Iran's oil sector already feels like the country is at war

Iran's economy won't collapse any time soon, but sanctions are cutting into oil exports and production, and eventually something will have to give.

During the first year of the devastating Iran-Iraq war of 1980-88, Iraq targeted Iranian refineries and oil installations. In 1981, the worst year of the war for Iran, oil exports plummeted to below one million barrels per day (bpd), a dramatic fall from pre-revolutionary exports of over 5 million bpd.

Iran's oil men still recoil when they recall those days. Today, they can be forgiven a sense of déjà vu: exports are back to the 1981 level. International Energy Agency figures say Iran exported 860,000 bpd in September, barely one third the level of a year earlier, when it was exporting 2.5 million bpd.

These are wartime numbers. Indeed, these are worse than wartime numbers. Throughout the eight-year Iran-Iraq war, which left hundreds of thousands of dead on both sides and did untold infrastructure damage, Iran's exports stabilised to average 1.5 million bpd - well more than today's figures.

The reason for Iran's export decline today is simple: sanctions. The multilayered web of US and EU-led sanctions against Iran's oil sector had long been quietly chipping away at production because most major energy players - even the Chinese state-owned companies - have either left Iran entirely or have been dragging their feet on projects. So total production has dipped below 3 million bpd - once again, Iran-Iraq warlike numbers.

Only recently, however, have sanctions begun to hit exports directly.

The year 2012 has been an annus horribilis for Iran's oil exports. Its major buyers - Japan, India, China, South Korea and Turkey - have all reduced their imports, to avoid US sanctions that could target the US subsidiaries of companies from those nations.

US sanctions, ratified by Congress on December 31, target all companies anywhere in the world that deal with Iran's Central Bank. And who deals with Iran's Central Bank? Refiners who buy Iran's oil.

The legislation does not mandate a total cut-off of purchases of Iranian crude, but calls for a demonstrable reduction of more than 20 per cent. All major buyers have dutifully complied, despite occasional chest-thumping defiance.

Further, as refiners buy Iranian crude in smaller amounts, they face other hurdles: getting insurance for tankers; dealing with ships that won't go to Iranian ports and transferring payment to the Central Bank in a world where few bankers will get involved in such deals.

The sanctions are comprehensive and, even where certain actions are permitted under them, most companies are erring on the side of caution. As one European banker put it: "Iran is toxic these days. No one wants to go near there."

Sanctions are intended to pressure Iran into greater transparency over, and a negotiated settlement about, its nuclear programme.

The pressure is certainly being felt, but thus far there have been no indications that the political elites of the Islamic Republic are about to break down.

The oil sanctions - particularly those targeting exports - have ratcheted up the pressure.

Oil is the lifeblood of Iran's government, accounting for 80 per cent of hard currency earnings and 60 per cent of the government's fiscal revenues. That money, once in the government's coffers, courses through the whole economy, paying for security services, patronage, imports and infrastructure, bolstering the private sector as it goes. The cash also serves as a honeypot of corruption, one that has made many a senior official's hand sticky.

The collapse of the rial, inflation and job losses in industry can all be attributed to the heavier sanctions environment.

This has led many to suggest that the economy is on the verge of collapse, but this is not so. Iran is certainly facing serious long-term decline, coupled with dramatic under-performance, but it still has a reserves base, estimated at over $100 billion (Dh367 billion) in 2011, to cushion some of the blows.

Further, real oil prices today are far higher than they were in the 1980s. In fact, they are higher than ever in history. Thus, while the bite on Iran's bottom line is real, it's not crippling. It is estimated that Iran will earn some $53 billion (Dh195 billion) from oil revenues in 2012. So although it is dipping into its reserves and its current course is unsustainable, a collapse is not imminent nor likely in 2013.

Iran's oil woes have allegedly led it to lash out at regional rival, Saudi Arabia, and erstwhile ally, Qatar. Leon Panetta, the US defence secretary, recently said that the cyber-attacks that afflicted some 30,000 computers at the oil company Saudi Aramco, and also targeted Rasgas in Qatar, originated in Iran.

Tehran has expressed frustration with fellow Opec member Saudi Arabia for replacing Iranian crude and taking market share from Iran as its traditional buyers cut back. Saudi Arabia argues that it is simply meeting demand.

Until recently, Qatar had amicable relations with Iran. Differences over Syria and Bahrain, however, have soured those ties. Meanwhile, Iran has also seen its links with Turkey deteriorate dramatically over differences about Syria.

Iran's support for the regime of Bashar Al Assad, currently waging a brutal campaign against the Syrian opposition, has pitted Ankara and Tehran in a serious geopolitical struggle. Expect Turkish refiners to move away from Iranian crude if relations continue to spiral downwards.

Iran is increasingly backed into a corner by its declining exports. Its economy is not on the verge of collapse, but its reserves are depleting. This cannot go on forever.

A country like Iran, with regional hegemonic aspirations, cannot be a hegemon with a steadily declining economy. As Iran's economy shrinks, however, the aspirations of its leaders will not. This will make for an increasingly bumpy ride in a region that has had its fair share of turmoil in 2012.

Afshin Molavi is a senior adviser at Oxford Analytica and a senior fellow at the New America Foundation in Washington DC

On Twitter: @afshinmolavi