Obama faces tough call on Iran oil sanctions

(Reuters) - Just weeks after the election, President Barack Obama will be faced with a pivotal decision on oil sanctions on Iran, in which he will have to balance the need to stay tough on Tehran without pushing oil prices too high.

In considering whether to extend a new series of six-month exemptions to Washington's oil sanctions, the administration must decide whether China, India, South Korea and other nations have done enough to wean themselves from Iranian oil.

Forcing cuts that are too aggressive could fuel a new rally in oil prices, benefiting Iran and hurting allies. Accepting meager cuts risks criticism from Congress and Israel.

The sanctions are aimed at slashing Iran's oil revenues to pressure it to stop efforts to enrich uranium to levels that could be used in weapons. Tehran has said its nuclear program is strictly for civilian purposes.

On paper, the sanctions require Washington to continuously tighten the screws on Iran's exports "toward a complete cessation" of purchases, forcing importers to make deeper and deeper price and volume cuts in order to win "exceptions," or waivers.

But the law allows the administration latitude to chart a middle ground in the sanctions, which have already proven more effective than some experts had forecast.

The sanctions require that importers must demonstrate that they are making "significant" reductions every six months, as measured by volume and price. What constitutes a "significant" reduction is at the administration's discretion.

"The point of this is that we would like to see a consistent and gradual reduction. That is the goal," said a U.S. government official, who spoke on condition of anonymity.

Iran's oil exports hit a low of 860,000 barrels per day last month, down from 2.2 million bpd at the end of 2011. That reduction is already greater than some experts had forecast.

Critics are keeping close watch. Obama is expected to face questions about whether he has been tough enough on Iran later on Monday during a foreign policy debate with Republican candidate Mitt Romney, their last debate before the November 6 presidential election.

The New York Times reported on Sunday that the United States and Iran have agreed in principle to private, bilateral negotiations on Iran's nuclear program, but both nations denied the report.

DIMINISHING RETURNS?

For countries including China, India and South Korea, the deadline for new waivers is December.

Even a key proponent of sanctions said he wonders about the need to force dramatically deeper cuts.

"We've probably reached the point of diminishing returns with respect to Iran's oil exports," said Mark Dubowitz, the head of the Foundation for Defense of Democracies, who has pushed for stronger sanctions on Iran.

Dubowitz said it would take a great deal of work to cut global imports of Iranian oil much below 800,000 bpd. Lawmakers are now turning their attention to new types of sanctions that could more quickly hit Tehran's foreign reserves.

A QUESTION OF "SIGNIFICANCE"

So far, all major oil importers have been granted the exceptions. Without the waivers, the United States has the power to blacklist foreign banks handling the oil transactions from the U.S. financial system.

Precisely what qualifies as "significant" is kept confidential, however, and may vary from buyer to buyer.

"The law is remarkably vague about what the baseline is," said Jeff Colgan, a professor at American University in Washington.

Japan had cut imports by 15-22 percent by the time it received its first waiver in March. It subsequently cut imports by more than a quarter each month except June, and won a second six-month waiver for the U.S. oil sanctions in September.

Senators Robert Menendez and Mark Kirk who co-authored the oil sanctions law last year have told the administration they believe a minimum cut should be about 18 percent for any nation seeking a waiver renewal, achieved through price discounts or volume reductions, a point Menendez underscored in a recent interview.

"We must make it clear - this is a big must - that absent some extraordinary circumstance, that we will not grant waivers to any nation that doesn't make our reduction benchmarks," Menendez told Reuters earlier this month.

DELICATE BALANCE

The administration is likely to carefully weigh the cuts required against the impact on prices, since price gains help Iran, hurt allies, and harm the global economy, said Trevor Houser, a partner with Rhodium Group, a New York-based policy and economic consultancy.

"If you tighten the screws too hard and it causes oil prices to spike, then you both undermine the effectiveness of the sanctions and you erode support for the sanctions from other countries," said Houser, a former State Department adviser.

Houser questioned how far Washington could push the sanctions while also keeping oil markets relatively stable.

Saudi Arabia, which has been pumping oil at its fastest rate in 30 years in order to make up for the diminishing exports from fellow OPEC member Iran, has limited additional capacity to tap if shipments fall further, analysts say.

The administration likely will face the most political scrutiny for its decision on a renewed waiver for China. China officially opposes the U.S. sanctions, but secured a waiver in June after a contract dispute resulted in steep import cuts in the first half.

Although its imports of Iranian oil rose in June to an 11-month high, they dropped in July and August to 25 percent below the same months in 2011, the most recent months for which data is available. China's first-half imports from Iran were down 20 percent from a year ago.

"China is a very different story and that's where we fear the administration will cook the books to give China a ‘get-out-of-jail-free' card in order to avoid a showdown with America's largest creditor," a senior Congressional aide said, on condition of anonymity.

With much bigger trade issues at stake, American University's Colgan believes a waiver for China is likely. "The trade consequences are unknown and potentially very bad if they start a trade war over this," he said.