access to credit and foreign exchange, and
regulatory protection from private sector competition. Using these
preferences, some of the major bonyads have been able to carve out
virtual monopolies in the import and distribution of several categories
of items. Several of the bonyads are headed by former or current major
figures of the regime, largely explaining their exemption from
substantial official oversight.
The most controversial allegation about the bonyads has been
whether or not their funds have been used to procure weapons of mass
destruction (WMD) technology. This allegation has long surrounded the
largest bonyad, the Foundation for the Oppressed and Disabled
(discussed further below), primarily because this bonyad has been run
by hardliners and former officials of the Revolutionary Guard (example,
Mohsen Rafiq-Dust, a former Minister of the Revolutionary Guard). The
theory underlying the allegation is that the bonyads, because they are
not formally part of Iran's government, can operate outside official
scrutiny of foreign governments, and could therefore illicitly procure
equipment that might not be approved for export to Iran. During an
official visit to Dubai in 1995, observers at the US consulate there
told me that Foundation employees were present in significant numbers
in Dubai, holding large quantities of cash which they were using to
procure technology from Russian and other arms and technology brokers
in the emirate. Others, however, put forward a less alarmist view of
the Foundation's activities, saying that Foundation officials carry
cash for the purpose of obtaining better pricing on purely civilian
goods such as household appliances and paper goods.
Some sources say there might be as many as 123 different bonyads in
Iran, but most experts focus only on the largest and best known of
them. The major bonyads are the following:
The Foundation for the Oppressed and Disabled (Bonyad
Mostazafin va Janbazan). The largest and most important of the bonyads,
it took over much of the assets of the former Shah and his associates
who fled Iran after the Islamic revolution. It is headed by Mohammad
Forouzandeh, the chief of staff of the Revolutionary Guard in the late
1980s and later Defense Minister. It now manages over 400 companies and
factories, with a total value estimated by Iranian experts at as much
as $12 billion, and it is considered the largest economic entity after
the government.\2\ The Foundation is active in the following sectors:
food and beverages, chemicals, shipping (Bonyad Shipping Co.), metals,
petrochemicals, construction materials, dams, towers, farming,
horticulture, animal husbandry, tourism, transportation, hotels
(including two major hotels in Tehran), commercial services, and
financing. It produces the best selling soft drink in Iran, called Zam
Zam. The Foundation uses the profits from these ventures to assist
120,000 families of veterans and victims of the 1980-88 Iran-Iraq war,
as well as large segments of the poor.
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\2\ The IMF estimated its value at $3.5 bilion in 2000.
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Martyr's Foundation (Bonyad Shahid). This foundation also
assists families of those killed or maimed in the Iran-Iraq war. It
owns several companies involved in mining, agriculture, construction,
and import-export.
The Shrine of Imam Reza Foundation. Based in Mashhad in
northeastern Iran, it used donations from 8 million pilgrims to the
Shrine of Imam Reza to buy up 90 percent of the arable land in its
area. The estimated value of this land could be as high as $20 billion.
The largest employer in Khorasan Province (Mashhad is its capital), the
Foundation runs 56 companies, including a Coca-Cola factory and two
universities, and it is said to have diversified also into automobile
manufacturing. It is headed by Ayatollah Abbas Vaez-Tabasi, who is on
the powerful Expediency Council that is headed by former President
Akbar Hashemi-Rafsanjani. Vaez- Tabasi's son is married to a daughter
of Supreme Leader Khamene'i.
The Noor Foundation. It reportedly imports sugar,
pharmaceuticals, and construction equipment, and has substantial real
estate holdings. It is headed by Mohsen RafiqDust, the first Minister
of the Revolutionary Guard and who later was head of the Foundation of
the Oppressed. RafiqDust is on the Expediency Council.
15 Khordad Foundation. In 1989, it offered $1 million to
anyone who killed Salman Rushdie, author of the Satanic Verses that
Ayatollah Khomeini called blasphemous. The Foundation is named for the
date in 1963 when Khomeini began revolutionary activities against the
then Shah.
Housing Foundation (Bonyad Maskan). This foundation was
set up in the months after the February 1979 Islamic revolution to
provide housing for the poor, particularly in rural areas.
Ahl al-Bayt Foundation. Said by observers to be run by
younger-generation clerics.
Isargaran Foundation. Said to be controlled by ex-
Revolutionary Guard officers, it provides services to the families of
those killed or taken prisoner in the Iran-Iraq war.
The Cooperatives. The so-called ``cooperatives'' are another sector
of the economy that have come under the control of key elites. There is
a Ministry of Cooperatives that, in theory, oversees the operations of
cooperatives. However, in practice, the larger cooperatives are run by
allies or relatives of regime heavyweights and therefore the Ministry's
oversight powers are limited.
The most well known cooperative, and which exemplifies the
privileged status of these organizations, is the Rafsanjan Pistachio
Growers Cooperative. It is run by the cousin of former president Akbar
Hashemi-Rafsanjani, who is chairman of the powerful Expediency Council.
The cooperative claims to represent over 70,000 pistachio farmers. The
pistachio export industry in Iran is valued at an estimated $746
million. Rafsanjani's older brother, Ahmad, headed the Sarcheshmeh
copper mine complex, although he is now retired. The control over these
sectors has given Rafsanjani substantial opportunities for patronage,
although obviously his wealth did not prevent his loss in the 2005
Presidential election. Some believe it was partly his wealth that
caused his defeat because he is viewed as corrupt and less in tune with
the interests of the lower classes than is Ahmadinejad.
The Revolutionary Guard. Some have noted that the Revolutionary
Guard--the part of the armed forces that is most loyal to the clerical
leadership--is playing an increasing role in the economy. President
Ahmadinejad was a commander in the Guard during the 1980-88 Iran-Iraq
war and his presidency is likely to only enhance the Guard's influence.
Its motivations for expanding its economic role are apparently to
provide rewards for senior officers, and to generate revenue to
supplement the budget allocated to the Guard by the government.
The Guard has formed contracting firms to bid on government
projects, using its strong political influence to win business. In one
recent example, one of the firms owned by the Guard, called ``Ghorb,''
is being awarded a $2.3 billion deal to develop two phases of Iran's
large South Pars gas field. Most of the other phases have been awarded
to well-known multi-national energy firms, and the work given to Ghorb
had originally been awarded to Norway's Aker Kvaerner, but was
retendered.\3\ This suggests that the Guard exerted political influence
to win the contract and take it away from what most industry experts
would consider a more capable firm. Two years ago, the Guard briefly
closed down the new international airport in Tehran to oust an
Austrian-Turkish firm from some airport operations; those operations
have now been taken over by the Guard.
---------------------------------------------------------------------------
\3\ Kalantari, Hashem and Sally Jones. Iran Set to Award Lucrative
Gas Deal to Elite Militia. Wall Street Journal, June 29, 2006.
---------------------------------------------------------------------------
THE POLITICS OF ECONOMIC REFORM
Many Iranian officials acknowledge the weaknesses of Iran's
economy, and argue for reform. However, differences among Iranian
leaders--in part caused by their different constituencies--undoubtedly
has contributed to the relative deadlock on broad structural reform of
the economy.
Some of the differences were exposed in the course of the 2005
Presidential election campaign, which resulted in the second round
victory (June 24) of hardline Tehran mayor Mahmoud Ahmadinejad. He
became the first non-cleric president since 1981. Ahmadinejad
campaigned on a platform of redistribution of wealth to the poorer
classes, rather than a growth-oriented strategy. He and his allies tend
to favor an extensive state role in the economy, including state
management of factories and other entities that can provide employment
for the working classes. Since taking office, he has tried to implement
those promises by proposing a ``marriage fund'' to provide monies to
newly married couples, as well as increasing some pension and other
social welfare payments run by the state. He also has authorized below-
market rate lending and debt cancellation for farmers.\4\
---------------------------------------------------------------------------
\4\ Diehl, Jackson. Deft Demagoguery in Iran. Washington Post, May
7, 2006.
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As a former Revolutionary Guard officer himself, he is close to
other former Guards and those who run the various bonyads, particularly
the Foundation of the Oppressed and Disabled, and he supports their
work in distributing social welfare to the poor. He does not favor
eliminating the preferences that the bonyads enjoy because he depends
on the bonyads to provide social payments to his core lower class base.
He is also less attracted than are other Iranian politicians to
greater economic interaction with Europe and other Western countries,
for example by joining the World Trade Organization\5\ or reaching a
free trade agreement with the EU (currently being negotiated).
Ahmadinejad believes that his lower class constituents would not
necessarily benefit from a more export-oriented, growth- oriented
economy, and the lower classes generally do not buy European-made
luxury goods that constitute a growing portion of Iran's imports.
---------------------------------------------------------------------------
\5\ Iran applied to join the WTO in May 2005 when the Bush
Administration dropped its nine-year-long objection to Iran's
application
---------------------------------------------------------------------------
Ahmadinejad's main competitor in the 2005 election, Rafsanjani,
represented another pole in the debate over economic reform. Rafsanjani
is a Khomeini disciple who has been a leading figure since the
revolutionary regime was formed. As one of Iran's richest men,
Rafsanjani believes Iran would benefit from a free trade agreement with
the EU that would open up big markets to increased volumes of Iranian
exports.
Another large economic interest that carries substantial weight in
Iran are the bazaar merchants (``the bazaaris''). The bazaaris control
not only an important engine of Iran's economy--the import and export
of goods, but several newspapers, including the well-known Resalat, are
considered their mouthpiece. They also have the ear of Supreme Leader
Ali Khamene'i, who has been supportive of the bazaaris throughout his
career. The bazaaris and their allies tend to oppose a large role for
the state in the economy. Like Iranian reformers, the bazaaris want
increased trade with the West, because doing so would expand the market
for Iranian goods. However, the bazaaris do not necessarily want a
completely open trading regimen that might impinge on their privileged
trading status. The bazaaris are also skeptical of increased foreign
investment, because Western factories and companies might operate more
efficiently than Iranian companies and compete effectively with the
bazaaris. Some Iranians complain that the bazaaris try to control
certain markets by acting in concert, such as jointly boycotting
supplier companies to force them to make concessions.\6\ Some experts
refer to practices like this as ``crony capitalism.''
---------------------------------------------------------------------------
\6\ Birch, Nicholas. In Iran, It Pays To Be a Religious Leader.
Seattle Times, August 20, 2003.
---------------------------------------------------------------------------
THE ENERGY SECTOR
Iran's energy sector is undoubtedly the most closely watched
portion of the Iranian economy, because of the dependence of the
economy on its revenues. Since the Islamic revolution, Iran's energy
sector has been deteriorating primarily because of antiquated practices
and equipment. Oil production fell from 6 million barrels per day (mbd)
in 1974, when the Shah was in power, to about 3.9 mbd since the 1979
revolution. Of that amount, Iran exports about 2.4 mbd. Iran's proven
oil reserves are about 128 billion barrels, about 10 percent of the
world's total. Its natural gas reserves are even more noteworthy--about
940 trillion cubic feet, second only to those of Russia. In the mid
1990s, Iranian leaders acknowledged that halting the deterioration of
the oil sector and developing the unexploited gas sector would require
foreign investment by the world's major energy corporations.
To develop the energy sector, Iran has been able to work around its
ideology to attract substantial foreign investment. In 1996, Iran first
offered various onshore and offshore oil and gas fields to foreign
investment under a ``buy-back'' arrangement, in which the investing
firm(s) incur all development expenses and are paid back, plus given a
fixed rate-of-return, from the proceeds of the field once it becomes
productive. This arrangement enabled Iranian leaders to claim that they
had not compromised Iran's sovereignty in allowing the foreign
investment.
Iran's buy-back offer has attracted significant foreign investment,
despite Congress' enactment in 1996 of the ``Iran-Libya Sanctions Act''
(P.L. 104-172). That law, extended for another 5 years in 2001, imposes
sanctions on foreign companies that invest in Iran's energy sector.
However, the Clinton and Bush Administrations have not imposed any
actual sanctions on investing firms, perhaps causing foreign firms to
minimize the importance of this U.S. law in considering whether or not
to invest in Iran.
Since 1997, when the first foreign investments began under the buy-
back plan, foreign companies have committed to at least $15 billion in
foreign investment to develop about a dozen Iranian oil and gas fields.
The earliest of the investments have begun production, and the more
recent investments are under development and expected to begin
producing oil and gas soon. Iran says that it expects these investments
to increase its oil production to about 5 mbd by 2009, and 7 mbd by
2024.
Most of the natural gas produced by the new investments has been
used for the domestic market or for re-injection to Iran's oil fields
to boost production of oil, although it is exporting gas to Turkey
through a joint pipeline. Iran is hoping to become a major gas exporter
and, over the past year, Iran has signed a number of long-term (25
year) agreements with gas buyers, particularly in China and India. Iran
is also in discussions with India and Pakistan for the construction of
a natural gas pipeline that would link the three. The Bush
Administration has publicly ``expressed concern'' about the pipeline, a
stance consistent with U.S. policy of opposing energy routes that
include Iran.
CONCLUSION
The current confluence of political interests and factions in Iran
will likely prevent any substantive economic reform. The connections
between the various bonyads, the Revolutionary Guard, and the upper
reaches of the regime are too strong to permit curbing their influence
in the economy. At the same time, the economic strength of the bonyads
and the cooperatives translate into political strength for the clerics
and politicians that run them. The income generated by these quasi-
state economic conglomerates give the clerics substantial opportunity
for patronage and keeps the Iranian public dependent on them for social
welfare. On the other hand, these economic mechanisms are keeping
Iran's poor fairly well sustained and, in the view of some, represent
useful and necessary institutions even if they reduce the transparency
of Iran's economy.
__________
Prepared Statement of Ilan Berman, Vice President for Policy, American
Foreign Policy Council
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.\1\
---------------------------------------------------------------------------
\1\ Energy Information Administration, United States Department of
Energy, ``Country Analysis Brief: Iran,'' April 2004, http://
www.eia.doe.gov/emeu/cabs/iran.html.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\2\ See, for example, Michael Rubin, ``What Are Iran's Domestic
Priorities?'' Middle East Review of International Affairs 6, no. 2
(2002), 26-27.
\3\ Aftab-e Yazd (Tehran), May 10, 2006, as translated in
Mideastwire Daily Briefing, May 12, 2006, http://www.mideastwire.com.
---------------------------------------------------------------------------
Iranian officials have attempted to solidify this economic status
through a major expansion of their country's international energy
profile. Over the past 2 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.
---------------------------------------------------------------------------
\4\ Robin Wright, ``Iran's New Alliance with China Could Cost U.S.
Leverage,'' Washington Post, November 17, 2004, A21.
---------------------------------------------------------------------------
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.\7\
---------------------------------------------------------------------------
\5\ ``Turkish Energy Policy,'' Turkish Ministry of Foreign Affairs,
n.d., http://www.mfa.gov.tr/grupa/an/policy.htm.
\6\ ``Iran, Armenia Sign Agreement on Gas Export,'' Asia Pulse, May
18, 2004.
\7\ ``Russia Favors Iran Route for Crude Exports,'' Tehran Times,
June 14, 2004.
---------------------------------------------------------------------------
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.\8\
---------------------------------------------------------------------------
\8\ Defense Intelligence Agency Director Lowell E. Jacoby,
``Current and Projected National Security Threats to the United
States,'' statement before the U.S. Senate Select Committee on
Intelligence, February 16, 2005, http://intelligence.senate.gov/
0502hrg/050216/jacoby.pdf.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\9\ Yossi Melman, ``Iranian official: U.N. Sanctions May Lead Us to
Seal Off Persian Gulf,''
Ha 'aretz (Tel Aviv), January 24, 2006, http://www.haaretz.com/hasen/
spages/674159.html.
\10\ ``Iran: Oil Undervalued,'' United Press International, April
20, 2006.
\11\ ``Tehran Warns of Fuel Disruptions,'' BBC (London), June 4,
2006, http://news.bbc.co.uk/2/hi/middle east/5045604.stm.
---------------------------------------------------------------------------
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.\12\ 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.
---------------------------------------------------------------------------
\12\ See, for example, Clifford Kupchan, ``Tehran's Trump Card,''
Los Angeles Times, April 23, 2006, http://www.latimes.com/news/
printedition/suncommentary/la-opkupchan23apr23,1,4489060.story?coll=la-
headlines-suncomment.
---------------------------------------------------------------------------
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.\14\ 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.
---------------------------------------------------------------------------
\13\ Energy Information Administration, U.S. Department of Energy,
``Country Analysis Brief: Iran,'' January 2006, http://www.eia.doe.gov/
emeu/cabs/Iran/Background.html; ``Iran's Refining Capacity to Increase
to 900,000,' '' iranmania.com, February 19, 2006, http://
www.iranmania.com/News/ArticleView/
Default.asp?ArchiveNews=Yes&NewsCode=40 656&NewsKind=CurrentAffairs.
\14\ Study by Iran's Institute for International Energy Studies, as
cited in Ali Nourizadeh, ``Exploring Iran's Military Options,'' Al-
Sharq al-Awsat (London), January 23, 2006, http://aawsat.com/english/
news.asp?section=3&id=3528.
\15\ Gareth Smyth, ``Iran `Will Need $5bn Subsidy' to Avoid Petrol
Rationing,'' Financial Times (London), May 28, 2006, http://
news.ft.com/cms/s/0627359c-ee77-11da-820a-0000779e2340, i
rssPage=3f6a0854-c8f8-11d7-81c6-0820abe49a01.html.
---------------------------------------------------------------------------
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.\16\ 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.\17\ 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 decisionmaking.
---------------------------------------------------------------------------
\16\ Paul Klebnikov, ``Millionaire Mullahs.'' Forbes, July 21,
2003, http://www.forbes.com/forbes/2003/0721/056 print.html.
\17\ Ibid.
---------------------------------------------------------------------------
Foreign direct investment
The dozens of billions of surplus dollars collected by the Iranian
government over the past 2 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.\18\ 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.
---------------------------------------------------------------------------
\18\ ``NIOC Undertaking Host of Projects to Boost Oil Output,''
Middle East Economic Survey XLVIII, no. 19 (2005), as cited in A.F.
Alhajji, ``Will Iran's Nuclear Standoff Cause a World Energy Crisis?
(Part 1 of 2),'' Middle East Economic Survey XLIX, no. 13 (2006) http:/
/www.mees.corn/postedarticles/oped/v49nl3-50DO1.htm.
\19\ Kenneth Katzman, The Iran-Libya Sanctions Act (ILSA)
(Washington: Congressional Research Service, July 21, 2003), 2.
---------------------------------------------------------------------------
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.\20\
---------------------------------------------------------------------------
\20\ George A. Lopez and David Cortright, ``Economic Sanctions in
Contemporary Global Relations,'' in David Cortright and George A.
Lopez, eds. Economic Sanctions: Panacea or Peacebuilding in a Post-Cold
war World? (Boulder: Westview Press, 1995), 9.
---------------------------------------------------------------------------
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,\21\ as well as initiating a
major privatization of governmental funds.\22\ 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.\23\ The goal of these efforts is clear:
to limit Western economic leverage over Iranian behavior.
---------------------------------------------------------------------------
\21\ ``Iran Moves Assets to China, East Asia, worldtribune.com,
January 23, 2006, http://www.worldtribune.com/worldtribune/06/
front2453758.41875.htm1.
\22\ Meysam Salehian, ``Central Bank vs. Government,'' Rooz
(Tehran), May 10, 2006, http://roozonline.com/english/015477.shtm/.
\23\ Christian Oliver, ``Iran to Halt Gasoline Imports, Impose
Rationing,'' Reuters, June 23, 2006; ``Iran Calls Halt to Petrol
Imports,'' BBC (London), June 23, 2006.
---------------------------------------------------------------------------
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.
---------------------------------------------------------------------------
\24\ ``Iran Nuclear Response `in August,''' BBC (London), June 21,
2006, http://news.bbc.co.uk/2/hi/middle east/5102544.stm.
---------------------------------------------------------------------------
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 Council-imposed
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.\25\
---------------------------------------------------------------------------
\25\ Alhajji, ``Will Iran's Nuclear Standoff Cause a World Energy
Crisis? (Part 1 of 2).''
---------------------------------------------------------------------------
By the same token, a cutoff 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.
__________
Prepared Statement of Dr. Andrew K. Davenport, Vice President, Conflict
Securities Advisory Group, Inc.
Mr. Chairman, thank you for the privilege of appearing today on
Iran's oil and gas industries and the rather unique perspective through
which my company views corporations from around the world that are
financing and developing the energy-related projects that generate
Iran's primary source of revenue.
By way of introduction, I am Vice President of Conflict Securities
Advisory Group, a Washington, DC-based research and risk management
firm that was founded 5 years ago to service a growing demand from
institutional and individual investors--as well as policy
practitioners--for data on those U.S. and foreign companies that
maintain business ties to U.S. State Department-designated terrorist-
sponsoring states. Our firm performs this research to help investors
and corporations better understand their exposure to so-called global
security risk, defined as the often-asymmetric financial risk to a
company's share value and reputation that can accompany these business
ties.
I would like to speak, first, about the broad role that Iran's oil
and gas industries play in supporting virtually all facets of the
Iranian government and then address the company-specific dimensions of
that equation. I will also touch on the impact of U.S. policy on
corporate decisionmaking regarding the pursuit of these business
opportunities.
IRAN'S OIL INDUSTRY: THREE INTERLOCKING PRESSURES
In our view, three central issues define Iran's oil industry today.
(1) Iran's oil exports play the central role in financially
underwriting the country's government. As oil prices increase, Tehran
experiences economic windfalls that have a direct impact on the
government's discretionary spending across the board. Iran has
obviously benefited enormously from the recent rise in global oil
prices. It is important to remember, however, that we have in the past
seen periods where the opposite has been true. In the 1990s, for
example, relatively low oil prices had Iran on the verge of defaulting
on its international debt obligations. Had it not been for the
intervention of the country's various creditors, in part through the
actions of specific foreign companies, Iran would have faced a
considerably more severe financial crisis.
Of course, Iran's is not the only economy that lives and dies on
oil prices. The Soviet Union in the 1980s is perhaps the best case
study of a government experiencing the highs and lows of relying too
heavily on oil prices.
(2) Despite the lucrative nature of Iran's oil exports, its energy
industry as a whole has distinct weaknesses that, since the revolution
in 1979, have prevented it from reaching its full potential. Iran's oil
industry is state-controlled, old, inefficient and in need of
significant upgrades that only foreign companies, with their access to
large-scale capital and advanced equipment and technology, are capable
of carrying out. These upgrades are essential for Iran to cushion the
impact of increasing domestic oil consumption and aging oil fields that
are currently putting downward pressure on the country's oil exports.
In order to reach the country's stated goal of increasing daily oil
production from 4 million to 5 million barrels per day by 2008 and to 8
million barrels per day by 2010, Iran will need to upgrade
significantly its existing fields and begin producing from new ones.
Tehran's challenge is to attract foreign investment in sufficient
quantity to reach these goals, despite unpopular contract terms and
intense international security concerns. As I will address in a few
minutes, although companies are starting to change the way they do
business in Iran due to security risk factors, in our view, security
concerns are not stemming the tide of companies interested in doing
business there. The real inhibitor to foreign investment seems to lie
more in bureaucratic obstacles within the country.
(3) The country's gasoline-related expenditures have put added
strain on Iran's budget. Despite booming revenues, Iran's lack of
refining capacity has forced the country to spend billions of dollars
importing gasoline. Moreover, the decision by Iran's parliament to lock
domestic gas prices at 2003 levels could cause even more pronounced
problems for Iran, as billions of dollars in state subsidies, which
could increase under the new President, lead to increased consumption.
Increased consumption leaves less oil for export and, combined with
decreasing production, could eventually have a material impact on
export-related revenues.
Over the coming years, the intersection of these three important
energy industry pressures will put the Iranian government and the
companies that do business in the country at a crossroads. With Iran
almost completely dependent on its energy exports for revenues and in
desperate need of foreign investment to keep these revenues flowing,
foreign companies will become even more important to the prosperity of
Tehran.
IRAN'S OIL INDUSTRY AND PROSPECTS FOR THE FUTURE
The summary statistics regarding the role of oil in the Iranian
economy tell the story: Iran holds an estimated 10 percent of the
world's proven oil reserves; its oil exports generate 80 to 90 percent
of the country's total export earnings and 40 to 50 percent of its
total government budget.
Although the state-owned National Iranian Oil Company largely runs
the Iranian oil industry, we understand that oil export revenues are
effectively funneled straight to the country's central bank, also known
as Bank Markazi. Accordingly, as might be expected, oil export revenues
quite literally equate to discretionary funds for Tehran. Although
Iran's military and nuclear spending is largely unknown--at least
through public sources--it can be reasonably expected that both, in
addition to most other government programs, are benefiting directly
from recent oil windfalls.
To maintain these higher revenue flows, however, not only will oil
prices need to remain high, but Iran will need to invest heavily in its
existing and prospective energy projects. Aging oil fields require
upgrades and new fields require development. Most would agree that the
success of both requires billions of dollars in foreign investment,
capital and technology in the coming years.
Although Tehran has not attracted as much foreign assistance as it
would like, our research shows that there are a wide variety of
corporations currently working in Iran's oil industry. In fact, there
seems to be no shortage of corporate interest in Iran's economy. In our
view, even considering the outrageous pronouncements of Iran's new
president, short of international sanctions, no significant number of
companies will forego the country's business opportunities. History has
shown time and again that companies will do what the law allows. As
long as operating in Iran is legal, the draw of a growing economy and
the country's vast oil and gas resources will lure companies in. Of
course, companies are aware of the political environment, but, simply
put, the risk appears to be worth the reward in the increasingly
competitive global energy industry.
There are, however, a few important exceptions. A number of
companies have correctly identified a growing sensitivity in the U.S.
investor community to business associations with Iran. The prospect of
being labeled as ``Doing Business with the Enemy''--the title of a 60
Minutes segment on this issue that aired twice over the past 2 years--
has influenced the behavior of some companies that place more value on
their corporate reputation in the U.S. than on their business prospects
in Iran. For most other companies, however, this calculation is still
in flux.
For at least five prominent U.S. companies, Comptroller William
Thompson of New York City made this calculation a good deal easier by
registering public shareholder resolutions with the SEC on behalf of
the City's fire and police pension funds calling for a Board-level
review of their corporate ties to Iran and terrorist-sponsoring states.
Specifically, Comptroller Thompson was interested in whether their
operations in Iran or these other countries circumvented the spirit, if
not the letter, of U.S. sanctions law. He was referring to what some
have called a major ``loop hole'' in U.S. law that allows U.S.
companies to do business in sanctioned states via arms-length overseas
subsidiaries.
After some wrangling, these companies made adjustments to corporate
policy and, in certain cases, renounced any future business ties to
Iran whatsoever. The five companies referenced are ConocoPhillips,
General Electric, Halliburton Cooper Cameron and Aon.
In my view, two important conclusions relevant to this committee
can be drawn from this anecdote. First, companies that discount
escalating security concerns in their risk-reward analyses may be less
likely to discount the views of leading shareholders. Second, companies
most vulnerable to this market-related pressure are those who have more
business or reputational exposure in the United States.
For example, let us assume that Company X and Company Y both have
business ties to Iran. Company X has a large market presence in the
U.S. and therefore has considerably more to lose in U.S. sales than
Company Y. Company X would be expected to be more responsive to the
concerns of Americans regarding its activities in Iran. In our
experience, the same holds true in the capital markets. Let us say that
10 percent of Company Y's stock is held by U.S. investors, compared to
35 percent of Company X's. In this case, U.S. investors who care about
Iran and, like Comptroller Thompson, act on those concerns would have
more leverage with Company X and wield more influence over its
corporate governance policies regarding business activities in the
country. In today's global economy, market forces such as security-
minded shareholder activism can be more effective than regulatory
regimes.
The impact of corporate reputational concerns and market forces,
however, should not only be measured by whether or not a company
chooses to exit completely from Iran. For many companies with large
exposure to the country, pulling up stakes is simply not an option. One
positive development stimulated by increased investor, government and
media attention to this issue has been a new sensitivity by companies
to the structure of their corporate ties to Iran. Increasingly, foreign
companies are scrutinizing their projects and transactions in Iran to
ensure that they do not have the potential to contribute inadvertently
to security concerns.
Some non-U.S. companies have begun to self-police their operations
in Iran at standards above and beyond the requirements of their
national laws to protect their reputations from potential Iran-related
harm. While this may be short of what some policymakers would prefer,
it demonstrates an innovative, market-oriented reaction that has a high
likelihood of reducing the security risks that these corporate ties can
represent.
For example, if a company's business in Iran involves the transfer
of dual-use equipment or technology, there is often little the U.S. can
do short of extraterritorially sanctioning the company. Were that
company, however, in deference to its shareholders or reputation in the
U.S. and elsewhere, to undertake additional due diligence, substitute
the problematic equipment or seek contractual assurances that it will
not be diverted to non-civilian projects, U.S. policy concerns would
benefit. No sanctions, no international controversies, no government
intervention would be entailed. Rather, in this example, the company is
self-policing its business activities in a risky country in response to
market forces.
Increasingly, our firm is witnessing corporations--out of concern
over their reputation in the United States--insisting on certain
contract terms with Iran, rather than vice-versa. In our view, this
increased security-consciousness, when it occurs voluntarily, should be
viewed as a good thing.
IMPACT OF U.S. POLICY
Given recent events and the importance of foreign companies to the
Iranian economy, one might ask: what role does U.S. foreign policy play
in the considerations of companies abroad operating in Iran. For a long
time, the answer, for non-U.S. companies, has been very little. The
primary impact of President Clinton's 1995 Executive Order banning U.S.
involvement in Iran's energy sector was that it cost Iran access to
certain U.S. technology. At the same time, it cost U.S. companies
business opportunities in Iran. For foreign companies, however, the
Order had little impact and business in the country continued at an
even faster rate than before, as Iran was in the midst of opening up to
foreign investors.
Congress then passed the 1996 Iran Libya Sanctions Act (or ILSA),
which sought to punish non-U.S. companies investing more than $20
million annually in Iran's oil and gas industries by restricting their
access to the U.S. economy. As a consequence of the controversial
``extraterritoriality'' of the law and for diplomatic face-saving, ILSA
sanctions were never implemented. Soon after the act was passed,
several large companies, including France's Total and Russia's Gazprom,
violated its provisions and, following an official review, went
unpunished. These early precedents cleared the way for other companies
to do the same and, today, there are, by our estimates, over 20
companies in technical violation of ILSA.
With U.S. sanctions policy toward Iran remaining fairly consistent
since the mid-1990s, one might further ask: what has changed over the
past few years causing some corporations to second-guess their
operations in Iran and others to enact voluntary, security-oriented
governance policies with respect to these higher-risk activities?
Surely, the nuclear standoff and President Ahmadinejad's election have
complicated the business environment, but the beginning of today's
corporate trends vis-a-vis Iran predates, for the most part, both of
these developments.
Our findings demonstrate that after September 11, the stigma
associated with corporate ties to U.S. State Department-designated
terrorist-sponsoring states increased significantly. This stigma
reverberated in the local and national press. State and municipal
governments began analyzing how their retirement and other public
investment funds were invested in companies that collectively form the
economic backbones of these irresponsible, dangerous governments.
Grassroots attention to these countries as supporters of terrorism and
proliferators of weapons of mass destruction and ballistic missiles
raised substantially the reputational risk associated with these
corporate ties and the potential for corporate activities to be linked
by the public to heightened security concerns.
This grassroots movement continues today. For example, the Missouri
Investment Trust recently became the first public fund in the country
to institute a policy that, after a careful review, screens out certain
companies with business in Iran and other terrorist-sponsoring states.
A so-called ``Terror-Free'' mutual fund, the Abacus Bull Moose Growth
Fund administered by Roosevelt Investment Group, has likewise been
created in response to market demand.
Even though, most of the time, corporate activity in Iran does not
represent a significant portion of a company's overall business, the
importance of the issue of terrorism in the U.S. has created the
potential for such ties to negatively impact corporate share value and
reputation and, in some cases, even raise questions of legal liability.
Accordingly, some companies are rightfully seeking to safeguard their
corporate operations from these types of associations by integrating
expanded, security-minded new due diligence into their overall
corporate risk management programs. To be clear, this is market-
oriented cause-and-effect.
As I noted earlier, most companies are unwilling to forego the
Iranian market, especially firms from countries that place huge
importance on Iran as a source of energy supplies. Increased vigilance,
however, with respect to the security dimensions of their business
activities in the country is leading to a new sensitivity to U.S.
security concerns on the part of some international companies doing
business where U.S. companies cannot.
CORPORATE INVOLVEMENT
According to our Global Security Risk Monitor online research
product that seeks to identify and profile every publicly traded
company in the world that has any kind of business tie with terrorist-
sponsoring states, over 300 publicly traded companies have carried out
business with Iran during the past 3 years.
This number does not include those private or state-owned companies
that are also doing business in the country. While most companies with
the risk appetite to do business in Iran are these larger publicly
traded entities, this does not hold true in all cases.
Nevertheless, the point remains the same: there are a large number
of companies that are key participants in Iran's economy. These
companies are often among the largest in the world and held in most
American investor's portfolios, including the Thrift Savings Plan that
invests on behalf of Members of Congress and many other U.S. public
officials. Although most of these firms are involved in the country's
energy sector, a number are in other sectors, contributing to Iran's
efforts to diversify away from its somewhat one-dimensional economy.
These ties range from petrochemical to telecommunications projects to
manufacturing plants to power generation projects and so on.
Most of the larger-scale projects, however, are infrastructure-
oriented and do not involve the revenue-generating potential for the
government that exists in the energy sector. In fact, Iran's
diversification efforts seem directed more at infrastructure projects
than at launching a new era of market-oriented policies that have the
potential to stimulate economic growth and, as a result, generate new
streams of government revenues. Although the country may seem more up-
to-date as a result, government revenues and stability remain firmly
dependent on its export of energy.
The bottom line is that foreign publicly traded companies play a
tremendously important role in Iran's current and future economy.
CONCLUSION
As stated, short of strong multilateral sanctions, which seem
unrealistic barring some kind of serious escalation of the current
Iranian nuclear crisis, there will continue to be companies looking to
enter the Iranian market or expand the corporate presence. The reach of
U.S. policy, therefore, is limited. These new market-oriented concerns,
however, are not. In our view, it is ultimately the implications of
potential reputational damage that will cause public companies to
reconsider their policies and business activities. As this reputational
risk increases, so too will corporate self-policing. Should companies
choose to remain in Iran, they could be encouraged by shareholders and
others to do so in a more security-sensitive mode than ever before.
Such new corporate guidelines and due diligence measures will not be
lost on the Iranian government and the state-owned companies that will
have to learn to be responsive to the reputational burden that they
bring to each of their prospective and existing business partners.
__________
Prepared Statement of Dr. Jeffrey J. Schott, Senior Fellow,
Institute for International Economics
Iran has long been an important player in world oil markets. Today,
it is the second largest producer and exporter of oil among the members
of the Organization of Petroleum Exporting Countries (OPEC). Iran
exports about 60 percent of its annual oil production of about 4
million barrels of per day.
Iran has been a major beneficiary of recent developments in world
oil markets. World oil prices have soared in response to (1) rapid
growth in global demand, fed by voracious new users in China and India;
(2) declining oil production in the OECD area; and (3) security
concerns in important producing areas such as Iraq and Nigeria. While
oil production has surged in Russia and increased moderately in Saudi
Arabia, the increased volumes have not been enough to forestall a sharp
tightening of global supply/demand balances that have propelled a
massive increase in world oil prices.
Over the past decade, the volume of Iran's annual oil exports has
averaged almost 2.5 million barrels per day. Over this period, the
prices of Iran's light and heavy crudes have increased almost fourfold
from about $16 per barrel in 1995 to the current level of more than $60
per barrel. As a result, the value of Iran's oil exports has grown from
about $15 billion in 1995 to more than $46 billion in 2005 (see table
1).
Iran now pockets an extra $30 billion of oil export revenues
compared to a decade ago. Oil profits fuel the Iranian economy; they
also finance Iranian investment in weapons development and support for
terrorism. What is good news for the ayatollahs is not so good for the
United States. We are paying a high price for these developments and
not just at the pump. Petrodollars make Iran more capable of pursuing
its nuclear ambitions and funding Hezbollah and other terrorist
organizations, and more immune to US economic coercion.
U.S. policy has tried to blunt Iranian adventurism for several
decades through international diplomacy and economic sanctions.
International cooperation with US initiatives have been modest, and
extensive US unilateral sanctions against Iran--codified in the Iran
and Libya Sanctions Act of 1996--have not achieved their difficult
goals. Despite this checkered past, some US political leaders are now
calling for broader economic and/or military responses to the ongoing
Iranian nuclear program and support for Hezbollah. In formulating the
appropriate US response to these outrages, the Congress should reflect
on our past sanctions experience as well as the new diplomatic and
economic conditions that will constrain the effectiveness of new U.S.
and multilateral measures.
U.S. ECONOMIC SANCTIONS AGAINST IRAN: EXPERIENCE TO DATE\1\
The UniteStates first imposed economic sanctions against Iran in
response to the hostage crisis of 1979-1981. The comprehensive trade
and financial sanctions eventually provided a crucial negotiating chip
to win the release of the American hostages on the day of President
Reagan's inauguration.
---------------------------------------------------------------------------
\1\ This section draws heavily on the Iran case study from the
forthcoming 3rd edition of Economic Sanctions Reconsidered, by Gary
Hufbauer, Jeffrey Schott, Kimberly Elliott, and Barbara Oegg
(Washington: Institute for International Economics, forthcoming 2007).
---------------------------------------------------------------------------
A few years later, Iran was implicated in the terrorist bombing of
a Marine Corps barracks in Lebanon. Iran was added to the US list of
countries that support terrorism. In incremental steps, the United
States imposed new restrictions on US trade with Iran targeted
primarily at limiting development of the Iranian oil industry and thus
its capability to fund terrorist groups. Subsequently, concerns about
Iran's nuclear power programs prompted additional US sanctions to
impair the military potential of Iran, particularly regarding the
development of chemical, biological, and nuclear weapons. The Iran and
Libya Sanctions Act (ILSA) of 1996 supplemented these measures with
additional restrictions on foreign companies that undertake new
oilfield investments in Iran.
Overall, sanctions have not prompted Iran to renounce the use of
terrorism or the acquisition of nuclear weapons. While other
industrialized countries also implemented narrowly targeted trade
sanctions designed to limit Iran's access to products and technologies
that could support the production and delivery of nuclear, chemical,
and biological weapons, they continued to trade extensively and invest
in Iran. Meanwhile, other countries supplied Iran with arms and nuclear
equipment and technologies.
The ILSA sanctions did lead some companies to defer bidding on new
contracts to develop Iranian oil and gas properties. US sanctions
deserve some of the credit, but most of Iran's problems in attracting
new investment were caused by self-inflicted wounds created by its own
domestic policies. Despite these problems, Iranian oil production has
grown modestly over the past decade since ILSA was enacted.
The appendix to this statement provides a chronology of the key
events in the decades-long sanctions effort. It sets out a troubling
story that brings to mind Yogi Berra's insightful commentary: ``it's
deja vu, all over again''. The same problems confronting US policy two
decades ago now again dominate the headlines: funding terrorists in
Lebanon, testing North Korean missiles, and Iran's pursuit of nuclear
weapons. Economic sanctions have not blunted Iran's foreign
adventurism, though they undoubtedly have inhibited the task and made
it more costly to pursue.
ECONOMIC SANCTIONS AGAINST IRAN: NEXT STEPS
The Congress is now considering extension or expansion of the ILSA
sanctions against Iran. Drawing counsel from the IIE study on
sanctions, based on 25 years of research and the authors' personal
experience in formulating US sanctions policies in the late 1970s and
early 1980s, I believe the current law should be renewed as is. But
Members of Congress should make a realistic assessment of the benefits
that can be obtained through the deployment of sanctions.
Can sanctions stop Iran from eventually developing a nuclear
weapon? Probably not. Iranian leaders have been developing this
capacity for more than two decades-despite diplomatic entreaties,
limited economic sanctions, and the threat of military strikes. They
believe that nuclear weapons will bring them regional dominance and
that--just like India and Pakistan--the West will grudgingly accept
their accession to the nuclear club without significant retribution.
Nonetheless, history shows that targeted sanctions can push back
the day of reckoning. Since the Nuclear Non-Proliferation Treaty
entered into force in 1970, four countries have acquired nuclear
weapons: Israel, India, Pakistan, and North Korea. The latter three
were subject to significant US sanctions and some multilateral
measures. Economic sanctions did not prevent proliferation but
collective denial by Western powers of key ingredients of the bomb
maker's art--reprocessing technology, centrifuges, tubing, metallurgy,
timers--substantially slowed the process.
Sanctions will not prevent a determined and well financed country
from eventually crossing the nuclear threshold. Even the tightest
sanctions regime can be evaded with sufficient incentive. Witness the
billions of dollars of goods smuggled into Iraq during Saddam Hussein's
reign. Land borders are porous, especially in the Middle East, and sea
and air freight are difficult to monitor effectively without intense
military operations. With Iran's petrodollar bonanza, it will be able
over time to procure the necessary material and technology to achieve
its nuclear ambitions.
To be sure, comprehensive economic sanctions against Iraq, which
were generally respected by the major powers including China and
Russia, arguably contributed to thwarting Saddam Hussein's nuclear
program. Since those measures coincided with low oil prices, little
economic pain was felt in the world at large, even though Iraqi oil
shipments were sharply curtailed. This fact was crucial to global
cooperation in enforcing U.N. sanctions for more than a decade.
Broad economic sanctions, comparable to the isolation of Iraq in
the 1990s, are no longer feasible. Unlike the cheap oil of the 1990s,
oil prices today are at or near record levels. Given tight global
supplies, Iran has greater leverage to counter sanction major oil
consuming nations by cutting back its oil exports. Few producing
nations have the spare capacity to increase shipments to offset
potential Iranian cutbacks, so prices would likely rise sharply. Iran
would sell less--and earn more.
For that reason, it's hard to find politicians who would support a
comprehensive sanctions strategy. Many Americans would question harsh
measures that might push oil above $100 per barrel and trigger a world
recession. Europe, China, and Japan have similar concerns and would
only endorse sanctions that are paced and mild, not sudden and harsh.
Russia will be even more ambivalent, for two reasons: it has gained a
lot from the oil price spikes generated by Mid East tensions since its
oil production has increased by almost 50 percent since 2000 to 9.5
million barrels per day; and it wants to continue to cultivate Tehran
as its best foothold in the Middle East.
So what should we do? The most immediate and obvious task is
continued denial of critical components (e.g., cascade centrifuges) for
Iran's nuclear industry. The policy already receives support from the
major powers but additional efforts should be made to ensure that
second tier powers undertake and enforce these restrictions as well.
Other targeted sanctions against Iran's ruling class should also be
considered, including travel restrictions and overseas asset freezes.
These measures will have minimal impact on Iran's financial ability to
finance terrorism or build a nuclear bomb. Rather the strategy of
limited sanctions, accompanied by coordinated diplomacy, is to let time
mellow Tehran's nuclear intentions. This is a less than satisfying
result but effectively what we can achieve, given current conditions in
world energy markets.
Table 1.--Iran: Petroleum Production, Exports and Revenues, 1995-2005
--------------------------------------------------------------------------------------------------------------------------------------------------------
Value of
Productiona Crude oil petroleum Iran light Iran heavy
(1000 barrels/ exportsb (1000 exportsb crudeb (spot crudeb (spot
day) barrels/day) (millions of price per price per
dollars) barrel, $) barrel, $)
--------------------------------------------------------------------------------------------------------------------------------------------------------
1995............................................................... 3,744 2,621 14,973 16.17 16.26
1996............................................................... 3,759 2,630 19,441 19.03 18.49
1997............................................................... 3,776 2,587 15,553 18.24 18
1998............................................................... 3,855 2,512 10,048 11.97 11.45
1999............................................................... 3,603 2,291 16,098 17.25 16.93
2000............................................................... 3,818 2,492 25,443 26.75 26.02
2001............................................................... 3,730 2,185 21,420 22.9 21.67
2002............................................................... 3,414 2,094 19,219 23.52 23.09
2003............................................................... 3,999 2,396 26,124 26.89 26.33
2004............................................................... 4,081 2,684 34,289 34.6 33.06
2005............................................................... 4,049 2,700c 46,600c 50.66c 48.32c
--------------------------------------------------------------------------------------------------------------------------------------------------------
aSource: BP Statistical Review of World Energy 2006.
bSource: OPEC, Annual Statistical Bulletin (2004).
cSource: Energy Information Administration, Department of Energy; price data as of December 30, 2005.
APPENDIX. U.S. Sanctions Against Iran: Chronology of Key Events, 1984-
2006
------------------------------------------------------------------------
------------------------------------------------------------------------
23 January 1984........................... Alleging Iranian
involvement in Marine base
bombing in Lebanon, US
State Department adds Iran
to list of nations
supporting terrorism, and
thus subject to stringent
export controls.
26 October 1987........................... President Reagan invokes
section 505 of the
International Security and
Development Cooperation Act
of 1985 and embargoes all
imports from Iran,
prohibits export of 14
types of potentially
militarily useful goods,
including inboard and
outboard motors, mobile
communications equipment,
electrical generators,
hydrofoil vessels.
15 March 1995............................. President Clinton issues
executive order barring US
citizens and companies from
financing, supervising and
managing oil development
projects in Iran-blocking
Conoco's pending $1 billion
investment in Iranian
offshore oil project.
30 April 1995............................. Citing proliferation and
terrorist concerns, the
White House announces it
will ban, effective 8 June
1995, all direct US trade
with Iran, as well as an
estimated $4 billion in
indirect trade, mainly by
American companies selling
Iranian oil in third
countries. French, German
and British officials call
sanctions the wrong
approach and announce they
will continue their policy
of ``critical dialog'' with
the Iranian regime. Oil
analysts estimate that Iran
will have no trouble
finding buyers for its
exports to replace American
companies.
7 March 1996.............................. US and Israeli
intelligence sources allege
Iranian involvement in a
recent wave of terrorist
attacks in Israel.
2 May 1996................................ US military officials
charge Iran has acquired
Nodong II missiles from
North Korea and is building
underground bunkers to
deploy them.
23 July 1996.............................. The House passes Senate
version of the Iran and
Libya Sanctions Act (ILSA),
which penalizes companies
investing over $40 million
in 1 year in Iran's oil and
gas sector; after 1 year,
the annual investment limit
triggering sanctions drops
to $20 million. Potential
sanctions include two or
more of the following: (1)
denial of credits from the
US Export-Import Bank; (2)
denial of export licenses
for controlled goods or
technology; (3) prohibition
of loans of more than $10
million from US financial
institutions for a 12-month
period; (4) prohibition of
foreign financial
institutions from dealing
in US government debt or US
government funds; (5)
prohibition against
participation in any US
government procurement
project; (6) import
restrictions. Sanctions are
required to be in effect
for up to 2 years, and in
``no case'' can they be
applied for less than 1
year. The President may
waive all or part of the
sanctions against a foreign
company if doing so is
deemed to be in the
national interest. Bill
sunsets 5 years after
enactment unless Congress
votes to extend.
19 August 1997............................ President Clinton issues
an executive order that
explicitly prohibits re-
exports of US goods,
technology and services to
Iran.
21 February 1998.......................... Despite US objections,
Russia decides to expand
role in building nuclear
power plant in Iran.
22 July 1998.............................. Iran tests a missile with
an 800-mile range, capable
of reaching Israel.
American officials say the
``Shahab 3'' missile came
from North Korea.
25 November 1998.......................... Russia signs an $800
million deal to finish
building the Bushehr
nuclear power plant in
Iran; announces it may bid
on three more nuclear
reactors for $3 billion.
Russia assures US that
agreement concerns peaceful
nuclear cooperation only.
23 February 1999.......................... US imposes import
sanctions on 10 Russian
entities for giving
assistance to Iranian
nuclear and missile
programs.
28 April 1999............................. President Clinton
announces that the US will
exempt exports of food and
medicine from future
sanctions imposed by the
executive branch. The new
rules also apply to food
and medicine sales to Iran,
Libya, and Sudan, which
will be permitted on a case-
by-case basis. Specific
licensing rules will be
drawn up for each country
and there will be no US
government, funding,
financing or guarantees for
the sales.
Early Dec. 1999........................... US officials say that
intelligence reports
suggest that Iran has
recently increased aid to
terrorist groups opposing
the Middle East peace
process.
15 March 2000............................. President Clinton signs
the Iran Nonproliferation
Act of 2000 into law. Act
requires the president to
send report to Congress
identifying countries and
entities assisting Iran
with its weapons programs
and gives the president the
authority to impose
sanctions on these
countries but does not make
sanctions mandatory. The
Act also bars the US from
making ``extraordinary''
payments to the Russian
Space Agency to build the
International Space Station
or any other organization
of the Russian government
until the president
determines that Russia is
actively opposing
proliferation in Iran. The
president may waive
sanctions for national
security reasons.
17 March 2000............................. Secretary of State
Albright announces that US
will lift ban on Iranian
non-oil exports such as
carpets, caviar, pistachios
and dried fruit, and states
that US will increase
efforts to reach a
settlement to all legal and
financial claims between
the two countries and to
reduce barrier to cultural
exchanges. US sanctions
barring American investment
in Iran's oil sector,
however, remain in place.
14 April 2000............................. US government determines
that five entities in North
Korea and Iran have engaged
in missile technology
proliferation activities
that require imposition of
sanctions under the Arms
Export Control Act.
Sanctions are largely
symbolic.
27 July 2001.............................. Congress renews ILSA for
another 5 years, despite
opposition from the US
business community and the
Bush administration. The
``ILSA Extension Act of
2001'' requires the
president to submit a
report to Congress within
24 to 30 months on the
effectiveness of the
sanctions, their impact on
other US economic and
foreign policy interests
and the humanitarian
situation in Iran and
Libya. European Commission
criticizes the ILSA
extension and threatens to
retaliate if sanctions are
imposed against European
companies.
13 February 2002.......................... US blocks Iran's bid to
join the WTO.
25 July 2002.............................. Under the Iran-Iraq Arms
Non-proliferation Act of
1992, the US sanctions nine
Chinese companies and one
Indian entity for selling
prohibited goods to Iran.
21 October 2002........................... Russian officials refuse
an American proposal to
lift restrictions on the
import of spent nuclear
fuel into Russia (which can
be reprocessed to make
enriched uranium or
plutonium for nuclear
weapons) in return for
Russia's ceasing all atomic
cooperation with Tehran,
including the construction
of the Bushehr reactor.
21-22 February 2003....................... IAEA Director General
Mohamed ElBaradei visits
Iran to make nuclear
inspections and urge Iran
to sign the Additional
Protocol to the IAEA
Safeguards Agreement, which
would require an increase
in the transparency of the
Iranian nuclear program and
provide the IAEA with
increased access.
May 2003.................................. Responding to US pressure,
Russia informs Iran that it
will not deliver the
nuclear fuel for Bushehr
unless Iran signs the
Additional Protocol.
4 June 2003............................... Russia changes course from
its May 2003 announcement,
now declaring it will not
link the supply of nuclear
fuel in Bushehr to Iran's
signing of the Additional
Protocol.
6 June 2003............................... IAEA report to its Board
of Governors concludes that
Iran has failed to meet its
``safeguards'' obligations
by failing to fully account
for nuclear material
imported from China in
1991.
10 November 2003.......................... IAEA report to its Board
of Governors condemns Iran
for 18 years of
manufacturing enriched
uranium and plutonium as
part of a secret nuclear
program.
18 December 2003.......................... Iran signs the IAEA
Additional Protocol.
13 March 2004............................. IAEA Board of Governors
unanimously rebukes Iran
for failing to disclose
significant aspects of its
nuclear program. In
February 2004, US
investigations into the
nuclear network
masterminded by AQ Khan of
Pakistan (the father of
Pakistan's nuclear bomb)
uncover Iran's plans to
build advanced P2 reactors
for enriching uranium.
Retaliating against the
IAEA rebuke, Iran
immediately bars nuclear
inspectors from entering
the country.
28 October 2004........................... Iran and China sign a
preliminary agreement to
allow China's Sinopec Group
to develop Iran's Yadavaran
oil field in exchange for
agreeing to buy 10 million
tons of Iranian liquefied
natural gas annually for 25
years.
26 May 2005............................... Prompted in part by Iran's
recent nuclear cooperation
in negotiations with the
EU, the US announces it
will allow Iran's WTO
membership talks to begin.
4 February 2006........................... IAEA governing board
refers Iran to the U.N.
Security Council over
concerns that the country
is developing nuclear
weapons.
14 February 2006.......................... Iran resumes uranium
enrichment. Earlier, Iran
announced it would no
longer permit surprise
inspections of nuclear
facilities.
------------------------------------------------------------------------
Source: Gary Hufbauer, Jeffrey Schott, Kimberly Elliott, and Barbara
Oegg. Economic Sanctions Reconsidered: History and Current Policy.
Third Edition. Washington: Institute for International Economics,
forthcoming 2007.