Iraq Tests U.S. Sanctions With Oil-for-Gas Deal With Iran

BAGHDAD—For a decade, Iraq has procured Iranian natural gas in an arrangement that powered millions of Iraqi homes but pushed Baghdad into billions of dollars in debt to Tehran because U.S. sanctions restricted payments for the fuel.

Now Iraq says it has found a way around sanctions: Paying Iran for gas with Iraqi oil. The agreement injects uncertainty into the Biden administration’s attempts to cool tensions with Iran and contain its nuclear program.

Iraqi Prime Minister Mohammed al-Sudani announced the barter arrangement this week after Iran cut gas supplies late last month over unpaid debts, plunging Iraq into blackouts and electricity shortages just as summer temperatures in the country’s south began breaching 120 degrees. Iran’s natural gas helps provide more than half of Iraq’s power needs during peak summer months.

Iran has since resumed supplying gas, and Sudani—who has had generally good relations with the Biden administration since taking office in October—blamed the U.S. for the electricity crisis. 

“We could not get approval to transfer all the dues,” Sudani said. 

Biden administration officials said they were seeking more details about how the oil-for-gas trades would work in practice and whether the system would violate U.S. sanctions. They rejected assertions by Sudani and other Iraqi officials that Iraq’s electricity shortages were caused by U.S. delays in approving Baghdad’s payments to Tehran.

“Any claim that U.S. sanctions on Iran are causing Iran to limit gas supplies to Iraq is absurd. Iran is limiting gas supplies to pressure and blackmail the Iraqi government and its people,” a spokesman for the National Security Council said, adding, “We are looking into the details of the reported swap.”

U.S. officials use their de facto control over Iraq’s payments to Iran as a way to deny Tehran hard currency, but the new procedure announced by Sudani’s government appears to offer Iran a way to sidestep those limits if it can refine and resell the oil it receives from Iraq on world markets.

For nearly a decade Iraq has sought U.S. Treasury Department approval before releasing energy payments to Iran to comply with sanctions, a procedure aimed at preventing dollars from going to Iran’s Revolutionary Guard, a military organization designated as a terrorist group. Iran has generally been limited to buying humanitarian goods and only in non-U.S. currency.

Since last December, the U.S. has approved €2.5 billion, equivalent to $2.7 billion, in payments by the Iraqi government to Iranian creditors. The payments included €886 million to Turkmenistan, partially repaying a debt owed by Iran, the officials said, for example.

The payments came at the same time as the Biden administration restarted indirect talks with Iran over freezing progress in its nuclear program and freeing U.S. prisoners in exchange for releasing billions of dollars in Iranian funds frozen overseas. The goal is to reduce tensions that have soared as Iran has provided drones to Russia for its war in Ukraine, pushed ahead with uranium enrichment and seized oil tankers in the Persian Gulf.

Tehran stepped up pressure to release the remainder of its unpaid debt in Iraq, totaling at least another $10 billion, as summer arrived and demand for electricity soared, senior Iraqi officials said.

By trading crude and heavy fuel oil for gas to settle its debts with Tehran, Iraq will no longer be vulnerable to temporary cutoffs of its energy supply, Sudani said. Iraq is the world’s fifth-biggest oil producer, but it has never fully exploited its natural-gas riches in a way that would allow it to be energy self-sufficient.

“We give raw oil or black oil and in return we get Iranian gas,” Sudani said. “Through this way we can guarantee continuation of the gas supplies.”

The cut in Iranian gas left power plants in southern Iraq with sharply less fuel for producing electricity, according to Iraqi officials, who said Tehran had turned up the pressure even more in recent days by shutting off gas shipments entirely. Tehran also reduced transmissions on power lines between the two countries, further reducing available electricity.

Farhad Alaaldin, Sudani’s foreign affairs adviser, said Iraq was seeking to escape what had become a perennial summer predicament, facing pressure from Tehran on one side to pay its energy bills in hard currency to avoid an electricity shortage and from the U.S. to enforce sanctions that prohibit dollars from going to Iran.

“The idea is we are not giving them dollars. Barter is a form of payment, but it’s not a payment that’s subject to sanctions,” he said. “We don’t want to have the repeated Iranian use of the nonpayment as an excuse to cut the gas supply every year.”

Henry Rome, a senior fellow at the Washington Institute for Near East Policy, said it was unclear how the new barter system would work in practice, and whether the U.S. will seek to block it.

“Based on the details announced so far, this arrangement appears riddled with legal and practical issues,” he said. “I think it’s fair to ask whether this deal was intended to function in practice, or whether it is primarily aimed at trying to jam the U.S. to be more flexible with the current arrangement.”

Iranian officials have pressed Baghdad to transfer Iran’s frozen funds to Oman’s central bank, according to Iraqi officials, arguing that Oman would approve payments faster than the U.S. Treasury. But Iraqi officials say they won’t shift the frozen funds without U.S. approval, which hasn’t been given.

Sudani has faced pressure in recent weeks from members of the Coordination Framework, a coalition of Iran-linked Shiite parties that dominates the Iraqi parliament, to stand up to Washington by releasing the Iranian funds.

“We have to get out from the humiliation of slavery,” Hadi al-Ameri, head of the pro-Iranian Badr Organization and a member of the Coordination Framework, said in remarks Thursday released by his office. “It’s unbelievable that an employee in the American Treasury controls money of big, strong Iraq.”

On Friday, after calls by Iraqi politicians in recent days for anti-U.S. demonstrations, a few dozen protesters chanting slogans gathered outside Baghdad’s heavily guarded Green Zone, where the U.S. Embassy is located. “America Out Baghdad Remains Free,” read a banner held by one protester.

Demand for air conditioning in the summer puts acute strain on Iraq’s power grid, which can’t generate enough electricity even in the cooler months. Electricity shortages last summer ignited demonstrations that grew into a broader challenge to the government from its core constituency in southern Iraq.

Some households receive no more than a few hours of state-provided power a day during peak demand. People who can afford it buy their own generators, or buy from neighborhood generators, when the power goes out.

U.S. officials have pressed Iraq to proceed to connect its power grid with Saudi Arabia and other Gulf states, to reduce Baghdad’s longstanding dependency on Iranian energy. On Monday, Iraq and French oil major TotalEnergies signed a long-delayed $27 billion deal to boost energy production, including the recapture and use of flared gas in southern Iraq for electricity production.

“Once the project is complete, Iraqis will benefit from increased domestic supply of electricity,” Jake Sullivan, President Biden’s national security adviser, said Monday. “The United States fully supports Iraq’s ongoing efforts to enhance domestic resilience, and diversify its energy supply.”

Write to David S. Cloud at [email protected]