Sanctions are convulsing Iran. In the past seven months, the Western turn from targeted sanctions to broader economic warfare has presented the Iranian regime with perhaps its greatest economic challenge since the Iran-Iraq War.
A looming European Union oil embargo, which goes into effect on July 1, along with additional U.S. pressure on Iran's customers to reduce their oil purchases, will make matters worse for Iran's leaders. The situation is already dire: Iran suffers from hyperinflation, stagnant growth, and a crumbling currency. And oil revenues, which constitute 80 percent of Iran's export earnings and half its government budget, have already dropped almost 40 percent, year over year.
Yet, sanctions have so far failed to achieve their intended objective of forcing Iranian Supreme Leader Ali Khamenei and his Islamic Revolutionary Guard Corps (IRGC) to agree to halt their nuclear weapons program. U.S. President Barack Obama and his European counterparts built the sanctions regime to increase their leverage at the negotiating table and cause financial desperation on a scale to match the determination and duplicity of the men who have spent three decades and billions of dollars to develop every component of an Iranian nuclear-tipped missile.
But the painful truth is that Western sanctions have been underwhelming. Three rounds of failed talks in Istanbul, Baghdad, and Moscow have shown that the United States and its allies do not yet have the kind of leverage that could make Khamenei yield and agree to meet Iran's obligations under international law. In spite of cyberattacks and sabotage, the supreme leader has reason to believe that Iranian physicists can construct a nuclear bomb faster than Western countries can undermine his economy.
For sanctions to work, Khamenei must be forced to make a fundamental decision between his nukes and his regime. While Obama and his allies in Europe have made no effort to overturn Khamenei's regime -- notably doing nothing to support the Green Movement in the summer of 2009 -- they have wanted him to think they will.
The best evidence that Khamenei fears what a massive U.S.-led economic offensive could do against his country is the quiet in the streets of Iran. A leader confident that his citizens would rally around the flag against Western sanctions would be busing in hundreds of thousands of Iranians from the towns and villages, where the regime's faithful live, to burn Obama in effigy. Khamenei hasn't done this. Since the summer of 2009, the regime has lived in fear of massive street demonstrations that could easily turn against him and the regime.
There is no denying that sanctions have had a devastating effect on Iran's economy. Iranian oil is now a distressed asset -- to sell oil, the National Iranian Oil Co. has been forced to provide Chinese traders discounts of $20 per barrel or give them extended payment terms. And according to the International Energy Agency, 67 million barrels of Iranian crude -- more than a month of normal Iranian oil exports -- are currently sitting in storage, looking for a home. All told, Iran is losing an estimated $4.5 billion per month in oil revenues, losses that will only increase if global oil prices continue to fall and the European embargo and U.S. oil sanctions take their toll.
But it's still not enough to make the mullahs abandon their nuclear program. Even a staggering 39 percent drop in oil revenues compared with 2011 would still net Iran $44 billion this year, according to Reuters's estimates. With between $60 billion and $105 billion in foreign currency reserves, Khamenei's economic expiration date -- when his cash hoard falls low enough to set off a massive economic panic -- may still be far off.
If Obama wants to bring that date closer, he should make it clear to the supreme leader that he will do everything in his power to destroy Iran's energy wealth. Obama and his allies should adopt an idea contained in legislation introduced by Rep. Ted Deutch (D-Fla.), Rep. Robert Dold (R-Ill.), and Sen. Mark Kirk (R-Ill.) that would blacklist the entire Iranian energy sector as a "zone of primary proliferation concern," preventing international companies that do business in the United States or the European Union from doing business with it. The Obama administration should also designate the Central Bank of Iran as an "entity of primary proliferation concern," barring firms from transacting with it as well.
There is precedent for such a decision: U.N. Security Council Resolution 1929, passed in 2010 with the support of Russia and China, explicitly notes a "potential connection" between Iranian oil and gas revenues and "the funding of Iran's proliferation-sensitive nuclear activities." In 2011, the Obama administration declared Iran's entire financial sector a money-laundering threat because of its role in supporting proliferation and terrorism, laying the groundwork for the limited sanctions against Iran's Central Bank that passed in December 2011.
Sweeping action along these lines is the only way to counter aggressive Iranian attempts to subvert international sanctions. For the past seven years, the U.S. Treasury Department has sanctioned hundreds of financial and commercial entities controlled by the IRGC, but Iran can spin off new front companies faster than Treasury officials can target them, conjuring up "clean" entities with which international companies can maintain their business relationships.
Blacklisting Iran's entire energy sector would solve that problem, prohibiting business dealings with every entity involved in it, both inside and outside the country. This would include the National Iranian Oil Co. and its many subsidiaries, the former National Iranian Tanker Co. (now known as NITC), and hundreds of other entities and front companies. Foreign companies that continued to do business with Iran's energy sector would face U.S. sanctions that could cut them off from access to the much larger American market.
Central Bank sanctions should also be extended beyond formal financial institutions, targeting foreign exchange houses in the Persian Gulf that assist Iran in accessing hard currency, gold suppliers that allow countries like China to pay for Iranian oil in gold in lieu of hard currency, companies that provide services to the Central Bank of Iran for the printing of the Iranian currency, and alternative payment and settlement mechanisms, like the Swiss-based Iranian company Naftiran Intertrade Co., which Iran is using to funnel funds to its Central Bank.
This step would also eliminate any ambiguity about what energy transactions are permissible with Iran. For example, it would target the Swiss company EGL's $22.5 billion, 25-year purchase contract for Iranian natural gas, which may still be permitted under current U.S. law as long as it doesn't route funding through the Central Bank of Iran or a designated Iranian financial institution.
Washington and its European allies should make some allowances for oil sales to enable Iran's current oil buyers to find alternatives. Current U.S. sanctions laws give the president the authority to provide exemptions to countries buying Iranian crude if they can demonstrate that they "significantly reduced the volume of crude oil purchases from Iran."
But too much Iranian oil is finding a home, and the United States should raise the threshold for these exemptions dramatically. So far, the Obama administration has granted exemptions to 18 countries for reductions in oil purchases that reportedly range from 11 to 22 percent.
These exemptions now appear much more generous than they need to be. Oil prices are dropping as new Saudi, Iraqi, and Libyan oil production has increased world capacity, the European debt crisis and a slowdown in Chinese economic growth rates have put a dent in world oil demand, and the United States has witnessed a much larger than expected decrease in oil consumption and larger than expected increase in domestic oil production. This means that oil markets could absorb a more significant reduction in Iranian oil sales without increasing pressure on global oil prices. It also gives the Obama administration more flexibility to insist that Iran's oil buyers reduce their purchases at a much more rapid pace in order to qualify for the next round of exemptions, which need to be determined between September and December.
A comprehensive ban on the Iranian energy sector, with a much higher threshold for permissible oil purchases, would discourage most foreign companies from investing in Iranian energy or doing any other business. It would also put the remaining companies operating in Iran in a position to extract major price concessions from the Islamic Republic. Finally, it would cut Iran's overall oil and petrochemical exports and prevent Iran's enormous natural gas reserves from being developed at a time when its leaders can ill afford any more bad economic news.
Economic warfare should not be limited to the energy sector. The United States and its allies should also target other areas of the Iranian economy, including the automotive sector, which is the largest part of Iran's economy outside the energy industry. Aggressive action against sectors controlled by the IRGC, the tip of the spear in Iran's efforts to expand its influence throughout the Middle East, should be a no-brainer -- that means blacklisting the IRGC-controlled construction and engineering sector and declaring the IRGC-controlled Iranian telecommunications and technology sector as a "zone of electronic repression." The Obama administration also should impose an insurance embargo on the underwriting of any Iranian business activity that would otherwise be sanctionable under U.S. law.
The European oil embargo signals a new stage in the pressure campaign against Iran. The White House must build on this momentum, intensifying economic warfare in an effort to shake the Islamic Republic to its core. And, if that's insufficient to get Khamenei to strike a deal -- and there is unfortunately no evidence so far that it will -- the president needs to unite the country in moving beyond sanctions and preparing for U.S. military strikes against Iran's nuclear weapons program.