Should South Korea Rethink Iran Sanctions?

During much of the crisis over Iran’s nuclear program, South Korea has sought to comply with EU sanctions on Iran while also protecting its interests in Iranian oil. At the beginning of July[1], South Korea halted imports of Iranian oil in response to European Union sanctions that inhibited the ability of other countries to insure oil shipments from Iran. With South Korea set to resume imports of Iranian oil this month, should it consider rethinking its approach to Iran sanctions? As the United States and the European Union work to induce Iran into serious negotiations over its nuclear program through increased sanctions, South Korea has found itself in a conundrum. Should it forgo its immediate-term economic interests or accept Iran’s offer to resume imports of Iranian crude oil?

Given the complex and volatile nature of the Middle East, issues in the region should not necessarily be viewed as unconnected. Instead, rather than viewing the issue of sanctions through the lens of South Korea’s economic and energy interests in Iran, they should be viewed from the perspective of South Korea’s broader interests in the region and how South Korea’s actions are likely to impact those interests.

The general understanding is that oil is the overriding interest of any nation that imports from the Middle East; however, the real underlying interest for importing nations is the maintenance of peace and stability which allows for oil to continue flowing at a reasonable price. As instability in the region increases the prospect of higher prices or disruption in the flow of oil becomes progressively larger.

Continuing the flow of oil from the Middle East is critical for the smooth functioning of the South Korean economy, which imported nearly 40 percent of its primary energy from the region in 2011 according to the Korea Energy Economics Institute. Based on WTO trade statistics, South Korea imported 87 percent of its oil from the Middle East last year, including 9.4 percent from Iran. The Middle East is also an important supplier of liquefied natural gas, which is another important energy source for South Korea.

South Korea was able to suspend imports from Iran in July thanks to increased imports from other Middle East nations. However, while the cost of importing oil from other sources is higher in the short-run for South Korea,  the cost of continuing to import discounted Iranian oil could be higher in the long-term. If South Korea’s resumption of oil imports increased Iran’s confidence in its ability to successfully ignore the sanctions—thus increasing instability in the region due to the varied responses to the sanctions—it seems unlikely that the short-term savings would outweigh the longer-term costs. As the price of oil rises from instability in the region, even a relatively small price increase can eliminate any savings South Korea might see from importing discounted Iranian oil.  Put another way, last year South Korea imported $100.8 billion in crude oil. If it had saved 20 percent, which would have been a generous discount, on imports from Iran, then the savings would have amounted to $1.9 billion. However, if the price of Dubai Brent Crude, which is the benchmark price for most of South Korea’s oil imports, had risen by 2 percent on the rest of South Korea’s imports due to increased tensions in the Middle East, then that result would have negated any savings from Iranian imports.

South Korea also faces the impact of U.S.-led sanctions on Iran that require reductions in Iranian oil purchases independent of those from the EU. While South Korea received a waiver from U.S. sanctions in June, in order to maintain the waiver, it will have to curtail its overall purchase of Iranian oil. Since South Korea will have to keep its overall purchases of Iranian oil below the level of prior purchases, the benefits from importing oil from Iran are reduced commensurately.

Beyond the issue of cost, recent reports indicate that Israel may be moving closer to considering a military option to address its concerns about Iran’s nuclear program. As the U.S. works to prevent the situation breaking into a conflict, the U.S. Congress is already considering harsher sanctions that would target Iran’s tanker fleet, potentially impeding the means through which South Korea would resume imports from Iran. Another consideration for South Korea is insurance. With the EU having prohibited the insuring of tankers carrying Iranian oil, Iran has offered to provide insurance. However, it is unclear if South Korea would be able collect on Iranian insurance or what reinsurer is standing behind Iran’s offer of insurance.

Should a conflict break out in the region, an increase in oil prices would not require an outbreak of full-scale war. Most analysts believe that, if Israel were to attack, just Iranian impediment, rather than full stoppage, of oil shipments through the Straits of Hormuz would be sufficient to drive up oil prices.

If avoiding instability in the region is the key to maintaining lower oil prices, there seems to be only two general overriding reasons to resume imports from Iran at this point: either the guarantees of additional oil shipments from the rest of the Middle East are not sustainable, or spare capacity in international oil markets falls to such a degree that sharp price increases due to scarcity undermine the sanctions. Both of these would require additional Iranian crude to return to the markets. However, neither of these situations seems to be the current case.

Granted, there are specific risks for South Korea in maintaining its ban on Iranian crude. Iran could follow through on threats to ban South Korean imports, which were worth $6 billion last year, even as dwindling Iranian foreign exchange earnings due to sanctions could inhibit Iran’s ability to pay for those imports should such a trade ban not materialize. At the same time, a prolonged ban could exclude South Korea from strategic positions in lucrative Iranian energy markets if the nuclear crisis is resolved. However, while real, these risks should not override the need for a peaceful solution to the current crisis that avoids a disruption to the flow of oil or a significant rise in its price. Additionally, the economic inroads South Korea could make in the broader region by continuing to distinguish itself from Japan and China could prove to be worth much more in the long run.


[1] South Korea formally stopped imports in July, but because some shipments were already on their way, there was not a complete drop off until August.