IRAN SANCTIONS: WHAT IMPACT FOR THE SHAH-DENIZ PROJECT?
The sanctions recently introduced by the U.S. and other states against Iran over its continuing nuclear program constitute the culmination of two years of discussion in the U.S. Congress, the UN, the EU and the IAEA. However, it is unclear whether Iranian investments in Azerbaijan’s Shah Deniz gas field through the National Iranian Oil Company (NIOC) will be subject to the new sanctions. Their omission in the new round of sanctions through the Iran Threat Reductions Act (ITRA) makes the Shah Deniz project safe for now.
BACKGROUND: A number of laws and executive orders authorize the imposition of penalties on any U.S. companies, institutions and persons who work with or in Iran. The aim of these measures is to make these entities choose between the Iranian market and the much larger U.S. market. The new round of sanctions, ITRA, passed the House in December 2011 in response to the IAEA report which concluded that Iran had a program for developing nuclear weapons and continues at least some of these activities. ITRA has not yet passed the Senate. This provision initiated by U.S. Rep. Ileana Ros-Lehtinen (R-FL), Chairman of the House Foreign Affairs Committee expands and strengthens U.S. sanctions on the Iranian regime. The bill closes loopholes in energy and financial sanctions that are already in place and specifically targets the Central Bank of Iran.
However, it is not clear whether Iranian investment in other countries, such as NIOC’s participation in Azerbaijan’s offshore gas venture Shah Deniz in the Caspian Sea, will be subject to new sanctions.
NIOC holds a 10 percent stake in the Shah Deniz upstream project since 2001, when the contract with shareholders was signed. At the time, this was intended to ensure that Azerbaijan’s southern Caspian neighbor would not challenge the oil and gas exploration and transportation projects using the legal status of the Caspian Sea as an argument. Russia’s Lukoil holds a stake for similar reasons.
The recently adopted sanctions and passed bills do not immediately present significant political and economic risks to the Shah Deniz co-venturers, contractors and other involved parties. The gas reserves of Shah Deniz’ Second Phase (SDII), which will come on stream after 2017, are currently considered the only source for feeding the Southern Gas Corridor. This project is vital to reduce Southeastern Europe’s almost total dependence gas supply from the Russian monopoly Gazprom.
Consequently, the realization of energy projects is crucial in order to balance Russian influence and keep external powers, especially the U.S. in the region, thus enabling the small but energy rich newly independent states to choose less politicized, lucrative and stable markets for their energy exports. Therefore, if further sanctions risk terminating further development of the upstream Shah Deniz project, these are obviously not in line with U.S. and the EU interests in the wider region and could be extremely harmful to achievements made so far. It is therefore imperative that the members of congress who voted for the bills on stronger sanctions against Iran understand the particular Caspian context.
IMPLICATIONS: The Congress is known for its radical standpoint on punitive measures with respect to Iran and its proliferation program, while many in the U.S. government recognize that sanctioning Shah Deniz would contradict U.S. interests in regional energy development. The project does not appear to constitute a violation of the Iran Sanctions Act (ISA) as there is no specific provision which would characterize this particular Iranian investment in as a sanctionable activity. Furthermore, the passed bills allow the White House and State Department flexibility and authorization to grant exceptions and waivers to the sanctions. For instance, Section 1245, Imposition of Sanctions with Respect to the Financial Sector of Iran of ITRA (5) Waiver subsection states: “The President may waive the imposition of sanctions … [if the President] determines that such a waiver is in the national security interest of the United States.”
The European Union recently imposed sanctions on Iran’s energy industry as well, and it can also waive any sanctions that would not be in the strategic interest of the block.
This time it was also possible to include a provision to exclude Shah Deniz II from the imposed sanctions 604 – Exclusion of Certain Activities in ITRA executive privilege section. Section 604 (2) states that the Act shall not apply to activities “involving a natural gas development and pipeline project prior to the date of enactment of this Act to bring gas from Azerbaijan to Europe and Turkey.” 604 (c) continues to state that “for the purpose of providing energy security and independence from Russia and other governments engaged in activities subject to sanctions under this Act.” This exclusion language included in the Act is indeed in the interest of all parties involved in the Southern Gas Corridor including Azerbaijan, Georgia, Turkey, the EU and the U.S., makes the Shah Deniz project safe for now.
However, some members of congress who tend to take a tougher stance on Iran may continue to bring the issue to the agenda every year and even twice a year to tighten the loopholes in energy and financial sanctions. Besides, if President Obama is voted out of office, the new Administration might reconsider the U.S. position and increase the pressure on Iran. The SDII project is designed with a long term perspective and as long as Iran is a shareholder, that country’s international position will directly affect the project.
It is important to bear in mind that, firstly, Iran will not get any revenues from the project as the new amendment will effectively prohibit private commercial banks from transferring funds to the CBI or other designated banks.
Secondly, the development of Shah Deniz Phase II will induce substantial cash calls on shareholders over the next few years. However, the consortium has some bank financing as well, so not all the money for Phase II capital investment will come directly from the shareholders. Oil sales to the EU in the past have probably ensured significant Iranian deposits in Switzerland, and its state-controlled Naftiran Intertrade Company (NICO), which is a NIOC subsidiary, is placed in this country to cover cash calls. Arguably, if the oil trade drops to near zero, then that may no longer be the case. However, Iranian oil can still be sold to others, particularly China, and such arrangements are already in place. We should therefore not expect any immediate danger that NIOC will not be able to meet its cash calls for SDII. It is more likely that there will be moves to pressure the remaining customers (especially China, India and Japan) and the few trading companies still handling Iranian cargoes (both China and Russia have trading entities based in Switzerland). While there are strict rules on transactions with Iranian banks, it is very likely that there are intermediary entities in Switzerland and elsewhere which would be happy (for a fee) to route cash call payments on Iran's behalf.
Thirdly, if the State Oil Company of Azerbaijan (SOCAR) would ask NIOC to pull out from the project under pressure from Washington, then SOCAR will according to the contract have to pay “equitable, fair, just and adequate” compensation which would constitute at least US$ 1.3 billion on the basis of current estimates. Providing Iran with such cash is not in the national security interest of the U.S., either.
CONCLUSIONS: If China and Russia carry on business-as-usual with Iran, it is very unlikely that NICO will have to default on the cash-calls and the Shah Deniz contract. There is currently no sign of China or Russia changing their respective policies. Thus, in the short term, the new sanctions will not affect NICO’s position in the Shah Deniz consortium. However, NICO’s continuing presence adds an additional complication to decision making in an already difficult project. In the long term, as a much smaller neighbor, Azerbaijan as well as the Shah Deniz project must fervently hope that Iran manages to normalize its relationships with the rest of the world. It is in general a good idea for small countries to arrange win-win relationships with large neighbors. This is clearly what late President Haydar Aliyev sought to do, but history reminds us that large countries with impressive cultures and capabilities can still make very dim decisions.
AUTHOR’S BIO: Gulmira Rzayeva is a Research Fellow at the Foreign Policy Analysis Department, Center for Strategic Studies under the President of the Republic of Azerbaijan.
