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The Case for an Iranian-Oil-Free Zone

May 30, 2011


If we buy oil from despotic states, are we somehow complicit in their crimes? Even after the Arab Spring has highlighted tyranny in the Middle East, Americans and Europeans still generally remove oil and natural gas from their moral calculations.

But what if we could do a lot of good by sanctioning Iranian oil? Is it possible, moreover, for Europeans to continue to buy Iranian crude but give the Iranian regime less money? And could China and India, major oil customers of Tehran who couldn’t care less about the regime’s behavior, purchase as much crude as they want and still hurt the mullahs’ ability to translate oil wealth into nefarious actions?

The answer to all three questions is “yes.” All buyers need is more incentive to shop ruthlessly whenever they buy from Tehran. Washington could provide it by declaring the United States an Iranian-oil-free zone. Any company that exports an oil-based product to America—gasoline, plastics, petrochemicals, synthetic fibers—would have to certify that no Iranian oil was involved in its manufacture.

In 2010, the U.S. imported approximately 5% of its finished (fully-refined) and unfinished daily gasoline consumption from Europe. Since Iranian oil is now freely blended into European stocks, the U.S. is certainly consuming Iranian crude. And Iran’s petrochemical exports to China amount to roughly $2 billion, so imagine how much of that comes to the U.S. via Chinese-manufactured plastics.

Making the U.S. an Iranian-oil-free zone would make it a hassle to trade in and use Iranian crude, which would strongly encourage any importer to demand a discount from Tehran. The pressure on Iran to lower its price everywhere could become acute.

The U.S. is Europe’s largest export market for gasoline, so Washington could give foreign refineries a six-month grace period to adjust their supplies, making it unlikely there would be any increase in the price of gasoline exported to the U.S. No refinery in Europe is dependent on Iranian crude: Even in a tight market, alternative oil supplies could quickly replace Iranian supplies for those refineries that prefer to avoid Iranian oil.

Even for countries that might try to cheat the system, like Venezuela, the incentive would be strong to take advantage of this American sanction and force a lower Iranian price. Moving oil from Iran to Venezuela isn’t free—ideological fraternity would probably come at a price.

It’s difficult to assess exactly, but it’s reasonable to posit that aggressive oil traders would force Tehran to discount its oil by at least 10%. Currently, gasoline traders willing to defy U.S. sanctions on refined petroleum demand premiums of about 30% for the sale of petrol to the Islamic Republic.

Given the state of the Iranian economy—oil production is declining, investments in natural-gas production and distribution are lagging, state subsidies are still exploding, and unemployment and inflation are both rising—a small reduction in oil revenue could have a cascading effect.

It would be easy for European Union countries to adapt to a U.S. Iranian-oil free zone. Under current practices, all foreign oil coming into the EU is so designated by origin for customs purposes. When petroleum is in port, it is tagged as a “T1” (non-EU) good. The discharge of this oil is managed by a handful of highly reputable survey companies that must certify how much oil was unloaded, whether any was lost in shipment, and who now owns the crude. The oil is then processed, refined, and distilled, becoming “T2” (EU) petroleum.

Because of the nature of the refining business, refiners know exactly whose oil is entering into the system and what its properties are (heavy or light, sweet or sour) owing to the desired final product (gasoline, diesel, heating oil, petrochemicals, etc). Iranian crude could be clearly marked as it enters a refinery, placing the legal onus on the refinery and the end-user to certify that Iranian oil has not entered a stream that becomes, for example, Shell gasoline destined for the American market.

In India and China, where legal checks are poorer, it will be more demanding to monitor imports and exports. Still, American pressure could force certification. The objective wouldn’t be to create a leak-proof system globally, but a mechanism that would encourage oil traders to demand discounts from Tehran.

On the American side, Congress can easily close a legal loophole that allows for the importation of refined petroleum and other petroleum-based products made from Iranian oil. (The direct importation of Iranian crude has long been illegal.) European refineries might at first bridle at the hassle of separating Iranian petroleum from everyone else’s, but they would soon comply given the importance of the American market. Oil traders everywhere would realize their new advantage over Tehran.

Sanctions are too often ineffective because they run counter to our pecuniary motivations, but an Iranian-oil-free zone wouldn’t be. It would bring cheaper Iranian oil to those who want it, and it would punish the Iranian regime—perhaps more so than any existing sanctions effort—for its transgressions. That’s a win-win for everyone.