Trade, Not Investment, is Iran's Sanctions Relief Must-Have

Last week, the seventh round of the negotiations over the fate of the JCPOA saw Iran table an initial proposal on sanctions relief. The proposal led to complaints from Western officials that the Iranian negotiators were being unreasonable. Iranian officials responded by insisting their proposals were “pragmatic.” The initial exchange suggested to some that disagreements over sanctions relief issue are going to prove the intractable because what Iran wants—significant investment—is impossible for the P5+1 to guarantee. Gérard Araud, former French ambassador to the United States and an astute observer of the nuclear talks, tweeted that “Even if the JCPOA was restored, no Western company would dare invest a cent in Iran.”

Even if the JCPOA was restored, no Western company would dare invest a cent in Iran, no Western bank would finance any deal in Iran with the threat of the return of US sanctions in 2025. Once was enough. The Iranians know it.

— Gérard Araud (@GerardAraud) December 3, 2021

Araud is rightly concerned. Western companies will be reluctant to invest in Iran due to fears that a Republican president could reimpose sanctions in 2025, putting their investments in jeopardy. In the months following the implementation of the JCPOA in January 2016, a flurry of big-ticket investment deals were announced. These deals became the symbols of the economic benefits of sanctions relief and of Iran’s moves towards normalised economic relations, namely with Europe and China. The deals included planned investments in Iran’s oil fields by Total and CNPC, the joint ventures planned by PSA Group and Volkswagen in Iran’s automotive sector, and Novo Nordisk’s decision to build a manufacturing plant in Iran, among others. But following President Trump’s decision to withdraw from the nuclear deal, essentially all European and Chinese efforts to invest in Iran unravelled (the Novo Nordisk project, with its humanitarian dimension, proved a rare exception).

For the P5+1, a significant technical interventions will be necessary to create conditions conducive to foreign direct investment. But, the economic value of the nuclear deal does not actually hinge on increased foreign direct investment, which was primarily sought by Iran as a commitment mechanism for technology transfer.

But for most Iranian manufacturers, the ambition is not to produce high-technology products. Rather, the ambition is to use high-technology equipment to more efficiently produce the wide range of basic goods that can be sold in the domestic and regional markets. Iran will receive most of the benefits on offer from sanctions relief when Iranian manufacturing firms can purchase new equipment from foreign suppliers that can be used to increase the quality and quantity of output. Such purchases represent a critical example of domestic investment deferred due to sanctions related pressures.

The industrial equipment on which Iranian factories depend is overwhelmingly imported from just two sources: the European Union and China. This trade can be tracked by looking at the relevant chapters of the so-called Harmonized System used by customs agencies categorise goods. Chapter 84 covers equipment such as boilers, pumps, turbines, furnaces, freezers, ovens, pulleys, cranes, forklifts, and other machinery that would be seen on a factory floor. Chapter 85 covers electrical equipment such as motors fuses, switches, lasers, heaters, magnets, batteries with various industrial applications. Looking at European and Chinese exports to Iran across these two categories offers a measure of whether Iranian factories are proving able to maintain or upgrade the equipment on their assembly lines. What’s clear is that sanctions significantly reduced European and Chinese exports of these goods to Iran, with significant consequences for Iranian productivity. Between the first quarter of 2018, prior to Trump’s withdrawal from JCPOA, and the last quarter of the year, by which point US secondary sanctions had been reimposed in full, Iran’s industrial output fell by 20 percent.

Part of the drop in production can be attributed to reduced demand. But many manufacturing firms also struggled to maintain output given difficulties not only in importing raw materials and intermediate goods, but also the parts and equipment necessary to keep assembly lines running at high capacity. Moreover, it wasn’t the wind down of foreign investment that was responsible for the drop in production—few investment projects had broken ground. Rather, it was disruption in the availability of European and Chinese industrial goods that saw Iran’s manufacturing sector regress.

In 2016, the first year of sanctions relief, European industrial exports to Iran averaged EUR 250 million per month. Over the first 8 months of 2021, the monthly average has been just EUR 80 million. That means, on an annualised basis, Iran is importing about EUR 2 billion less industrial goods from Europe than prior to the reimposition of US secondary sanctions.

The trends are similar when looking at Chinese exports to Iran. In 2016, average monthly exports to Iran totalled about USD 453 million. Over the first 10 months of 2021, the monthly average has been just USD 241 million. On an annualised basis, that is a difference of about USD 2.5 billion.

Looking at the European and Chinese data together suggests that sanctions relief could be worth around USD 4.8 billion in additional annual industrial exports to Iran from its two largest suppliers, if trade returns to pre-sanctions levels. A significant portion of the goods imported in these two categories are purchased as part of fixed capital investments by Iranian manufacturing companies, meaning that Iranian firms can be expected to invest billions of dollars in their own production capacity if sanctions are lifted and European and Chinese exports rebound.

Such a rebound is probable. For European and Chinese companies, the decision to enter the Iranian market as a supplier is far less risky than the decision to enter as an investor. Even with concerns that JCPOA implementation may falter again in 2025, the data from 2016-2017 makes clear that trade in industrial goods can rebound quickly, even in an environment where banking challenges and legal ambiguities persist. Many European and Chinese companies will be able to make lucrative sales to Iranian customers within the 2-3 year window in which sanctions relief is basically assured, especially those suppliers who are currently selling to Iran while US secondary sanctions remain in place.

Importantly, the fact that trade in industrial goods can rebound in a short period of time does not mean that the benefits will be short-lived. Equipment like pumps and furnaces have lifespans up to 20 years. Many Iranian factories are hampered with old equipment. Sanctions relief would enable these firms to finally upgrade old equipment, much of which was installed in the early 2000s during which Iranian industry underwent a critical development phase characterised by the installation of European manufacturing equipment. Should more Iranian companies be able to avail themselves of the opportunity to invest in new industrial equipment following the restoration of the JCPOA, Iran industrial output would benefit from higher productivity and greater resilience for a decade or longer, a fact that makes sanctions relief, even if cut short by political events, fundamentally attractive.

Economically speaking, trade, not investment, is the key for robust Iranian growth in the years immediately following restoration of the JCPOA. Attracting foreign direct investment would of course maximise Iran’s developmental outcomes, and has a crucial role to pay should Iran aim to return to its pre-sanctions growth trajectory, but such investment is not essential for Iran’s short-term economic recovery. The primary goal for the P5+1 should be to ensure that trade rebounds as quickly and robustly as possible. Here, the provision of trade finance is important and technical work will need to be done to ensure that global export credit agencies can serve companies that wish to sell equipment to Iran. Still, finding solutions to extend billions in trade finance will prove far easier than facilitating billions in foreign direct investment in the short term.

Politically, facilitating foreign direct investment would usefully demonstrate that the P5+1 is making good on economic commitments set forth in the JCPOA. On one hand, the Raisi administration would surely welcome more intensive efforts on the part of Western governments to ensure foreign investments can materialise, particular in sectors where such investment is really necessary like the energy sector. On the other hand, the fact that trade, and not investment, is the real economic must-have will suit the Raisi administration just fine. President Raisi is unlikely to make Western foreign investment a major target of JCPOA implementation given the emphasis on economic self-reliance that colours his administration’s economic planning and the reluctance to undertake deeper structural reforms on which many foreign investors will insist. But by focusing on trade, Raisi will have a compelling story to tell—sanctions relief will enable Iran to buy the industrial goods that will undergird the country’s economic resilience for the next two decades.

Photo: IRNA

Renewable Iran: Creating the Energy Network of the Future

The global energy industry continues to find greater value in efficiency and clean technology, with a rapidly growing reliance on renewable energy. For Iran and the Middle East however, oil and gas have hardly been challenged as the dominant industry forces. But now that Iran prepares to once again open doors to the international business community, we must ask if renewables can, or even should, play a greater role in the future of Iran’s energy sector.

So, what’s the problem?

Iran is the country with the world’s largest conventional gas reserves and is the world’s third largest producer of natural gas - behind the US and Russia. Given these abundant reserves and production, you have to question why has a country of Iran’s population been a consistent net importer of natural gas during the last decade. The answer is Iran has very high per capita consumption of gas and other fossil fuels, with much of it going into power generation. In 2014, Iran burned 50 billion cubic meters of gas for power generation: that is more than in the UK, Germany, Italy, and France combined. In fact, in 2013, Iran consumed more gas than China, and was the 8th biggest energy consumer in the world, despite being the 32nd largest economy (World Bank) and the 17th most populated country. 

Moreover, according to the International Energy Agency (IEA), Iran is among the top ten global emitters of CO2. Iran is the top emitter in the Middle East and accounts for almost a third of the region’s total carbon emissions. Fossil fuels account for almost 98% of Iran’s total primary energy consumption.

Of the 70 gigawatts (GW) of power generation capacity installed in the country, only around 11 GW are low carbon sources with most of that hydro (10 GW) while 1 GW is nuclear, and 0.1 GW is either solar or wind. The rest is largely old, inefficient, and polluting fossil fuel power plants burning either fuel oil or natural gas. According to Iran’s Ministry of Energy, over the past decade electricity demand has grown by almost 6% annually, and is expected to grow by at least 2% - 4% through the end of the decade. There are now more than 30 million grid connected clients in Iran, compared to less than 20 million only ten years ago. 

So, Iran faces the problem, how can it meet this rapidly growing electricity demand while reducing its consumption of gas and fuel oil to eliminate imports (and facilitate exports), reducing carbon emissions to more average global per capita levels, effectively addressing the challenging air quality issues, and still attracting foreign investment and new technology?

The Role of Renewables

The answer is likely to be found in a combination of a modernisation of its power generation capacity, greater energy efficiency, and much greater reliance on renewable forms of generation.

In terms of renewables, Iran is naturally blessed with very good solar and wind conditions. Iran receives around 300 days of sunshine each year, compared to less than 64 days in Germany, the world’s leader in solar power with almost 25% of the global solar power capacity. The Global Wind Energy Council stated that some of Iran’s mountainous areas in the west and northeast have unique wind corridors that have plenty of potential for renewable generation.

The Iranian government is starting to get that renewables should now be an important part of the country’s energy strategy. In early 2014, Iran’s Ministry of Energy unveiled its plans for adding some 5 GW of renewable power capacity, mostly wind, to the country’s power fleet by 2018. Since the beginning of 2014, construction for around 400 MW of renewable capacity has started, and contracts for more than 500 MW have been awarded. The Iranian government increased its budget for renewable energy by more than 400% last year to around $60 million; although still small, the growth is going in the right direction.

Iran has also adopted a number of new policies towards renewable expansion, using similar policies to many Western European countries and opening up the sector to foreign investors. The Ministry of Energy has set up the Renewable Energy Organization (SUNA) that will administer these policies that include a feed-in-tariff scheme, under which the Ministry of Energy will buy the power generated from renewable sources at set tariffs for a 20 year period. At the set energy tariffs, investors are expect to be able to recover a full return on their investment in around four years of operations. In addition, the Iranian government is committed to providing up to 50% of the cost of installing residential solar panels, and to installing solar panels in public buildings. 

Another spur to renewables growth comes from the calls to introduce a carbon emissions trading scheme. In February 2014, Iran announced that it is planning to introduce an emission trading scheme (ETS) that would cover its power sector. Although little information is available about the structure of the scheme, it is certain that such ETS's are designed to discourage the use of inefficient fossil fuel burning power plants. The emissions cap will eventually increase the power generation costs for inefficient power plants and will further support the growth of clean energy and renewables.

With all the challenges Iran is facing, renewable energy offers a unique sustainable solution for Iran to fundamentally overcome these issues, while providing significant investment opportunities for international investors, and also boosting the overall sustainability of economic growth. 

Photo Credit: Wikimedia