IRAN SANCTIONS: GETTING ITALY TO DO MORE

C O N F I D E N T I A L SECTION 01 OF 04 ROME 000601 NOFORN SIPDIS E.O. 12958: DECL: 05/22/2019 TAGS: EFIN ETRD IT KNNP PREL SUBJECT: IRAN SANCTIONS: GETTING ITALY TO DO MORE REF: A. 08 ROME 1445 ¶B. 08 ROME 1500 ¶C. ROME 97 ¶D. ROME 252 ¶E. MOSCOW 1273 ROME 00000601 001.2 OF 004 Classified By: CDA Elizabeth Dibble for Reasons 1.4 (b) and (d). ¶1. (C/NF) Summary: Italy's argument that it should be included in the P5 1 is based on long-standing Italian claims to a major economic relationship with Iran. The trade relationship is not, in fact, particularly large and any vulnerability appears to be more on the Iranian side. Even energy imports from Iran are relatively low and fungible. Although one of Italy's motivations for asserting an expanded role in Iran policy making appears linked to a desire to avoid disadvantaging Italian exporters, positioning Italy for future economic transactions, particularly in the energy area, appears to be key. However, economic factors are only one element in Italy's push to be in the decision-making club. GOI officials harbor an enormous desire to be counted -- along with Paris, Berlin and London -- as a "major" EU player in terms of influence -- especially regarding the Middle East and Iran. Playing off Rome's desire to be taken seriously (first and foremost with Washington -- witness Italy's assiduous efforts to be "Israel's best friend in Europe"),it is worth turning aside the trade and economic arguments for Italy not doing more and challenging the GOI to take purposeful actions to demonstrate leadership. Importantly, as we look ahead to engagement with Tehran after the June presidential elections, we need to make sure that Italy avoids steps, such as new energy deals or relaxation of trade and investment insurance criteria, that would signal fractured allied resolve vis-a-vis Iran. End Summary Vanity and Commerce Combine - - - - - - - - - - - - - - ¶2. (C/NF) Italy declined a 2003 offer to be part of the EU-led (and USG-supported) effort to negotiate an end to Iran's pursuit of a nuclear enrichment capability. Clearly regretting its earlier caution, Italy has spent the last three years strenuously objecting to its exclusion from the P5 1 format which replaced the European only effort. We suspect a variety of motivations. Vanity is certainly one, but the force and staying power of Italian arguments for inclusion appear related to commerce and the strong desire to shape sanctions that might impact upon Italo-Iranian trade. In discussions with GOI officials, an Italian seat at the negotiating table is explicitly linked to Italy's supposedly "important" trade relationship with Iran. The Italian arguments generally make use of some or all of the following points: Sanction decisions that might disadvantage Italian exporters vis-a-vis European, Chinese or other competitors are patently unfair without direct Italian input. GOI officials claim that the lack of an Italian presence is tantamount to "taxation without representation." Finally, the Italians assert that sanctions themselves historically have proven ineffective as a foreign policy instrument. Trade-Based Policy Without the Trade - - - - - - - - - - - - - - - - ¶3. (C/NF) The magnitude of the Italo-Iranian trade relationship is not, in fact, particularly large, at least for Italy. The argument that far reaching sanctions or even a total cut off of the economic relationship would have especially onerous consequences for the Italian economy is not borne out by GOI-furnished trade data. Italian imports from Iran, primarily oil and petrochemical products, totaled 4.2 billion Euros in 2007, or less than 2 percent of Italy's total imports. Italian exports to Iran, primarily machinery, mechanical parts and appliances, were even less significant. They totaled only 1.8 billion Euros in 2007, less than one percent of all Italian exports. Even the often repeated assertion that Italy has a significant degree of energy dependence on Iran is not based in fact. In 2008, only five percent of Italy's energy was imported from Iran. All of it was in the form of readily fungible crude oil. Putting it somewhat differently, Iran ranks 24th among Italy's trading partners, indicating that the current trade relationship is not as vital for the Italian economcy as advertised. ROME 00000601 002.2 OF 004 ¶4. (C/NF) Some of the Italian officials, even at the policy level, who claim that the Italo-Iranian trade and/or energy relationship is economically important to Italy clearly believe those assertions to be true. Many have been repeating the argument for years, but few have likely looked at the numbers. We also believe that the links between individual companies and political actors are often activated to secure favorable consideration of one transaction or another. The repeated rebuffs that we experienced when trying to halt shipments of fast boats and engines during the Prodi Government were such examples. Of course, many transactions of concern to the USG do not fall under any of the proscription lists. ¶5. (C/NF) We have been pleased, nonetheless, that SACE, the GOI's foreign trade and investment insurance agency, has declined to renew risk insurance on Iranian transactions over most of the past year, producing a reduction in total risk insurance for Iranian projects. Over the period from November 2008 to March 2009, policies declined by 200 million Euros, reaching 1.3 billion Euros (refs A and D). Italian Desires: Future Options and Avoiding the "Libya Model" - - - - - - - - - - - - - - - - - - - - - - - - ¶6. (C/NF) We believe that ENI, the Italian energy giant and parastatal, may be the most important actor influencing Italian policy vis-a-vis Iran, playing a role similar to its influential one in shaping Italy's Russia policy (refs C and E). It wants to expand operations in Iran, opposes tougher sanctions and is not at all shy about using its power to influence Italian Government policy. (Note: Though it is a fact well-known to Italy watchers, it always comes as a shock to most observers to learn that the Italian Foreign Ministry has senior level diplomats assigned as Diplomatic Advisors to both ENI and ENEL. In the absence of an independent Energy Ministry, these advisors ensure that the information flow between the GOI and energy firms is robust. The arrangement also prompts the question as to who runs Italian energy policy. End Note) ¶7. (C/NF) ENI has been operating in Iran since at least 1957, when ENI subsidiary AGIP entered into a joint venture with local oil interests. After the Iranian revolution, ENI reentered the Iranian market when, in 1991, Tehran permitted so-called "buy back" arrangements allowing firms to be paid in kind for government oil projects. ENI repatriates its profits from its own Iranian energy investments in like fashion. Our most recent exchanges with ENI officials seem to indicate that ENI's investment in Iran currently totals about 700 million Euros. ENI's management would like to further expand their Iranian operations, using two justifications: Competitors, particularly Total, are prepared to assume ENI's interests in Iran and, second, that the envisioned new investments would be in advanced extraction technologies, permitting ENI to recoup its earlier investments. ¶8. (C/NF) Italian officials have regularly raised their fears about future business opportunities in Iran, citing with some bitterness the example of pressure exerted by the U.S. on Italy regarding trade and investment in Libya in the aftermath of the 1988 Pan Am bombing. As they see it, Washington's 2008 reconciliation with Tripoli led to a swamping of Italian competitors as U.S. firms rushed for the suddenly open Libyan door. A senior ENI representative put it even more succinctly in a comment to an Embassy officer on the margins of a recent conference on the Maghreb. Noting that ENI built commercial relationships with countries for the long-term, he said that ENI had set up a joint venture with the Libyan Government in the 1950s, putting Libyan officials on the board. ENI subsequently resisted USG efforts to close the venture down and "we will do the same with Iran, now and in the future." (Comment: This revisionist account of the Italo-Libyan economic relationship is most valuable for clarifying the Italian position vis-a-vis its problematic economic partners more broadly. It is competition averse, reliant on long-term ties, rather than more transparent market interactions, and reluctant to accept losses in pursuit of political goals with which there is weak affiliation. End Comment) ROME 00000601 003.2 OF 004 Italy as a "Player" - - - - - - - - - ¶9. (C/NF) While we see Iran as not particularly important in economic terms for Italy, the reverse is not true. In 2007, Italy supplied Iran with about 4 percent of all its imports. Moreover, Italy bought approximately 5.7 percent of Iranian exports. It would appear, therefore, that the vulnerability to trade disruption is considerably greater on the Iranian side of the equation. And therein lies the rub. For as we saw with the Italian pratfall over FM Frattini's hastily-cancelled trip to Tehran this week, GOI officials are fearful of using even the modest leverage they have with Iran. Having been told the price tag of a visit to Tehran (to discuss Iranian participation in the upcoming G8 Foreign Ministerial session on Afghanistan-Pakistan) was a Frattini call on President Ahmadi-Nejad, GOI officials gulped hard and agreed (despite repeated USG counsel to cancel the trip), only to be pushed into backing out of the trip en route to the airport in an embarrassing fashion when the IRIG insolently upped the ante by fixing the meeting venue at a ballistic missile launch site. ¶10. (C/NF) Nevertheless, Italian officials continue to harbor ambitions to play in the major leagues, especially in the Middle East (and with Russia). They have prioritized Iran and Israel as the two big interlocking issues on which to make their mark. This appetite has been sharpened by the advent of the new U.S. administration, one explicitly committed to pursuing direct engagement with Tehran, an effort the Berlusconi government has been eager and even anxious to assist. Berlusconi's return to power in 2008 brought a decided shift in tone and substance regarding Italy's stance toward Israel. Government officials have worked tirelessly to brand Italy (with a recent acknowledgment from the new Netanyahu Government during FM Lieberman's visit to Rome) as "Israel's best friend in Europe." ¶11. (C/NF) While courting Israel (and through it, Washington),the Berlusconi government has creatively used its tools at hand -- in this case, Italy's Presidency of the G8 -- to try to fashion a facilitative Italian role for an approach to Iran. What began as a side-bar "outreach event" on Afghanistan-Pakistan grafted onto the G8 Foreign Ministerial in Trieste now threatens to overshadow the ministerial itself. The Italians clearly hope to be "useful" in brokering direct high-level U.S.-Iranian contact (even if at Trieste this is no more than a Secretary-Mottaki handshake) as well as bringing the Iranians around to a more pragmatic collaboration on the number one security priority of the U.S. Administration. Avoiding the Slippery Slope - - - - - - - - - - - - ¶12. (C/NF) Italy does in fact cooperate in enforcing measures against Iran, but not in a manner that would expose much of its economic relationship with Iran. While Italy has for some time been a partner in quiet discussions to identify national measures to build upon UNSC and EU trade/financing instruments against Iran, Italian officials have brought little to the table in terms of concrete ideas (Ref B). In the meantime, as the Italians wait for unveiling of the USG policy review on Iran, we are seeing warning signs that they may slip down a slope leading to an uncomfortable level of cooperation with Tehran. Well placed contacts with SACE (the foreign trade and investment insurer) tell us there is political pressure building among industrial circles and in the Prime Minister's office to break the lock on new policies for Iranian transactions. (The halt on new policies and refusal to renew old ones is currently linked to a heightened evaluation of political risk.) Second, ENI has approached both the Embassy and the Department to secure our views on the advisability of signing a new MOU to permit new energy investment in Iran. Though both Embassy Rome and Department officials have warned ENI off, the Iranian English language news agency, PressTV, has already broadcast news of the supposed imminent initialing of the agreement. ENI emphatically denied that the MOU will be signed without further consultation with Washington (ENI CEO Paulo Scaroni intends to travel to Washington June 19 on this errand),but it is clear that ENI, other business interests and high-level ROME 00000601 004.2 OF 004 officials are anxious to push for the kind of big-ticket commercial transactions that would only signal lack of Western resolve vis-a-vis Iran. What Can Italy Do? - - - - - - - - ¶13. (C/NF) The Berlusconi government, despite its tough rhetoric on Iran, has acted much like previous Italian governments -- reluctant to adopt big, bold economic measures that might provoke an Iranian backlash directed at Italian firms. Nonetheless, even modest measures by Italy would send an interesting, and useful, message to Tehran. One step the Italians could take at negligible financial cost would be to close Bank Sepah. This Iranian bank remains nominally open, though unable to conduct business. It is under constant supervision by Italian authorities. Its closure might additionally spur the U.K. and France to take similar measures against Iranian banks located on their territories (lest they appear weaker on Iran than the Italians). Second, the GOI needs to hear clearly that SACE's higher political risk premiums on Iranian trade and investment are absolutely appropriate and that the steady reduction in the Iranian portfolio should be continued. Finally and most critical, we need to be crystal-clear with senior ENI and GOI officials that signing an MOU with Iran to expand investment at the current time, or the contemplation of any other near-term energy investment, is out of the question. Comment - - - - ¶14. (C/NF) In this strategic pause as we wait for Iran's presidential elections, and as we look down the road toward direct engagement - whether through the P5 1 or another structure - it is worth preparing the Italians for some more hard work later on financial/trade pressure. At a minimum, we need to get the GOI to hold the line on several things: expansion of energy investments, big new commercial deals, or relaxation of political risk assessments for trade and investment purposes. Italian arguments in defense of economic interests bear more than a passing resemblance to what we hear from GOI officials about their commitments of other resources. Simply put, the Italians are casualty averse -- in economics and defense, particularly when the ultimate goal is perceived as less important to them than it is to their alliance partner(s). That conclusion argues for a forceful and sustained engagement with the Italian government and public, to ensure that we have the best possible set of tools available to us as we move forward on engagement with Tehran. DIBBLE