IHS ENERGY

Strategic Horizons
28 November 2016

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Iran: Trump Administration questions nuclear deal

Executive Summary
The election of Donald J. Trump as US President significantly increases the risk to the Iran nuclear agreement, the Joint
Comprehensive Plan of Action (JCPOA). We believe that over the next six months the status quo is likely to be
maintained, due mainly to the lack of recent Trump announcements on Iran, but risk to the agreement increases materially
beyond that time. A breakdown of the JCPOA would delay the opening of the Iran upstream to international firms while
simultaneously increasing geopolitical tensions in the broader region and the threat of armed conflict.

Assuming the Trump Administration declines to take any proactive measures regarding the JCPOA, May 2017 is
the longest time it could hold off before having to renew sanctions waivers assuming the outgoing Obama
Administration exercises its right to extend the waiver for 120 days in January 2017. Whether in May or before,
the new president will need to choose whether to ratchet up enforcement, pull the US out of the agreement, or
renegotiate, each of which were enunciated by Trump on the campaign trail.

The Trump Administrations failure to renew the sanctions waivers would almost certainly instigate the collapse of
the JCPOA. Survival of the nuclear deal becomes even less likely when taking into account the opposition of the
Republican-controlled US Congress. The Trump Administration will therefore have a political disincentive to
pursue implementation of the provisions within the JCPOA actively, depriving certain sanctions relief for Iran and
delaying the resumption of European business ties with Iran.

This could initiate a reversal in the Iranian political calculus as to the tangible benefits of the nuclear deal itself,
boosting the risk of Iran failing to fulfil its obligations under the JCPOA. While IHS Economics expects that Iran
is more likely to show restraint in its response to US aggression, with the aim of weakening the multilateral
sanctions regime, the looming Iranian presidential election in May 2017 adds the pressure of domestic politicking
and aggressive rhetoric from hardline constituencies within Iran. Domestic political dynamics in both countries
increase the likelihood of drift towards armed conflict and could introduce a greater risk premium to oil markets
that have been heretofore dismissive of the violence occurring across the Middle East.

From IHS Energy Economics and Country Risk

Author: Nazanin Soroush, Senior Analyst

Contacts
Susan Farrell, Vice President, Energywide Perspectives
Susan.Farrell@ihsmarkit.com
+1 202 872 1199
Ponciano Manalo, Sr. Research Analyst
Ponciano.Manalo@ihsmarkit.com
+1 202 777 3758

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IHS Energy | Strategic Horizons

Iran deal falls prey to US domestic changes

The election of Donald J. Trump as the next US President poses a significant risk to the Iran nuclear agreement, known as
the Joint Comprehensive Plan of Action (JCPOA). Under the JCPOA, finalized in July 2015 and implemented in January
2016, Iran agreed to scale back its nuclear programme in exchange for sanctions relief. Although the agreement is
multilateral (involving China, Russia, France, the United Kingdom, the US, and Germany) and endorsed by the United
Nations Security Council (Resolution 2231), it is ultimately a political agreement and its survival is contingent on Iranian
nuclear compliance and the US and EUs willingness to suspend the application of sanctions. While Trumps rhetoric vis-vis the Iran nuclear agreement has cooled in recent months, it remains a core part of his campaigns platform.
Moreover, irrespective of a Trump Administrations desire to address the JCPOA immediately, the implementation of the
deal requires continued action on the part of the US government, most notably the renewal of sanctions waivers by the
president, which run out every 120-180 days. Assuming President Obama signs the sanctions waivers in January 2017
prior to leaving office, the Trump Administration has at most four months before it has to announce the renewal of
sanctions waivers and to comply with its obligations under the JCPOA, unable to avoid taking a stance. Changes to the
JCPOA have also been pushed by the Republican-led Congress, which has consistently opposed the nuclear agreement and
has sought legislation that, if passed, would undermine the JCPOA, such as banning the sale of civilian aircraft to Iran.
Critically, the JCPOA breakdown occurs if any permanent member of the United Nations Security Council (UNSC)
introduces a UNSC resolution to snapback the nuclear-related sanctions that were lifted by the JCPOA, or if Iran pulls out
of the agreement unilaterally. We see increasing risks over time that either the Trump Administration would pursue a
snapback resolution directly or diminish the benefits for Iran from continued compliance, in any of the following potential
ways:
1. The US could unilaterally force JCPOA breakdown by submitting a snapback resolution at the UNSC.
2. It can also instigate a collapse of the JCPOA by passing new broad secondary sanctions that impede Iran's ability
to gain from nuclear-related sanctions relief, or simply by refusing to renew the nuclear-related sanctions waivers.
Either way, the US imposition of secondary sanctions would prohibit non-US companies from doing business with
Iran. This would increase the likelihood of Iranian non-compliance. Iran is unlikely to accept a one-sided
renegotiation of the JCPOA, particularly if more onerous terms are proposed (e.g. an Iranian admission of guilt on
past nuclear weaponisation activities, anytime, anywhere access to Iranian nuclear and military sites, restrictions
on Iran's ballistic missile program, or a full dismantling of the Iranian nuclear program). It would ask something in
return if a renegotiation were to be pursued.
3. A rigorous implementation of the nuclear agreement would likely significantly reduce, if not eliminate, any room
for resolving inevitable technical issues and minor Iranian non-compliance, such as having excess heavy water
before it gets shipped out of the country. Again, such a course of action could serve to increase tensions and create
cover for pulling out of the agreement from either party.

Consequences of JCPOA breakdown: near-term geopolitical risk, medium-term supply

risk
Any breakdown in the JCPOA has direct impacts on the oil market in two ways: increasing geopolitical tensions and
delaying the already long-overdue international investment in Irans upstream.
Armed conflict and reintroduction of risk premium: A possible breakdown of the JCPOA will increase the likelihood
of armed conflict, which would infuse acute geopolitical risk to oil markets that have effectively shrugged off events in
Yemen, Iraq, and Syria over the past several years. The involvement of the US or Israel in direct military action (most
likely airstrikes on nuclear installations) would inject a much more impactful degree of risk to regional dynamics, elevating
the possibility for material disruptions in physical markets. The possibility of US or Israeli strikes on Iran would

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substantially increase in the event that the JCPOA broke down and Iran sought to reduce its breakout window the
timeline for creating weapons-grade fissile material, currently estimated at two months.
Apart from the US, the regional Iran-Saudi proxy conflict has intensified, with both countries funneling funds and materiel
to factions in all three of the above conflicts. While the two regional powers are likely to avoid a direct military
confrontation, tensions and rivalry will continue to simmer and keep baseline risk of confrontation in the region elevated.
The reintroduction of sanctions would also serve to derail the process of Irans upstream opening for international oil
companies, especially if European countries follow the lead of the US. Even without multilateral cooperation through the
JCPOA, operators and investors in potential Iranian upstream projects will become more reticent, starving the industry of
much-needed capital to boost production, and grow long-term supply potential. All things being equal, a lack of investment
in the Iranian upstream would result in less pronounced growth in our Iranian production outlook, although the effect is
more likely to be felt in our balances post-2018.
The likely change in US policy will have economic and political repercussions in Iran itself: A re-imposition of
sanctions represents a clear risk to Iran's economy. Iran's economic outlook has improved with the implementation of the
JCPOA, mainly through the provision of sanctions relief, rebounding oil production, and greater access to foreign capital
and markets. IHS Economics expects Iran to average 4.6% growth over the next three years, though with continued
downside risks from implementation uncertainty and low oil prices. Nevertheless, the economic benefits of the JCPOA are
likely to be restrained by the challenges of doing business in Iran, including the widespread economic presence of the
IRGC (under US and EU terrorism-related sanctions), US primary sanctions complicating dollar transactions with Iran, and
the fear of snapback of sanctions if the US policy shifts under a Trump presidency or if Iran is seen as not complying
with the JCPOA. Although Iran's economy has developed some resilience after years of sanctions, the return of some
sanctions combined with continued weak global oil prices increases the risk of another recession.
The timing of these headwinds will matter: If the economy remains on an even keel this spring, it is likely that Rouhani
will maintain a broad base of support in the run-up to the presidential elections in May 2017, minimising the risk of a
significant hardening of Iranian politics. Although the hard-line conservatives, including the powerful Islamic Revolution
Guards Corps (IRGC), have capitalised on the disappointment over the slow pace of sanctions relief, they likely recognise
that Rouhani (or a similar centrist figure) best serves Irans strategic interests of maintaining the nuclear-related sanctions
relief and securing international recognition of Irans role as a regional powerbroker. A breakdown due to a US shift in
policy would serve to validate Iranian hard-line conservatives mistrust of, and ideological aversion to, the US. Near term,
the run-up to the May 2017 presidential elections in Iran may add pressure to Rouhani to resist perceived US provocation.
The most serious risk to domestic stability ultimately stems from the leadership transition that will take place after
Khamenei, although this is likely a longer-term challenge. The hard-line conservatives are expanding their influence at the
expense of other factions ahead of this succession process. This risks the selection of a hard-line successor who in turn
marginalizes the remaining factions, specifically the moderate parties and officials, thereby jeopardizing the domestic
balance of political power, threatening internal instability.

An unsettled future with rising political and oil market risks in 2017
There are three distinct scenarios to contemplate for how the US could choose to engage with Iran and the JCPOA over the
next six months:
Scenario 1 - US fulfils its JCPOA obligations, JCPOA implementation continues: If the US continues to meet its
obligations under the JPCOA, Iran is likely to continue its nuclear compliance. This remains our base case over the next six
months. Provided that the administration of outgoing US president Barack Obama signs the sanctions waivers in January
2017 before transitioning out of office, the Trump Administration has about four months (120 days) before it has to decide
whether to renew the sanctions waivers and comply with its obligations under the JCPOA. If the Trump Administration
adopts the policy of rigorously implementing the agreement and buying time for its re-negotiation, then it is likely to sign

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those waivers. This would be intended to defend the US from the perception that it was unfairly instigating JCPOA
breakdown in the eyes of the international community.
Nevertheless, longer term this is likely to be an unsustainable scenario. The Trump Administration would be likely to have
a lower commitment to JCPOA survival, and therefore have less tolerance for technical issues and minor Iranian noncompliance. The Trump Administration is also unlikely to actively pursue a resolution to the US prohibition on Iranian
access to dollar markets, a lingering issue that has discouraged most major international banks from resuming business ties
with Iran. Thus, even a short-term continuation of US JCPOA participation entails the likely suppression of further foreign
investment in Iran over the coming years and increases the possibility that Iran recalculates the benefits of sanctions relief.
Such a development would increase the risk of Iran failing to fulfil its obligations under the JCPOA beyond the one-year
outlook.

This scenario poses the least risk to an escalation of tensions particularly if it carries the JCPOA until after
Iran's May 2017 presidential elections.

Scenario 2 - JCPOA breaks down, Iran shows restraint: If the US pursues a course of action that instigates a JCPOA
breakdown, such as failing to renew the sanctions waivers, Iran would likely show restraint in its response. This scenario
presupposes that the US lacks discernible, verifiable evidence of significant Iranian nuclear non-compliance as justification
for instigating the JCPOA breakdown. As a result, Iran would be able to project the US as responsible for the breakdown
of the UNSC-endorsed nuclear agreement, to which Iran remained compliant. Although the Iranian leadership would come
under domestic political pressure to respond to the US provocation, this would likely be limited to symbolic measures, like
increasing the number of operational centrifuges, rather than measures intended to narrow Irans breakout window.
Irans restraint would be intended to weaken the multilateral sanctions regime, acting as an olive branch to dissuade other
members of JCPOA from complying with US secondary sanctions, since JCPOA breakdown would automatically reimpose the pre-JCPOA sanctions provisions. Iran would likely calculate that, absent provocative measures in its nuclear
programme, it could sustain sufficient political will by countries like China to resist the pressure of sanctions snapback.
Although Iran would also hope for the weakening of European compliance with US secondary sanctions, this would be less
likely given significant European exposure to the US financial system, forcing European companies to choose between
doing business with Iran or risk losing access to the US economy and financial system.

This scenario would more likely play out if Rouhani or a similar centrist figure won the May 2017 elections,
indicating Iranian willingness to project a moderate image abroad even amid growing risks to the JCPOA.

Scenario 3 - JCPOA breaks down, Iran narrows breakout window: If the US instigates a JCPOA breakdown and
succeeds in coalescing the previous multilateral sanctions regime, then sustained economic pressure would likely result in
Iran seeking to narrow its breakout window. This would be intended to enhance Iranian leverage ahead of a potential
further round of negotiations. Iranian willingness for re-negotiation would increase if there were a credible risk of US or
Israeli military action and if it maintains a co-operative relationship with Russia, improving the prospects of another
multilateral resolution. Russia announced a potential US$ 10 billion arms sales agreement with Iran on 14 November 2016,
a positive indicator for bilateral relations over the coming year.
Iranian perception that US military action is inevitable would indicate a growing risk of Iran pursuing a covert nuclear
programme. In turn, this would significantly increase the risk of military strikes by the US or Israel. This scenario would
also become more likely if Iran-Russia relations deteriorated, thereby removing a potential complication for a US or Israeli
strike.

This course of events will have a higher probability if Iran were to indefinitely expel inspectors from the
International Atomic Energy Agency (IAEA), limiting transparency over its program. The election of a
hardline candidate in the May 2017 presidential elections would also indicate limited flexibility in Iranian
policy in the event that the JCPOA broke down.

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