401c Energy Policy, the Environment, and the Gulf States

Professor Harold Feiveson

An Analysis of U.S. Efforts to Prevent Investment in Iran

Eric Reicher

January 4, 1999

Executive Summary

The Iran-Libya Sanctions Act (ILSA) of 1996 allows the President to impose sanctions on foreign companies if they invest in Iran’s energy sector. It complements Executive Orders that forbid investment in Iran by American companies. The law, however, does provide mechanisms for the President to waive the sanctions, if it is in the country’s national interest. The purpose of the law is to restrict Iranian access to hard currency and to bring about an end to Iran’s opposition to the Middle East peace process, its use of terrorism as a political tool, and its production of weapons of mass destruction.

The efficacy of ILSA has been mixed. ILSA has discouraged investment in Iran and made it more difficult for Iran to develop its energy sector, its main source of revenue. Likewise, funding for some of Iran’s weapons programs and support for terrorist groups has been delayed. However, unilateral sanctions in and of themselves will never be able to curb these activities all together. Sanctions have not been able to bring about a wide ranging change in Iranian policy, as hoped.

ILSA and the Executive Orders have also damaged U.S. interests in certain areas. American businesses are hurt by their inability to conduct any business in Iran. More critically, ILSA has greatly angered America’s closest allies, the European Union and Canada. These nations view America’s use of ‘extra-territorial sanctions’ as a great affront to their sovereignty and their ability to conduct independent trade policies. To assuage EU and Canadian threats to retaliate, the U.S. waived sanctions, rather than risk retaliatory measures being taken against them.

Due to these waivers, it is very unlikely that sanctions will be implemented against foreign companies in the future. To do so would cause more harm than it would do good. However, a repeal of sanctions is not, at present, politically feasible. A repeal would also be premature at this juncture for strategic reasons.

The United States is in the process of a very slow and uncertain rapprochement with Iran. The election of President Khatami has raised the hopes that an easing of tensions will ensue, but Khatami faces strong internal opposition against forging ties with the United States. The final resolution of this power struggle is far from certain.

In these circumstances, the U.S. should take cautious steps towards improving relations with Iran, but repealing ILSA should not be the first move. The U.S. should consider lifting some of the other types of punitive measures it currently has against Iran, as a sign of goodwill. Easing the Executive Orders against U.S. investment and unfreezing some Iranian assets are possibilities. If the Iranians make conciliatory policy changes in response, the U.S. should make further concessions. The U.S. should hold the formal repeal of ILSA as the final carrot along the gradual and uncertain road towards reconciliation.

Introduction

The United States has gone to great lengths to isolate Iran and curb its influence around the world. One major component of this policy has been to try to prohibit investment in Iran’s energy sector. In 1995, President Clinton issued two Executive Orders that forbid U.S. companies from conducting business in Iran. In an effort to extend the scope of sanctions against investment in Iran, the United States passed the Iran-Libya Sanctions Act in 1996 (ILSA). This paper will provide an analysis of U.S. efforts to prevent investment in Iran: its scope, its purpose, the purposes of sanctions more generally, and its effectiveness. Finally, the various options open to the U.S. for amending or repealing ILSA and the Executive Orders will be considered.

The Act

On July 23, 1996, the U.S. Congress unanimously passed the Iran-Libya Sanctions Act of 1996. While the act itself covered Iran and Libya, this paper will only concern itself with the elements regarding Iran. ILSA continued America’s policy of isolating Iran economically and politically. Previously, President Clinton issued two Executive Orders that prohibited U.S. companies and their foreign subsidiaries from doing any business in Iran and banned them from engaging in a "contract for the financing of the development of petroleum resources located in Iran." The Executive Orders only covered investment by U.S. companies, but ILSA extended sanctions to foreign economic dealings in Iran, an example of so called ‘extra-territorial sanctions.’ ILSA called for the imposition of sanctions on foreign companies that make investments of more than $20 million (reduced from $40 million originally) which "directly and significantly contribute to Iran’s ability to develop its oil and gas resources." If the President determines that an investment violates ILSA and that sanctions are warranted, he is required to impose at least two of the following sanctions on the offending company:

"1. Denial of Export-Import Bank assistance, with regard to approving

guarantees, insurance, or credit extensions

1. Denial of export licenses or of permission to export to a sanctioned party
2. Prohibition of any U.S. financial institution from providing loans or credits of over $5 million in any 12-month period (unless engaging in humanitarian activities)
3. Prohibition of designating as a primary dealer in U.S. government debt instruments.
4. Prohibition on serving as an agent of the U.S. government or as a repository for U.S. government funds.
5. Denial of opportunities for procurement contracts with the U.S. government
6. Ban on some or all imports of the sanctioned party."

However, the imposition of sanctions is not automatic. ILSA provides the President with two ways in which he can waive sanctions, should he consider a waiver appropriate. ILSA allows the President to waive sanctions for nationals of a specific foreign country, "if that country has agreed to undertake substantial measures, including economic sanctions, that will inhibit Iran's efforts to carry out activities," such as terrorism and pursuit of weapons of mass destruction (WMD). This is a 4(c) waiver. The President can also issue a 9(c) waiver. A 9(c) waiver, or a so called national interest waiver, can be given for a specific investment project when the imposition of sanctions is deemed to hurt the U.S. overall national interest.

Purposes of ILSA

ILSA was originally passed in response to American disapproval over three main aspects of Iranian policy. Iran’s vitriolic denunciation of the Middle East peace process. Iran steadfastly refused to recognize the existence of the State of Israel and condemned any peace arrangement between Israel and the Palestinians as an abandonment of the Palestinian cause. Interference in the process has not been limited to rhetorical condemnation. Iran is the primary sponsor of organizations such as Hamas, which commits terror attacks in Israel, and Hezbollah, which fights Israel in Southern Lebanon. Both groups violently oppose the peace process and seek to derail it. Iran’s more general use of terrorism as a key element of its foreign policy is the second main concern of the U.S. government. The U.S. views Iran as one of the chief sponsors of international terrorism. A German court found Iran responsible for the murder of Iranian dissidents in Germany in the Mykonos incident in 1997. Iranian elements were allegedly involved in the Khobar towers bombing in Saudi Arabia, in which 19 U.S. servicemen were killed. Iran is also believed to be behind the bombing of the Israeli embassy and a Jewish center in Argentina in 1994, killing a total of 105 people. Finally, Iranian efforts to acquire WMD greatly concern the U.S.. The U.S. alleged that Iran had made substantial efforts to become a nuclear power with the assistance of Russia and North Korea. The U.S. is equally concerned about Iranian efforts to develop long range ballistic missiles which have the capability to strike any point in the Middle East, including America’s strategic allies, Israel and Saudi Arabia. In the U.S. view, successful Iranian efforts to acquire WMD or long range missiles represent a serious threat to stability in the Middle East and to the unimpeded flow of oil, and therefore must be stopped.

The America Israel Public Affairs Committee (AIPAC), one of Washington’s strongest lobbies, vigorously supported ILSA. AIPAC seeks to ensure a strong relationship between the United States and Israel and supports legislation that will increase Israel’s security. Therefore, legislation that would purportedly punish Iran for its use of terrorism, opposition to the peace process, and attempts to gain WMD was of primary importance to the organization. AIPAC instituted an intensive lobbying and public relations campaign in support of ILSA and was "instrumental" in assuring its passage. Timing contributed to AIPAC’s successful effort, since the bill passed just months before the 1996 elections. Senator Alfonse D’Amato, continuing his efforts to aggressively court the critical voting block of Jewish and pro-Israel groups in New York, spearheaded the effort to pass ILSA.

Classical interest group theory states that when one side has a well organized and united block that strongly favors the passage of a bill, without any mobilized opposition, the bill will generally pass easily. Such is the case with ILSA, since American businesses, which oppose sanctions because they restrict trade, were unable to rally congressional support. Congress, in fact, passed ILSA unanimously. Congress did not conduct an extensive analysis of the costs and benefits to the legislation. With an election approaching, the desire to pass legislation with strong domestic support and little opposition outweighed concerns about specific details of the bill.

The Use of Sanctions in U.S. Policy

ILSA is emblematic of a growing trend in American policy to make sanctions the "first line of attack" on international issues. Sanctions have increasingly been applied by the U.S. to target foreign behavior that is considered objectionable. Sanctions have been imposed more times in the last five years than they had been in the previous fifty years, leaving 70 countries currently subject to U.S. sanctions. America does not want to appear as if it is indifferent to objectionable behavior or even complicit in that behavior by trading with foreign governments. However, it is impossible to use force for every situation in which there is a disagreement about policy. Sanctions are seen as a middle ground in which the U.S. expresses its displeasure about a policy without taking drastic measures, such as the use of force. Sanctions are also believed to be an effective implement to force a change in the offending nation’s behavior, without incurring costs.

Critics, however, charge that sanctions are a lot like chicken soup. "They make you feel good," but they don’t work and it "keeps you from…taking the corrective measures you really need (and also) it really does a job on the chicken." A brief look at the theory behind the use of sanctions will show that sanctions are only effective in a very limited context, and are not nearly as painless as presumed.

The theory behind economic sanctions is that by applying economic coercion one can induce compliance by causing significant economic hardship on the target. The leader of the target country may come to believe that his personal sacrifice is too great to endure the sanctions. Likewise, popular discontent caused by the hardships of the sanctions may lead to a popular overthrow of the government and to a change in policy.

However, unilateral sanctions are rarely this successful for a variety of reasons. For one, sanctions are rarely airtight and smuggling of goods often reduces the effectiveness of sanctions. Unilateral sanctions are even less effective because other nations openly ignore the American effort to isolate the target country. The other nations that maintain economic relations with the target are usually able to make up, at least partially, for the lack of trade with the U.S.. In cases where economic sanctions by one nation are ignored by the rest of the world, it is nearly impossible to create the level of hardship in the target country that might force a change in policy or regime.

Sanctions may actually be counterproductive to the professed goals of the sanctioning country. Sanctions often hurt the developing middle class in targeted countries. However, the development of a strong middle class is often a precursor to the type of social change and liberalization that the sanctioning country would like to see. Also, the target country can use the economic attack as a pretense to limit civil liberties and increase the current leaders control over society. While the U.S. may hope that the local population will hold the indigenous ruler responsible for their political and economic hardships, the opposite often occurs. A siege mentality develops and a ‘rally around the flag’ scenario occurs where the ruler in question actually gains support because he is viewed as fighting an external enemy. By blaming societies problems on the outside power, a leader can often increase his popular support, contrary to the goals of the sanctioning country.

In addition to sanctions often being counterproductive, they can also cause direct harms to the sanctioning country. First, the sanctioner forgoes trade with the country in question. Such loss of business activity reduces economic growth and costs jobs in the sanctioning country. Willard Berry of the European-American Business Council claims that although sanctions may have "laudable" goals, they are rarely successful and "the most likely effects are damage to U.S. companies and fewer jobs for U.S. workers." His organization claims that ninety-four percent of U.S. owned companies have been hurt by U.S. sanctions and fifty-eight percent have lost business opportunities. The National Association of Manufacturers (NAM) calculates that the U.S. has experienced an "estimated $790 billion loss in potential exports so far because of attempts to punish or isolate 35 countries during the Clinton presidency." The Institute for International Economics, a more disinterested institution, makes similar calculations to NAM stating that "economic sanctions in place today cost the U.S. some $20 billion in lost exports annually. This corresponds to a loss of some 200,000 jobs and an unquantifiable value of lost opportunities." Economic losses from sanctions can extend even past when the sanctions have been lifted, because American firms may be unable to regain the market share that they previously held.

Discord between the U.S. and its allies, brought about by sanctions, caused the most damage to U.S. interests. When the U.S. imposes sanctions outside of the context of the UN or other international organizations, it rarely receives support for its actions. The world, which is generally wary of U.S. domination as the only remaining super power, views unilateral sanctions as "American Imperialism." More importantly from the perspective of U.S. interests, sanctions often bring the U.S. into conflicts with its European allies, with whom cooperation is essential to fulfill a wide range of foreign policy objectives. Resentment brought about as a result of unilateral sanctions can imperil U.S. objectives around the globe.

The Costs and Benefits of ILSA

ILSA provides an excellent case study regarding the costs and benefits of sanctions that were discussed in general terms above. ILSA has helped to impede development of Iran’s energy sector. "Fewer companies have been applying to participate in Iran’s oil and gas projects. U.S. companies, of course, have been absent, and some others, concerned about the threat of U.S. sanctions, have delayed commitments…." Iran has tendered 11 oil and gas projects since the imposition of ILSA and "no foreign firms have so far invested…although some firms are interested." The threat of sanctions has in fact been able to break up deals that were being discussed. Secretary of State Madeleine Albright claims that U.S. intervention helped to break up a deal between a Canadian Company, Bow Valley, and an Indonesian company, Bakrie. Both Shell and British Petroleum have explored investment opportunities in Iran, but have avoided any investment because they were waiting to see "some progress on ILSA." "Neither company has been prepared to contravene ILSA", because of their substantial U.S. investments that would be subject to sanction. The U.S. has further impeded Iran’s ability to get hard currency by using "it(s) influence in multilateral bodies such as the World Bank and the IMF, stopping them from giving loans to Iran."

While the U.S. has been partially successful at limiting Iran’s ability to get capital, it certainly has not been able to completely strangle investment and capital flow in Iran. Where the U.S. has exited the market, other world powers have entered. Iran has been able to secure $5 billion in loan guarantees from the Europeans and Japanese from mid-1995 to the end of 1996. "In March 1997, France offered to provide $500 million in medium term loans for Iranian banks to finance imports of French goods and services." The effectiveness of sanctions has been greatly reduced, because the EU and Japan have filled a large part of the void created by the lack of U.S. economic involvement, which is mandated by the Executive Orders. One Western diplomat stated, "Sanctions are an irritant, and no more" to Iran. In fact, "various international organizations and foreign media outlets report that economic indicators (in Iran) are healthier than at any time since the early 1990’s." "Currency reserves are at record highs, and foreign debt payments are being made on schedule." Sanctions have also not hurt Iran’s ability to produce oil: "Daily crude oil production in 1996-97 was higher then in 1993-94. So were oil export receipts and net foreign assets." The sanctions have reduced some direct investment in the oil sector. However, sanctions have in no way crippled the Iranian economy, nor the current Iranian regime.

It is important to remember, though, that the goal of U.S. policy was not to cripple the Iranian economy per-se. Therefore, an analysis of the effectiveness of ILSA should also focus on the ways that sanctions have or have not effected the three main goals for the American government regarding Iran. It appears as if sanctions have had at least a limited effect on the ability of the Iranian government to fund terrorist groups. Gary Sick notes that "Iran is being forced to change some of its spending priorities. Some Islamist groups have complained that Tehran’s contributions have decreased recently." However, sanctions will never, in and of themselves, be able to stop the funding of terrorist groups and Iran’s opposition to the Middle East peace process. "Terrorism is effective and cheap…An oil-producing state can always find $10 or $20 million for clandestine subventions to Hamas, Islamic Jihad, or the Hezbollah." Since these groups "are particularly dear to many cleric’s hearts", it is unlikely that sanctions could ever eliminate funding for these groups.

The effects regarding the development of Iran’s military are also somewhat mixed. Representative Benjamin Gilman, Chairman of the House International Relations Committee, claims that "sanctions have also made an important contribution to U.S. security by depriving Iran of the resources it otherwise could have used for a military buildup. Iran has informed the International Monetary Fund that it has reduced its military spending because of budgetary shortfalls." In addition, "the sale of nuclear reactors and surface-to-surface missiles to Iran have been held up in part because of the Islamic regime’s lack of ability to pay for them."

While sanctions may have imposed slight difficulties for Iran’s weapons programs, such programs have still been making significant strides. Iran recently successfully tested the Shahab 3 which has the ability to strike Israel. The Shahab 4 missile which has an even a greater range and the ability to carry non-conventional weapons should be operational in two to five years. Progress on the development of WMD has also been steady. With the assistance of Russian scientists, the Iranians are proceeding with development of the Bushehr I nuclear reactor and Russia may also help to complete the Bushehr II reactor as well.

While the Executive Orders and ILSA have made positive, albeit limited, progress towards achieving the goals of U.S. policy, it has not come without cost, both at home and abroad. According to one key observer in the oil industry, since other nations have not been avoiding Iran economically, and the U.S. has not strictly enforced ILSA as will be discussed later, "The United States is now in the process of ceding the tremendous energy resources of much of the Persian Gulf and the Caspian basin to foreign companies- effectively withdrawing from one of the world’s most plentiful energy supply sources." For example, when the Executive Orders prevented Conoco, an American oil company, from making a $1 billion investment in Iran, Total, a French company, took over the exact same project. Boeing had a $1 billion dollar agreement to sell Iran 16 Boeing 737-400s, but the deal was likewise blocked by the Executive Orders. Now Iran is forced to look to Europe or Russia to upgrade its civilian air program. Caterpillar and Coca-Cola are other major U.S. companies that had made investments in Iran prior to the imposition of sanctions, but were forced to pull out once investment in Iran was prohibited." In each of the cases, the inability of U.S. firms to conduct business impeded U.S. economic growth and eliminated U.S. jobs. For example, Solar Turbines, a firm from San Diego, had a contract to service gas turbines in Iran for $50 million that could not be completed because of sanctions. A group that favors U.S.-Iranian trade claims that this one deal resulted in "San Diego’s economy losing approximately 400-500 jobs directly attributable" to the sanctions.

The most serious problem for the U.S. is that ILSA precipitated a major rift between the U.S. and its closest allies. The rest of the world deeply resents America’s use of extraterritorial sanctions, mainly ILSA and the Helms-Burton Act which penalizes investment in Cuba. Canadian Foreign Affairs Minister Lloyd Axworthy stated, "The extraterritorial effects of this latest act represent once again an attempt by the United States to dictate trade policy to its allies. Canada will continue to defend its interests against the application of such legislation." Equally firm denunciations of ILSA have been made by the EU. The EU has threatened to take retaliatory measures against the U.S. government and U.S. companies in response to ILSA and Helms-Burton. The EU threatened to sue the U.S. in the World Trade Organization, saying that extraterritorial sanctions were "incompatible with international trade rules." According to sources in the American administration, "State Department experts believe that the Europeans would win such a case in the WTO." Regardless of the outcome of the case, "the dispute would damage relations with Europe and undermine support for U.S. participation in the WTO among the American public." The EU has also threatened to impose visa restrictions on U.S. business executives in a similar manner as to U.S. restrictions of that nature. Canada has likewise made claims that ILSA is a violation of the North American Free Trade Agreement. Canada passed the Foreign Extraterritorial Measures Act, which makes it illegal for Canadian companies to comply with American extraterritorial sanction. Violators can be punished with a stiff fine or even imprisonment of up to five years.

The extraordinary measures that the EU and Canada have taken to combat ILSA and the Helms-Burton Act clearly demonstrate the level of anger that America’s closest allies have regarding American trade policy. Representative Lee Hamilton, the ranking Democrat on the House International Relations Committee and a critic of ILSA, notes many practical problems that would arise from a substantial trade war between the EU and the U.S.. Reduction in trade would lead to a reduction in jobs on both sides of the Atlantic. Acrimonious battling over trade would make it more difficult for the EU and the U.S. to cooperate on other elements of containment against Iran, particularly regarding weapons proliferation. Finally, discord between the U.S. and the EU, would further "undermine the already difficult effort to maintain international support for US policy toward Iraq", which is also vital to U.S. security interests in the Middle East.

The dispute between the EU and the U.S. would increase dramatically should the U.S. actually apply ILSA sanctions on European companies. For that reason, the Administration decided to waive application of ILSA sanctions. Such a decision has significant short term and long term implications for U.S.-EU relations.

Waivers

The first potential confrontation regarding ILSA came about when a 2,000 mile pipeline project was proposed that would carry gas from Turkmenistan across a 778-mile stretch of northern Iran to Turkey and then to Europe via the Mediterranean. The implementation of the pipeline would provide the "first significant easing of the economic isolation of the Tehran regime," according to U.S. officials. However, the Administration chose not to take action. The Administration claimed that the project "does not technically violate ILSA…(because ILSA) does not address pipelines carrying another country’s gas or oil across Iran." However, the Administration’s explanation is not universally accepted. James Phillips, of the Heritage Foundation, a supporter of ILSA, argues that if "the pipeline does not violate the letter of the law (a point not entirely conceded), it surely violates its spirit." Had the U.S. been looking for an opportunity to show its resolve to stop investment in Iran, pretense could have been found to attempt to stop the pipeline, either through ILSA or other means, he argues.

Side stepping the issue was not an option for the next instance that ILSA collided with a proposed project . A multinational effort by Total, Petronas, and Gazprom; French, Malaysian, and Russian companies respectively agreed to a $2 billion dollar investment to develop the South Pars oil field in Iran. In this instance, the U.S. found that the project violated ILSA. President Clinton could either impose sanctions or issue a waiver. In this case, a 9(c )waiver was issued. Albright went to great lengths to explain the specific reasons why the sanctions were waived in this case, which might not necessarily apply to others. The Administration decided that "sanctions would not deter any of the three oil companies from proceeding." Total had divested itself of most of its U.S. assets and Gazprom "unilaterally canceled a $750 million line of credit they had with our (American) Ex-Im Bank." Therefore, sanctions would have had little ability to deter these companies from investing in Iran, because the U.S. had very little leverage over them to influence policy.

Albright also expressed strategic reasons for the waiver claiming that that the issuance of the waiver would actually go further towards fulfilling U.S. goals in the region than would have the imposition of sanctions. As a result of negotiations with Russia and the European Union, the Administration received a reaffirmation of their commitment to preventing Iran from developing WMD. Russia agreed to establish a "joint U.S.-Russian working group" to help monitor an "export control regime" that the U.S. is helping to create in Russia. Previously, Russia had no functioning export controls and therefore it was easy for Russians to export physical and intellectual properties for the production of WMD. It is hoped that American-Russian cooperation can help stem the flow of such technology to Iran, which has not been accomplished by sanctions alone. Such cooperation would have been impossible had the United States issued sanctions and further isolated itself from Europe and Russia. Furthermore, the U.S. worried that antagonizing Russia with sanctions would have been detrimental to progress on issues ranging from START II, to Iraq, to Kosovo. Therefore on the strategic grounds that U.S. interests could best be served without sanctions, combined with the fact that sanctions were unlikely to be effective anyway, the U.S. exercised a 9(c) waiver, which again is a project specific waiver that only applied to the investment in question.

While in one sense Albright maintained that ILSA was still law and could still be enforced, she also stated that "we would expect…future ILSA cases…would result in like decisions." The EU and oil companies have focused on the last part of the U.S. statement. They did not view this as a waiver limited only to the specific project in question. Oil companies viewed the U.S. decision as "an amber, if not green, light" to invest in Iran. One European oil executive boldly declared that "ILSA is dead." More importantly for the U.S. government, the EU itself made similar proclamations. European Union Commission president Jacques Santer declared that, "The deal today (waiver of sanctions) means European companies and businessmen can conduct their business without the threat of U.S. sanction hanging over their heads." The perceived end of ILSA ended the most serious threat to a cordial U.S.-EU relationship from the EU’s perspective.

The political ramifications of the EU’s position on ILSA is of vital importance to the U.S.. Clearly, the EU believes that it will no longer face sanctions for its dealings with Iran. The EU believes that dialogue and engagement with Iran is the only way to bridge ties and encourage moderation within the Iranian government. In fact, relations between the EU, and more particularly Great Britain, have significantly improved in the time since the decision to waive sanctions in the South Pars deal. The main stumbling block to better relations between Britain and Iran was the outstanding fatwa, or religious decree, issued by the late Ayatollah Khomeini that called for the death of Salman Rushdie. Rushdie was ordered killed because he wrote The Satanic Verses, which was viewed to be blasphemous against Islam. In October 1998, President Khatami claimed that Iran would no longer actively seek to have Rushdie killed and considered the matter to be finished. In response, Britain decided to establish full diplomatic relations with Iran and "British companies are free to enter into contract and agreements for oil and gas projects in Iran", as far as the government is concerned.

Europe has been taking measures to strengthen political and economic ties with Iran. Europe believes that ILSA has been forsaken in favor of mutual cooperation between the E.U. and the U.S.. This creates a major problem for U.S. policy makers, since ILSA is still U.S. law and the Administration maintains the right to implement sanctions should an investment warrant them. Should the U.S. choose to implement ILSA sanctions at this point, it would create tremendous tensions between the U.S. and Europe. The EU would likely further pursue legal measures against the U.S. through the WTO, as well as pursuing the other punitive measures that were mentioned before. More generally, it would create a significant diplomatic confrontation with America’s strongest allies that could imperil U.S. interests around the globe. Therefore, the U.S. will have to weigh such diplomatic discord with its allies versus the potential gains, before choosing to implement sanctions.

Iranian Politics

ILSA was passed in 1996, when Akbar Hashmi Rasfanjani was President of Iran. However, in May, 1997, Mohammed Khatami overwhelmingly defeated Ali Akbar Nateq-Nuri, receiving 70% of the vote. The religious establishment favored Nuri, because Khatami advocated internal social reform and further rapprochement with the West. Khatami’s victory, which was heavily supported by the young and the middle class, was widely seen as a call for reform within Iran from the populace.

However, the defeat of the conservatives in the Presidential elections did not mean that they were stripped of their power. Iran’s spiritual leader, Ayatollah Ali Khamenei, actually wields more power within Iran than does Khatami, the President. Khamenei is the commander-in-chief of the armed forces, controls the state run media, and is the final determinant on foreign policy. Furthermore, "The judiciary is answerable to him and his word on all affairs of state is paramount, final and beyond challenge." While Khatami has been pushing for greater contact with the West, conservatives within the government limit his ability to further ties with the West.

Tensions between Khatami and conservative hard-liners have developed into a major struggle for power between the two factions in Iran. Khatami seems to have the popular support, while the entrenched conservatives have more institutional power at the moment.

The arrest of Tehran’s mayor, a moderate with close ties to Khatami, was emblematic of this power struggle. His arrest and subsequent conviction, ostensibly on charges of corruption, "is widely perceived as a bid by the clerics to twist Khatami’s arm, show him the limits of free government, and put an end to his pro-Western rhetoric. Most of all it demonstrates the power of the mullahs and the Ayatollah’s still have despite their crushing defeat in last year’s election."

Conservatives further demonstrated their power in the October 1998 elections for the Assembly of Experts, which is the body that elects Iran’s spiritual leader. The Assembly of Experts has the power to screen candidates for the elective office and prevents candidates from running who "attempt to undermine the foundations of the government", meaning the strict Islamic nature of the government . Of the 396 people who applied to run for the Assembly of Experts, only 167 were approved. The vast majority of those who were rejected were moderates who were affiliated with President Khatami. Such actions led to a large scale boycott of the election by moderate factions, which allowed conservatives to maintain a strong majority in the Assembly of Experts and maintain the ability to choose the next spiritual leader.

Such a scenario places U.S. policy makers in a difficult position. According to U.S. intelligence officials, "It is clear to us that Khatami is the real thing", meaning he is legitimately interested in reform and improved ties with the West. At the same time though, he has only limited ability to bring about the reforms he advocates, particularly in the international arena.

The contradictory nature of current Iranian policy seen today is emblematic of this power struggle. Khatami has made some progress on the issues that are of the most importance to the U.S. According to European governments and the U.S., "there have been no incidents (of terror) since Mr. Khatami assumed power." Iran has also helped to encourage moderation within Hezbollah, the organization that is seeking to forcefully evict Israel from the self-created Security Zone in Southern Lebanon. Sheik Nasrallah, Hezbollah’s leader, said that the guerrilla group would consider its military mission complete with the end of Israeli occupation of Southern Lebanon and would not patrol the territory from which Israel withdraws. This could allow Israel to withdraw from its quagmire in Lebanon without imperiling the safety of northern communities in the Galilee. This "new pledge (to halt attacks against Israel proper once Israel withdraws from southern Lebanon) is seen as unlikely without pressure from Tehran." Furthermore, Iran has toned down its rhetoric against the Middle East peace process. Khatami has said that Iran will accept a deal that is acceptable to all the Palestinian people. AIPAC has recognized the changes within Iran and has toned down its rhetoric, saying that "We’re the last people who are going to oppose mindlessly any and all change." Israel has also taken tentative steps towards Iran by ending broadcasts by Iranian opposition groups from an Israeli satellite, "because they contained incitements to violence."

While these apparent policy changes by all sides are encouraging, for every positive sign of change mentioned above, there is a corresponding negative sign that leads to a less positive assessment for the future of the region. After the signing of the Wye Accords in October, 1998, Khamenei vehemently denounced Arafat as a traitor to the Palestinian people. Sheik Nasrallah of Hezbollah went so far as to call for Palestinians to kill Arafat. Furthermore, the amount of arms delivered from Iran to Hezbollah, estimated to be worth between $60 and $100 million has not decreased at all as early believed. Likewise, Israel’s aforementioned minor concession to Iran is sharply contrasted by public musing about the necessity of a preemptive strike against Iranian weapons facilities by Israeli generals. A relaxation of tensions is possible, but by no means assured in the region.

There is, however, no consensus on what role the U.S. could play in encouraging moderation within the Iranian government. Professor Mohammed Mahallati, Professor of Transregional Studies at Princeton University, argued that U.S. sanctions make it much easier for hard-liners within Iran to label the U.S. as the ‘Great Satan’, making it more difficult for Khatami to urge moderation. Geoffrey Kemp concurs saying that the Ayatollahs fear an end of sanctions because it will weaken their position within Iran. However, Chris Stevens, the State Department Iran Desk head, disagrees. He believes that the matter is an internal Iranian power struggle that the U.S. will not be able to influence. Given the balance of power in favor of the Ayatollahs in the Iranian Constitution, he is very pessimistic about the possibility of positive change.

Current Policy Options

The U.S. has three main options regarding ILSA. It can enforce the statute strictly. The statute can be repealed. Lastly, the law could be left on the books, but loosely, if ever enforced.

Strictly enforcing the sanctions poses two major problems. First and foremost, U.S. imposition of sanctions against a European company would sharply strain relations between the U.S. and Europe, causing many aforementioned problems. ILSA has not proved so successful at curbing objectionable Iranian behavior that causing such discord with U.S. allies would be worthwhile. Furthermore, high profile imposition of sanctions against Iran will greatly impede the process of reconciliation with Iran that almost all analysts believe is necessary and beneficial. Khatami, already in a precarious position vis-à-vis the conservatives, will have a very difficult time making the argument that Iran should moderate its policies towards the U.S., while the U.S. takes the very public step of imposing new sanctions on Iran. Keith Weissman of AIPAC, who would like to see sanctions employed in relevant cases, concedes that it is unlikely that the U.S. would impose sanctions for anything other than a major pipeline project at this point.

Repealing ILSA also has serious problems, one strategic and one practical. The process of forging ties with Iran will have to be gradual. Repealing ILSA at this point is a major concession to the Iranian government and would be interpreted as a sign that the U.S. has ended most of its attempts to isolate Iran. Such a strong gesture is premature at this point. Although Khatami has instituted many meaningful reforms, there are still many issues in which the U.S. and Iran have significant differences of opinion. Khatami is either unwilling or unable to make further concessions. Khatami made a first gesture to America, by praising the American people in an interview on CNN. Albright responded to Khatami’s courageous remarks by making a similar compliment of the Iranian people and advocating a thaw in U.S. Iranian tensions. The difficulty now becomes moving both sides towards practical, in addition to rhetorical, concessions.

There are many steps that the U.S. could take, short of repealing ILSA, that would be a sign of U.S. interest in reducing tensions with Iran. The U.S. should strongly consider unfreezing all or part of the Iranian assets that were seized at the time of the revolution in 1979. This would symbolically show that the U.S. is able to get beyond the mutual animosity that characterized the period of the revolution. It would also provide Iran with some hard currency, which theoretically could be used by Iran to finance interests and activities hostile to the United States, but only in limited quantity.

Another possible gesture to Iran could be the resumption of limited imports and exports between U.S. and Iranian private sectors, which would require a change to the existing Executive Orders. Such actions would allow greater contact between the two peoples, contact that may be politically impossible to have on a governmental level. If business contacts help indirectly to improve relations between the two countries, direct investment in Iran could eventually be permitted.

These steps should be taken gradually over an admittedly unspecified amount of time. As the U.S. makes more substantive concessions, Iran would likewise be expected to make concrete concessions, above and beyond the reduction in hostile rhetoric. The next step in the process of reconciliation should only be made if Iran reciprocates. Much of the process of reconciliation, particularly early on, should be done behind the scenes with quiet meetings and informal contacts so that both nation’s domestic opposition to rapprochement will have less ability to impede progress.

The second reason that the repeal of ILSA should not be considered by U.S. policy makers is that it is politically infeasible at the moment. While AIPAC has slightly moderated its tone regarding ILSA, it still views Iran as a major threat to Israel. AIPAC would likely strongly fight a measure to repeal ILSA at this moment. AIPAC believes that ILSA should be the last, not first, concession made to the Iranians.

While ILSA passed without major opposition in 1996, there would likely today be a more organized force opposing ILSA, or advocating its repeal. Business interests, particularly the oil industry, have been lobbying to be allowed back into Iranian markets. Likewise, some members of Congress, such as Representative Hamilton, have spoken out against ILSA, and the use of sanctions more generally. However, it is unlikely that these forces who are critical of ILSA would be able to muster the Congressional support to repeal the statute. Some have argued that "Congress is maybe more hawkish on the Iran issue than the Israeli government", and seems unlikely to consider a repeal of ILSA at this time.

Therefore, ILSA should remain on the books and can be implemented if desired. However, there should be a generous use of waivers. Such a policy confers many advantages. First, it appears to be politically feasible. With the widespread realization that some dialogue with Iran is essential, it is unlikely that the President would face more than scattered criticism from Congress and domestic interest groups should he use waivers for investment in Iran. Also, if there is a focus on 9(c) waivers, and an aggressive campaign to show the public other measures that are being taken to address Iran’s objectionable behavior, public opposition should be further muted. Waiving sanctions for particular cases, rather than eliminating sanctions all together, allows the U.S. to make the type of gradual concessions that should coincide with reciprocal Iranian concessions, as described previously. Should Khatami be unable to further alter Iran’s behavior due to conservative opposition, as predicted by many in the State Department, the process could be stopped.

Having sanctions in place also gives the U.S. the ability to impose sanctions in the limited instances in which development projects would threaten U.S. interests and security. Individual development, or even minor pipeline projects, need not be considered a threat. However, should a pipeline through the heart of Iran to the Persian Gulf, as proposed by some oil companies, become the only major oil pipeline for oil from the Caspian, the U.S. may have reason to intervene. Such a pipeline would be objectionable on two fronts. One the Persian Gulf already is already a major conduit for the world’s oil and therefore it is unwise to make oil supplies even more dependent on one area for distribution. Furthermore, if Iran were the only major conduit for oil from the Caspian, Iran would have a great deal of leverage over policy throughout the region, which could given Iran undesired influence in the affairs of many newly independent states in the region that are already unstable. By keeping sanctions on the book, the U.S. would still have the ability to discourage such a pipeline from being constructed. According to a study by the International Energy Association, ILSA sanctions would make it very difficult for Iran to gain funding for such a major pipeline project. Therefore, the U.S. could still use sanctions for projects that would be truly dangerous to U.S. interests, but would not try to block all investment in Iran’s energy sector.

There is one major drawback to the policy described above. Under such an arrangement, foreign companies would be given nearly a free reign to invest in Iran, while American companies would still be forbidden to make any investments in Iran because of the Executive Order. The business community is fearful of losing out to foreign companies. They argue that waiving sanctions for foreign firms "undercuts the rationale for our own unilateral sanctions." In the long term such a position is correct. There is no reason to make American companies sacrificial lambs for a policy of isolation that is anachronistic and no longer being enforced.

However, in the short term it may be necessary to place American companies at a slight disadvantage to their European counterparts. As mentioned, normalization of relations with Iran will have to be a slow process, with each side making small, gradual concessions. Allowing U.S. companies free reign into Iran would be a major practical and symbolic concession to the Iranian government, which at least at this point is premature. Sanctions against foreign companies cause widespread international repercussions, and are therefore a very costly way to send a political message to Iran. In contrast, the Administration can impose sanctions on U.S. companies with the only cost being the ire, and potential political fallout, of the companies themselves. Therefore, at least until time is given for the hoped for reconciliation to take place, it may be necessary to keep American companies out of Iran, even while foreign companies are given access.

There is reason to believe, however, that American companies would not be at as severe a disadvantage as assumed. The oil companies fear a repeat of the "Norway scenario", in which a nation allows a few initial companies to invest for the long term and then forbids any companies that were not initially involved from making investments. However, there are many factors that indicated there will not be an immediate rush of investment into Iran and therefore, U.S. companies will not suffer irreparable harm by being initially excluded from Iranian markets.

"There are 99 reasons out of 100 not to invest in Iran, and they’re all Iranian. … There’s only one ILSA", remarked a State Department official, referring to many unfavorable Iranian business practices that make investment in Iran difficult. The first is that the Iranian constitution forbids profit-sharing contracts. Only buy-back contracts, which offer only limited returns that are often not worth the risk of investing, are permitted. Given that this issue is part of the struggle between moderates and conservatives within Iran, it is highly unlikely there will be a change to the constitution in this regard in the near future. Another factor against investment in Iran is that most export credit agencies in Europe do not cover Iranian risks. Therefore, companies must go to the private sector to obtain political risk insurance, increasing the cost and uncertainty of doing business. British companies, who were just given a green light to invest in Iran after the end of the Rushdie affair, have shown little interest, with one official bluntly stating, "The investment climate in Iran at the moment is not very attractive." Since Europe is not rushing into Iran and capturing all investment opportunities, as feared by American oil companies, the detrimental impact of being initially excluded from Iranian markets should not be terribly severe.

A second mitigating factor is that U.S. restrictions on American companies need not necessarily be absolute, as they are now. Assume for the moment, that relations with Iran are slowly improving, but it is still too early for the U.S. to play its trump card of allowing U.S. companies unlimited access. The U.S. could take intermediate measures, by amending the Executive Orders, that would both partially satisfy the oil companies, while also serving as a further gesture to Iran. The U.S. recently took one such measure, albeit a small one, by easing the reporting rules for foreign affiliates of U.S. companies who are involved in petrochemical deals. A more significant, yet still potentially viable, proposal has been put forth by Conoco. The CEO of Conoco, Arthur Dunham, has proposed that the Executive Orders be amended to allow American companies to invest $20 million dollars a year, the same amount that foreign companies are allowed to invest without facing sanctions. Mobil has made a request to be permitted to swap Turkmenistan crude with the National Oil Company. Such an arrangement would allow to more cheaply get Turkmenistan oil to market. Allowing swaps would provide Iran with some hard assets, but it would not alter Iran’s production capabilities and would not radically change Iran’s leverage in the region. Therefore the Treasury Department should consider granting the license to swap that would be needed to do this. Allowing limited American investment in these two ways, would give the U.S. an important foothold in Iran, without immediately forgoing all sanctions against Iran. As long as U.S. companies are not entirely shut out, they will be in a better position to more extensively invest in Iran, whenever reconciliation has reached a point which makes abolition of all sanctions tenable.

As mentioned earlier, sanctions have become a staple of U.S. foreign policy in the past few years, but present many problems for U.S. policy. Due to these problems, Congress has initiated measures, most notably H.R. 2708, to limit the use of American sanctions. H.R. 2708, the Enhancement of Trade, Security, and Human Rights through Sanctions Reform Act calls for an analysis to determine what American interests, both economic and strategic, would be hurt by the imposition of sanctions. It also calls for a honest assessment of the likelihood that sanctions would be effective in eliciting a change in the offending states behavior. These studies would have to be conducted before sanctions could be used as an instrument of U.S. policy.

This legislation does not say that sanctions should never be used. It merely says that a more thorough cost-benefit analysis should be performed before sanctions are passed. If sanctions were found to be relatively painless and likely to succeed, than they could still be used. However, such policy would make it unlikely that sanctions would be flippantly passed with out real discussion of their merits, as many would argue was the case regarding ILSA.

The bill currently has 39 cosponsors in the Senate and 93 in House, but so far there has been no vote on the measure. Strong actions should be taken by the 106th Congress to pass H.R. 2708 and the corresponding S. 1413 and mandate a cost-benefit analysis of sanctions before future sanctions are imposed.

ILSA has and will be a piece of legislation marked by very mixed results. ILSA has had an impact on curbing the Iranian practices that the U.S. found most objectionable, but unilateral sanctions on their own were entirely unable to bring about a wide ranging change in Iranian behavior. Plus, in many ways ILSA was self-defeating. The diplomatic uproar that would have occurred had ILSA actually been enforced would have far outweighed the benefit that the legislation would provide. Due to this, ILSA sanctions will most likely never be imposed.

Nevertheless, the repeal of ILSA is discouraged, not because of the intrinsic value of the legislation, but because of the symbolic message that it would send to the Iranian government and the world. A gradual process of reconciliation with the government of Iran is needed. Over time relations between the two nations may improve to the point that ILSA and the Executive Orders are no longer necessary. Although Khatami has made some progress, the ultimate degree of reform within Iran is uncertain. Some amendments to the Executive Orders and an unfreezing of Iranian assets are advocated as a first gesture toward the Iranian government. If, and only if, Iran makes reciprocal concessions the U.S. should take further steps to end sanctions. ILSA is scheduled to sunset in 2001. At that time, a general reevaluation of Iran’s policies and America’s general interest in the region should be made. If positive progress has been made along the road to reconciliation, serious consideration should be given to not renewing ILSA.

Bibliography

Afshar, Shariar. "U.S. Trade Sanctions Miss Iran, Hit San Diego," San Diego Daily Transcript World Trade Supplement, November, 3, 1997.

"British trade official sees improving economic ties with Tehran," Agence France Presse, October 3, 1998.

Amuzegar, Jahangir. "Adjusting to Sanctions,", Foreign Affairs, May-June 1997. P. 32.

"Iran- The Economic Base," Arab Press Service Organization, No. 20, Vol. 48, May 19, 1997.

"The U.S. Helms-Burton Act, The D’Amato Law, and Retaliatory Measures Being Taken by the EU and Canada," Baker and Mackenzie international law firm, October 1996.

Ba’rel, Zvi., "Iran Contra," Ha’aretz, June 12, 1998.

"Canada Objects to Iran/Libya Sanctions Legislation", Department of Foreign Affairs and International Trade, August 6, 1996, No. 137.

Dogget, Tom. "U.S. relaxes rules on petrochemical deals with Iran," Reuters, November 10, 1998.

Drozdiak, William. "Even Allies Resent U.S. Dominance", Washington Post, November, 4, 1997.

Entous, Adam. "U.S. sanctions hurt companies, cost jobs - survey", Reuters, October 1, 1997.

Galtung, Johan. "On the Effects of International Economic Sanctions: With Examples from the Case of Rhodesia," World Politics, April 1967.

Gardner, David. "Two Falls, No Submission," The Financial Times, August 4, 1998.

Gilman, Benjamin. "Special to Insight", Insight on the News, July 20, 1998.

Haas, Richard N. "Sanctioning Madness," Foreign Affairs November/December 1997.

"Full Version of Hezbollah Statement on Wye Agreement," Hezbollah Central Press Office, October 26, 1998.

Hamilton, Lee. speech to the Council on Foreign Relations, April 15, 1998.

"Unilateral Sanctions Policy," Information Technology Industry Council, July 1998.

"Israel Mulls Strike On Iran," Jane’s Defence Weekly, October 7, 1998.

Kemp, Geoffrey. America and Iran: Road Maps and Realism. Washington, DC: The Nixon Center, 1998.

Kemp, Geoffrey. Presentation to WWS 401c, November 3, 1998.

Kirschten, Dirk. "Chicken Soup Diplomacy", National Journal, January 4, 1997.

Larson, Alan. in U.S. Congress, House of Representatives, Committee on International Relations, Iran-Libya Sanctions- One Year Later, Hearings 105th Congress, 1st session, July 23rd, 1997.

Lelyveld, Michael S. "Fight Averted with Israel Lobby Over Sanctions", Journal of Commerce, July 17, 1998.

Lelyveld, Michael S. "Pro-Israel Lobby Tones Down Drive for Iran Ban," Journal of Commerce, March 30, 1998.

Lobe, Jim. "U.S.-Iran: French Oil Deal a Blow to U.S. Policy," Inter Press Service, October 1, 1997.

Lyons, Jonathan. "Iran’s Leader Blasts Arafat Over Mideast Deal," Reuters, October 30, 1998.

Lorenzetti, Maureen and McQuaile, Margaret. "Europe Sees End to Broader Sanctions Issue," Platt’s Oilgram News, May 19, 1998.

"Press Briefing By Senior Background Officials," M2 Presswire, May 20, 1998.

MacAlister, Rodney. Presentation to WWS 401c, November, 2, 1998.

Mahallati, Mohammed. Presentation to WWS 401c, October 12, 1998

Mann, Hillary. "Iranian Links to International Terrorism- The Khatami Era," Washington Institute for Near East Policy: Policy Watch, Number 296, January 28, 1998.

Markle, Jeff. "The Mindset and Possible Consequences of Dual Containment," Politics of International Oil, April 30, 1996.

May, Barry. "Iran Factions Face Off Before Key Election," Reuters, October 6, 1998.

"US Administration Eyes Compromise Solution To ILSA Sanctions Problem," Middle East Economic Survey, Vol. XLI, No. 3, January 18, 1998.

"Effects of U.S. Sanctions on Iranian and Caspian Petroleum Industries; Can the World Do without Iran, Iraq, and Libya?," Middle East Executive Report, Vol. 20. No. 12, December 1997.

Mirfendereski, Guive and Meshkati, Najmedin. "The Other Peace Process: Tips on how Iran and the U.S. Should Start Normalizing Their Relationship", The Iranian, January 6, 1997.

Morgan, Dan and Ottaway, David B. "U.S. Won’t Bar Pipeline Across Iran; Move Seen as Gesture of Reconciliation, Easing of Tensions," The Washington Post, July 27, 1997.

"Do Not Enter: U.S. Government at Work," Mobil Corp., May 24, 1998.

"Industry Welcomes Sanctions Waiver for Total," The Oil Daily, May 19, 1998.

Peterson, Scott. "Sanctions Against Iran Sting US Businesses More," The Christian Science Monitor, March 28, 1997.

"Mixed Reactions to the Opening Up of the Exploration Sector," Petroleum Economist, August 12, 1998.

"European Softening Towards Iran Contrasts with U.S.," The Petroleum Intelligence Weekly, June 15, 1998.

Phillips, James. "Maintain International Pressure and Sanctions on Iran," The Heritage Foundation, Roe Backgrounder No. 1135, September 5, 1997.

"Iranian Reformers Pay Price for Rushdie Deal," Reuters, October 14, 1998.

Rodan, Steve. ""New Iran Missile ‘Will Have Nonconventional Capability’," Jerusalem Post Daily Internet Edition, July 31, 1998.

Rogers, Elizabeth S. "The Conflicting Roles of American Ethnic and Business Interests in U.S. Economic Sanctions Policy: The Case Study of South Africa", in David Skidmore and Valerie M. Hudson eds., The Limits of State Autonomy. Boulder, CO: Westview Press, 1993.

Sieff, Martin. "State Dept. scrambles to avert Iran sanctions - Penalizing French could harm WTO," The Washington Times, December 31, 1997.

Stevens, Chris. Presentation to WWS 401c, November 3, 1998.

"USA ENGAGE Criticizes ILSA for Forcing a "No Win" Situation", USA ENGAGE, May 18, 1998.

U.S. Congress, House of Representatives, To Provide a Framework for Consideration by the Legislative and Executive Branches of Unilateral Sanctions, 105th Congress, 1st session, H.R. 2708, October 23, 1997.

United States Energy Information Administration, Country Analysis Briefs, Iran, 1998.

Valinejad, Afshin. "Iran Reformists Meet Rejection," Associated Press, October 7, 1998.

Van Dusen, Mike. Presentation to WWS 401c, November 3, 1998.

"The Iranian-American Confrontation", The Wall Street Journal Interactive Edition, May 23, 1997.

Weissman, Keith. Presentation to WWS 401c, November, 2, 1998.

Woods, Scott. "A Persian Détente," Time Reports, January 18, 1998.