WASHINGTON -(Dow Jones)- While the U.S. Congress appears on course to approve legislation that sanctions Iran, the Obama administration isn’t convinced the punitive measures will work.

The administration is still grappling with a number of questions, such as can such sanctions be effective without multilateral support and could they ultimately backfire by playing into Tehran’s hands?

A majority of lawmakers in both chambers of Congress support legislation that would hit Iran where it is thought sanctions will hurt the most: embargoing petroleum products such as gasoline and diesel. Although the Persian nation has one of the largest crude reserves in the world, the country imports around 35%- 40% of its petroleum products because it lacks refining capacity.

Lawmakers say they plan to pass the Iran refined Petroleum Sanctions Act after the August recess to give President Barack Obama leverage in upcoming international negotiations.

Political analysts and former State Department officials say such a measure by itself isn’t likely to lead Tehran to halt its nuclear enrichment program but they warn it could be one of the last and most effective alternatives to military action, particularly by Israel as that nation fears a nuclear-armed Iranian hegemony in the Middle East.

If the administration hesitates too long, many warn it could miss an auspicious opportunity amid ongoing unrest over the recent presidential election and before Iran finishes building new refining capacity.

“This is exactly the time to use financial tools to build leverage for diplomacy,” Matthew Levitt, a former Bush-Administration Treasury official responsible for international sanctions, told a Senate panel earlier this month. Levitt now directs the Stein Center on Counter terrorism and Intelligence at the Washington Institute for Near East Policy.

Officially, the State Department has declined to say whether it’s considering the embargo sanctions. In response to questions about the issue last week, Secretary of State Hillary Clinton said the U.S. would continue to try to engage Tehran in talks. But, she added, in the absence of a positive response from Iran, the next steps could include tougher sanctions.

Several senior officials within the State Department have confirmed to Dow Jones Newswires that a petroleum embargo is one of the options under review.

“The question…is more a case of can they be effective, and whether that is something that can get the international community support,” one official said, speaking on condition of anonymity. “You want to have it impact on the government (and) you have to be careful that you don’t have undue impact on the Iranian people…driving the people back to the regime,” the official said.

Following the June Presidential election, opposition protests have rocked the Tehran and other Iranian cities, with tens of thousands of Iranians accusing the regime of stealing the election and violent repression.

With the regime significantly de-legitimized and both moderates and hard- liners overtly questioning the supreme leader, “the regime’s ability to easily deflect criticism over the state of Iran’s economy over sanctions imposed over the nuclear program is significantly undermined,” Levitt said.

Mark Dubowitz, executive director of the Washington-based think tank Foundation for Defense of Democracies, said based on the targeted sanctions the U.S. and the United Nations has already established, “I think we’ve seen the evidence…that there won’t be a rally around the flag.”

The timing isn’t just based on political expediency. The construction of new refinery capacity that could make the country a net exporter of petroleum products by 2012 builds a deadline for petro sanctions.

At the same time, the Obama administration is hesitating to win multilateral action. So far, support from Russia and China for censuring Tehran has been a hard-fought task. Russia has strong business ties with Iran, providing nuclear expertise, petroleum development and arms sales. Likewise, China has sold arms to Iran and has been investing heavily in its oil and natural gas sector.

“We’re talking to a number of partners on this…and I wouldn’t say there’s a complete meeting of the minds,” said another ranking State Department official. “But those discussions continue.”

Obama has set an unofficial deadline for Iran to come to the negotiating table by the time the Group of 20 leading nations meet this September in Pittsburgh. In the meantime, U.S. diplomats hope to shore up international support for stronger sanctions.

Supply Chain Repercussions

The administration’s also concerned that while U.S. action may curb gasoline and diesel shipments, Iran could import from other countries such as Russia.

But some analysts say multilateral efforts – while certainly helping to enforce any embargo – aren’t absolutely necessary.

Dubowitz says the concern is largely founded on a misunderstanding of the petroleum trade. While many firms from around the world ship petroleum products, there’s a limited number of companies that underwrite both the ships carrying the petroleum and the cargo itself.

By targeting shipping underwriting, not only would the risk premium paid by Iran to ship their fuel become prohibitive, Dubowitz said it could be possible to persuade the insurance companies to exit the market.

The Chinese and the Russians have a very limited ability to provide such service, he said, and since Iranian insurance companies have already been sanctioned, petroleum traders would have to do business with designated entities.

Furthermore, with the Iranian Revolutionary Guard Corps and other designated entities integrated so intimately into the Iranian economy, Dubowtiz said many Western companies doing business there are likely unknowingly working with sanctioned groups or their proxies. If the U.S. or an organization were to publish a report the business links that show such activities, the reputational risk for Western companies would also likely curb petroleum imports.

“It’s not that difficult to map the supply chain,” Dubowitz said.

By Ian Talley, Dow Jones Newswires; (202) 862 9285; ian.talley@dowjones.com ;

 (END) Dow Jones Newswires 08-10-091240ET Copyright (c) 2009 Dow Jones & Company, Inc.