Nuclear Talks: Protracted Negotiations Likely

BMI View: Following recent progress in talks on Iran's nuclear programme, we reaffirm our core view that talks will continue over the coming years, with potential for a long-term agreement to be found. However, we cannot preclude a breakdown in talks over the coming quarters, which could unleash a Western military response.

Iran and the so-called P5+1 countries - China, France, Russia, the UK and the US plus Germany - agreed during talks in Vienna on a timetable for negotiating an end to the confrontation over the Islamic Republic's nuclear programme, it was announced on February 20. Talks in Vienna follow a joint plan of action agreed upon in November in Geneva, when Iran and the 5+1 powers clinched a landmark interim deal paving the way for a partial easing of sanctions ( see 'Interim Nuclear Deal: Key Implications', November 25 2013).

According to officials, the atmosphere during the latest talks was reportedly constructive and businesslike. Although delegates refused to describe the topics for the meetings, a senior US official said "Every issue of concern to us is on the table," including uranium enrichment, Iran's heavy-water reactor project and its suspected nuclear military research and ballistic missile programme. According to the ongoing plan, a six-month interim arrangement agreed in November, which expires on July 20, could be extended by an additional six months should both parties agree.

Fordow and Arak Are Key
Iran - Main Nuclear Facilities

BMI View: Following recent progress in talks on Iran's nuclear programme, we reaffirm our core view that talks will continue over the coming years, with potential for a long-term agreement to be found. However, we cannot preclude a breakdown in talks over the coming quarters, which could unleash a Western military response.

Iran and the so-called P5+1 countries - China, France, Russia, the UK and the US plus Germany - agreed during talks in Vienna on a timetable for negotiating an end to the confrontation over the Islamic Republic's nuclear programme, it was announced on February 20. Talks in Vienna follow a joint plan of action agreed upon in November in Geneva, when Iran and the 5+1 powers clinched a landmark interim deal paving the way for a partial easing of sanctions ( see 'Interim Nuclear Deal: Key Implications', November 25 2013).

According to officials, the atmosphere during the latest talks was reportedly constructive and businesslike. Although delegates refused to describe the topics for the meetings, a senior US official said "Every issue of concern to us is on the table," including uranium enrichment, Iran's heavy-water reactor project and its suspected nuclear military research and ballistic missile programme. According to the ongoing plan, a six-month interim arrangement agreed in November, which expires on July 20, could be extended by an additional six months should both parties agree.

Fordow and Arak Are Key
Iran - Main Nuclear Facilities

Despite recent progress, it is clear that the gulf between Iran and the P5+1 countries remains wide. We hereby provide five key issues which will be discussed over the next few months:

Dismantling Iran's Ballistic Programme: Iran has the largest and most diverse ballistic missile arsenal in the Middle East. Iran's missiles are reportedly not likely to be decisive in armed conflict at this stage, given technical issues of accuracy. However, they remain a powerful political weapon to pressure adversaries, and further development could increase the capabilities of the programme. US officials have repeatedly indicated that Iran's ballistic missile programme is "on the table" in negotiations. However, Iran's chief nuclear negotiator Abbas Araghchi suggested that Iran's missile programme is not negotiable, and the issue will likely prove a key point of contention over the coming months.

Number And Sophistication Of Centrifuges: Under a scenario whereby an agreement on Iran's nuclear programme is reached, the West will have to ensure that, should Iran break out of its constraints, it would have sufficient time to take action. A timeline for this is a function of the number of centrifuges Iran would be allowed to possess, and their relative sophistication. Iran is likely to demand to be allowed a minimum of 10,000 centrifuges currently enriching uranium, while the US will likely insist on a far more modest programme, possibly along the lines of 3,000 centrifuges. Moreover, the West will want to limit the level of enrichment and allow a more intrusive level of inspections by the International Atomic Energy Agency. This would entail significant technical hurdles to negotiators.

Shutting Down/Altering Fordow And Arak: US negotiators will insist that Iran either shuts down its underground enrichment facility at Fordow, near the city of Qom, and the heavy water reactor under construction at Arak, or substantially alter their design. Fordow is buried deep underground, helping protect it against a military strike. The Arak reactor will be moderated by heavy water, meaning that the potential weapons-grade plutonium that could be extracted is significantly higher compared to a so-called light water reactor. That said, Iran will fiercely resist any steps it perceives as a dismantling of its nuclear infrastructure.

Unwinding Sanctions Regime: The West will want sanctions relief to be provided at regular intervals through the term of the agreement, and UN sanctions to be suspended in successive periods, with a permanent repeal only available in the latter stages. However, Iran could argue that a partial suspension of sanctions in the early years of a comprehensive agreement is insufficient to improve the economic situation in the country, the very reason why Tehran is sitting at the negotiation table.

Duration Of An Agreement: The final outcome of talks is to reach a 'permanent' agreement. However, the Joint Plan of Action has made clear that such agreement will have an expiration date, after which "the Iranian nuclear program will be treated in the same manner as that of any non-nuclear weapon state party to the NPT (Non-Proliferation Treaty)." The Obama administration will seek as long an agreement as possible, likely on the order of 20-25 years, with a view to providing maximum assurance that Iran has given up its nuclear weapons ambitions. For their part, Iranian officials will seek a shorter period, which some put at approximately five years. Discussion on the agreement's duration could be a key stumbling block to an agreement, especially in the final stages of talks.

Risks Abound
MENA - Short-Term (LHS) and Long-Term Political Risk Rating

Below, we outline three key scenarios on how negotiations could play out over the coming quarters.

Core View: Gradual Improvement. 45% Chance

Despite the vast gulf between the opening positions of Tehran and the West, both sides have a strong incentive to keep the negotiation process alive. Obama sees a potential deal with Iran as a key legacy of his presidency, and will exercise his veto power on potential attempts by Congress to increase sanctions. Moreover, the US is keen to show the world its commitment to talks, with a view to maintaining the support of key buyers of Iranian oil - most notably India and China - in the implementation of existing sanctions. On the other side, Presiden Hassan Rouhani's administration has strong incentives to compromise on the least sensitive issues on the table in exchange for an easing of sanctions, given that his popular mandate rests on his ability to improve relations with the West and consequently the domestic economy. Some areas of compromise may thus emerge, which would justify rolling over the current interim agreement in July and potentially again in January 2015. At that stage, the US administration will have to show concrete progress on the issues under discussion to Congress. However, under our core view, the Senate's ability to shut down negotiations will be limited, even should Republicans gain a majority in mid-term elections scheduled to take place in November 2014.

The potential for reaching a 'permanent' agreement on the nuclear issue over the 2015 - 17 period is significant in our view. However, the Islamic Republic will most likely remain a threshold nuclear power. We believe that Iran will retain the requisite knowledge to reconstitute its programme and then move to weaponize it should a political decision be made. Crucially, the West will seek to deny Iran an exercisable nuclear weapons option, ensuring that Iran cannot use its enrichment activities to produce a bomb before the West can intervene. The timeline between an Iranian decision to seek a bomb and success in building it could reasonably be within six to 18 months.

We expect the core of international oil and banking sanctions to remain in place until a 'permanent' agreement is found, with potential for only marginal easing. As a result, oil exports will at best improve only gradually over the coming years, while Western companies will remain reluctant to invest in key sectors such as energy and infrastructure or tap in Iran's large consumer market. The Iranian economy will also expand below potential. We expect real GDP growth of 2.8% in 2014 and 3.4% in 2015, after a 3.5% contraction in 2013.

Among the sectors which could benefit the most from a continuation of talks are mining and automotives. French carmaker Renault already recommenced shipments of auto parts in November, and fellow carmaker PSA Peugeot Citroen has signalled its intent to return. Despite attempts at domestically producing spare auto parts, the Iranian autos industry has been traditionally dependent on imported components, and a return of the French automakers could boost production significantly over the coming years.

Under the agreement signed in November 2013, some sanctions on mining and metals were suspended. Our commodities team highlights Iran's potential as a metals player given its substantial raw materials and large consumer base. While the continued restrictions on access to finance will mean that a boom in Iran's metals sector is highly unlikely to occur, we still forecast growth in the sector over the coming years, after almost a decade of decline.

Growth Below Potential
Iran - Components of GDP (IRRtrn) & Real GDP Growth

Breakdown: 30% Chance

The huge challenges associated with the nuclear issue could cause talks to be derailed in 2014 or 2015. A collapse could result from domestic machinations in Iran, with Rouhani losing key internal support especially from the Supreme leader Ayatollah Ali Khamenei and the conservative military establishment. Indeed, Khamenei recently expressed pessimism about the outcome of the latest round of negotiations in a speech directed to a domestic audience, despite declaring that Iran will not back away from its commitments. Similarly, a lack of progress could reduce support for talks in the West. Iran 'hawks' are present amongst both the US Republican and Democrat parties, and risks will persist that a bipartisan sanctions bill passed through the Senate could significantly worsen the climate for negotiations. Under such scenario, prospects for Western companies to enter Iran would be minimal, while isolation would likely lead to a continuation of the economic crisis in the country.

Should talks collapse, we cannot preclude that the US and/or Israel could exercise the military option. A military strike could in particular emerge if Iran is discovered producing highly-enriched uranium in secret facilities. This would be an unambiguous indication that Tehran is seeking to build a bomb, and a clear casus belli. A less likely scenario would see Iran openly exiting negotiations and moving to high enrichment; such a decision is highly unlikely in our view, given that it would trigger a harsh Western response.

POSSIBLE SCENARIOS As diplomacy advances
Event Chance Timeline Summary
Core Scenario: Gradual Improvement 45% 12 - 36 months Strong incentives to remain at the negotiating table lead to protracted negotiations. Potential for reaching a long-term agreement is significant.
Scenario 2: Breakdown 30% 5 - 18 months Mutual disagreements cause talks to derail, with risks of a military intervention by the US and Israel in Iran coming back to the fore.
Scenario 3: Breakthrough 25% 5 -18 months Public support for talks in Iran contribute to reaching a 'permanent' agreement, paving the way for a subsequent easing of sanctions.
Source: BMI

Breakthrough: 25% Chance

It is possible that a 'permanent' agreement could be reached in 2014 or in 2015. Such a scenario would indicate that the moderate camp within Iran has gain a greater control on the back of significant public support as economy starts to pick up. Indeed, Iranian negotiators were greeted by large cheering crowds on their return home in November, and Khamenei expressed his support for the interim accord. Conservatives could well adjust their more hardline positions, given that an improvement in political stability and the economy could indeed reinforce their hold on power. A potential agreement would most likely entail the continuation of Iran's civil nuclear programme. We believe that an arrangement by which the entire nuclear infrastructure is dismantled would not meet the approval of either moderates or conservatives in the country.

A breakthrough and the subsequent easing of sanctions would be key to global oil markets. Iran could quickly be able to put additional volumes on the market, with an estimated 25 - 30mn barrels of oil contained in floating storage alone. Moreover, with new investment Iran could eventually recover to pre-sanctions production capacity, which was in the area of 4.0mn bbl/d, compared to current output of 2.75mn bbl/d in December 2013 (according to International Energy Agency data). Similarly, foreign investors will be keen to enter the country, given its large consumer base as well as potential in key sectors such as energy and infrastructure.

Read the full article

This article is tagged to:
Sector: Country Risk
Geography: Iran
×

Enter your details to read the full article

By submitting this form you are acknowledging that you have read and understood our Privacy Policy.