[Senate Hearing 109-720]
[From the U.S. Government Printing 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

                               __________

          Printed for the use of the Joint Economic Committee




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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

                              ----------                              

                      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.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
    \2\ The IMF estimated its value at $3.5 bilion in 2000.
---------------------------------------------------------------------------
     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.
---------------------------------------------------------------------------
    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.