As EU tightens the screws, Iran looks toward China (VIDEO)

The Iranian government narrowly escaped a European ban on its oil exports today, as France failed to garner enough support for the unprecedented measure. But there is still a latent fear in Tehran that the sharpening decline in European relations – accelerated by this week's attack on the British Embassy in Iran – will lead to a disadvantageous rise in Russian and Chinese influence over Iran's economy.

While the European Union failed to agree to an oil ban today, they did impose sanctions on 180 individuals and companies affiliated with the Iranian regime, putting the Islamic Republic in an increasingly tight spot.

“The government as a whole and the business community are worried about the deterioration of relations with Europe,” says a Tehran-based analyst. “Iran's relationships with the Russians and Chinese will become lopsided because they'll expect preferential treatment from Tehran in order to continue the relationship. As a consequence, it will give the Russians and the Chinese a lot of leverage over the Iranians, which will translate into economic concessions – and that is problematic.”

Oil official: We may turn to China

After months of Europe – prodded in part by Washington – gradually increasing the pressure on Iran, tensions have dramatically escalated in recent days. On Tuesday, hard-line Iranian protesters upset about Britain's latest sanctions against Iran's central bank attacked the British Embassy in Tehran. In response, Britain shut the embassy and expelled Iranian diplomats from its soil.

If other European countries choose to downgrade diplomatic ties, or decide to tighten financial sanctions against Iran's central bank, the impact on Iran's economy and currency would be significant. Already, France, Germany, and the Netherlands have pulled their ambassadors out of Iran for “consultations.”

Oil officials in Tehran say they will look to refineries in Asia if heightened financial sanctions or political pressure from the US reduce purchases of Iranian oil by European customers. Iran, which provided 5.8 percent of EU oil imports in 2010, is the EU's fifth supplier of oil after Russia, Norway, Libya, and Saudi Arabia. 

“We will have to ask other countries, especially China, to [purchase] more oil, though they will try and push us to give more of a discount,” says a senior National Iranian Oil Company official.

Why Iran has discounted its oil sales

In fact, Iran has already been offering discounts to foreign customers of Iranian oil for more than a year in order to offset the rise in transaction fees and lengthy bureaucracy resulting from US financial sanctions and international sanctions.

"Somebody will buy their oil, and Iran would earn less revenue,” confirms Hossein Askari, an economist at George Washington University who has advised Persian Gulf governments on energy policy. “Iran would be forced to barter.”

Indeed, Tehran's “bartering” with global trading partners, through which foreign refineries pay for Iranian oil using their own local currencies and keep the cash in locally held banks outside of Iran, has risen in line with heightened implementation of US Treasury sanctions on Iran's banking sector. In China alone, Iran has for the past year been forced to keep most of its cash from oil sales in Chinese banks, instead using the funds to finance imports of Chinese goods back into the Islamic Republic.

By the end of 2011, Iran will have an estimated $5 billion of cash trapped in South Korea, according to Reuters.

“Our country and our government are ready to pay as much as is necessary because they want to show the world that they can be successful,” the Iranian oil official says. "Though, it won't be easy."

Iran on the brink of 'serious inflation'

The Islamic Republic has become increasingly isolated internationally since last month, after Washington claimed to have discovered a plot by several members of Iran's Quds Force to assassinate Saudi Arabia's ambassador to the US on American soil.

In November, the US imposed a new round of sanctions, primarily on Iran's petrochemical sector, and the United Kingdom announced unprecedented sanctions against Iran's central bank, cutting off all financial dealings between British and Iranian banks. US Congressmen have also threatened to sanction Iran's central bank, which acts as a clearinghouse for nearly all oil and gas transactions with foreign countries.

After Tuesday's attack on the British Embassy in Tehran, Iran's Central Bank temporarily closed the local currency exchange market for fear of any blowback that could result from citizens rushing to buy foreign currency as a haven against Iran's currency, the rial, in the wake of Iran's worsening political relations with Europe.

"Iran is teetering on the border of serious inflation," says the Tehran-based analyst. "Anything that can push inflation up, including any major changes in the exchange rate, is worrisome.”

Conservative factions jockey ahead of March vote

The storming of the British embassy highlights an ever-deepening rift between Iran's conservative political factions, with infighting becoming increasingly combative in the run-up to Iran's March 2012 parliamentary elections.  

Ahmadinejad's administration is expected to face strong competition from conservatives – including former political allies – vying for parliamentary seats. As the elections approach, key political players are likely to capitalize on the nationalistic sentiments that sparked the anti-British protests, in an effort to gain favor from conservative voters.

It is still unclear which faction within Iran's political elite may have orchestrated the protests and subsequent attacks on the British embassy compounds. Iran's foreign ministry was quick to criticize and express regret for the attack on the British embassy, calling it “unacceptable,” while many traditional conservatives, including speaker of parliament Ali Larijani, lauded the protesters' storming of the British embassy, calling the act a “normal” reaction to years of anti-Iranian British policies.

At the same time, the state IRNA-news agency, whose chief is a close ally of Ahmadinejad, provided ample media coverage of the attacks, while state Islamic Republic of Iran Broadcasting, which is controlled by the office of Supreme Leader Ayatollah Ali Khamenei, downplayed them.