U.S. GOVERNMENT PRINTING OFFICE

WASHINGTON : 

For sale by the Superintendent of Documents, U.S. Government Printing Office

Internet: bookstore.gpo.gov Phone: toll free (866) 512–1800; DC area (202) 512–1800

Fax: (202) 512–2250 Mail: Stop SSOP, Washington, DC 20402–0001

30–856 PDF 2007

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

(

(II)

JOINT ECONOMIC COMMITTEE

[Created pursuant to Sec. 5(a) of Public Law 304, 79th Congress]

HOUSE OF REPRESENTATIVES

JIM SAXTON, New Jersey, Chairman

PAUL RYAN, Wisconsin

PHIL ENGLISH, Pennsylvania

RON PAUL, Texas

KEVIN BRADY, Texas

THADDEUS G. MCCOTTER, Michigan

CAROLYN B. MALONEY, New York

MAURICE D. HINCHEY, New York

LORETTA SANCHEZ, California

ELIJAH CUMMINGS, Maryland

SENATE

ROBERT F. BENNETT, Utah, Vice Chairman

SAM BROWNBACK, Kansas

JOHN SUNUNU, New Hampshire

JIM DEMINT, South Carolina

JEFF SESSIONS, Alabama

JOHN CORNYN, Texas

JACK REED, Rhode Island

EDWARD M. KENNEDY, Massachusetts

PAUL S. SARBANES, Maryland

JEFF BINGAMAN, New Mexico

CHRISTOPHER J. FRENZE, Executive Director

CHAD STONE, Minority Staff Director

(III)

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

(1)

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

2

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

3

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

4

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

5

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

6

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 21⁄2 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.

7

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.

8

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.

9

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?

10

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 statesponsor 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

11

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 NonProliferation 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.

12

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

13

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,

14

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 secondlargest 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

15

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

16

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

17

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

Khamene ́i.

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.

18

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.

19

[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 de- velopment 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

20

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 ineffecVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00024 Fmt 6633 Sfmt 6633 C:\DOCS\30856.TXT DianeA PsN: DianeA
21

tive. 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 preVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00025 Fmt 6633 Sfmt 6633 C:\DOCS\30856.TXT DianeA PsN: DianeA
22

vented 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.

23

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

24

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 stateowned 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.

25

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

26

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.

27

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

28

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

29

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 beVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00033 Fmt 6633 Sfmt 6633 C:\DOCS\30856.TXT DianeA PsN: DianeA
30

cause 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.

31

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

32

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

33

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.

34

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.]

(35)

Submissions for the Record

36

37

38

39

40

41

42

43

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 ‘‘buyVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00047 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
44

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.

45

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

46

1World Bank Report No. 25848–IRN. Iran: Medium Term Framework for Transition. April 30,

2003.

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.

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.

47

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

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. • 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. VaezTabasi’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.

48

3Kalantari, Hashem and Sally Jones. Iran Set to Award Lucrative Gas Deal to Elite Militia.

Wall Street Journal, June 29, 2006. 4Diehl, Jackson. Deft Demagoguery in Iran. Washington Post, May 7, 2006. 5 Iran applied to join the WTO in May 2005 when the Bush Administration dropped its nineyear-long objection to Iran’s application

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.

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

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 Organization5 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.

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

49

6 Birch, Nicholas. In Iran, It Pays To Be a Religious Leader. Seattle Times, August 20, 2003.

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.’’

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

50

1 Energy Information Administration, United States Department of Energy, ‘‘Country Analysis

Brief: Iran,’’ April 2004, http://www.eia.doe.gov/emeu/cabs/iran.html. 2See, 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. 4 Robin Wright, ‘‘Iran’s New Alliance with China Could Cost U.S. Leverage,’’ Washington Post,

November 17, 2004, A21.

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 quasistate 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

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.

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.

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 biVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00054 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
51

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.

8Defense 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. 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. 12See, for example, Clifford Kupchan, ‘‘Tehran’s Trump Card,’’ Los Angeles Times, April 23,

2006, http://www.latimes.com/news/printedition/suncommentary/laopkupchan23apr23,1,4489060.story?coll=la-headlines-suncomment. 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. 14Study 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.

lateral 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

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

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.

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.

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

52

15Gareth 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. 16Paul Klebnikov, ‘‘Millionaire Mullahs.’’ Forbes, July 21, 2003, http://www.forbes.com/

forbes/2003/0721/056 print.html. 17 Ibid. 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. 19Kenneth Katzman, The Iran-Libya Sanctions Act (ILSA) (Washington: Congressional Research Service, July 21, 2003), 2. 20George 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. 21 ‘‘Iran Moves Assets to China, East Asia, worldtribune.com, January 23, 2006, http://

www.worldtribune.com/worldtribune/06/front2453758.41875.htm1. 22Meysam Salehian, ‘‘Central Bank vs. Government,’’ Rooz (Tehran), May 10, 2006, http://

roozonline.com/english/015477.shtm/.

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.

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.

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.

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

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 prodVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00056 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
53

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. 24 ‘‘Iran Nuclear Response ‘in August,’’’ BBC (London), June 21, 2006, http://news.bbc.co.uk/

2/hi/middle east/5102544.stm. 25 Alhajji, ‘‘Will Iran’s Nuclear Standoff Cause a World Energy Crisis? (Part 1 of 2).’’

ucts 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.

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.

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 Councilimposed 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

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.

54

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 energyrelated 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 conVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00058 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
55

sumption 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 armslength 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

56

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 facesaving, 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 mid1990s, 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 visa`-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 deVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00060 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
57

struction 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, securityminded 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 selfpolicing. 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.

58

1This 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).

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 DATE1

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.

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-inVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00062 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
59

flicted 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 de ́ja` 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 decadesdespite 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 satisVerDate 11-MAY-2000 09:08 Jan 25, 2007 Jkt 030856 PO 00000 Frm 00063 Fmt 6601 Sfmt 6621 C:\DOCS\30856.TXT DianeA PsN: DianeA
60

fying result but effectively what we can achieve, given current conditions in world

energy markets.

Table 1.—Iran: Petroleum Production, Exports and Revenues, 1995–2005

Productiona

(1000 barrels/day)

Crude oil exportsb

(1000 barrels/day)

Value of petroleum

exportsb

(millions of dollars)

Iran light crudeb

(spot price per

barrel, $)

Iran heavy crudeb

(spot price per

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 Iranblocking 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.

61

APPENDIX. U.S. Sanctions Against Iran: Chronology of Key Events, 1984–2006—Continued

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 nonoil 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.

62

APPENDIX. U.S. Sanctions Against Iran: Chronology of Key Events, 1984–2006—Continued

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.

Æ