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LONDON (Reuters) -- Bank of America Merrill Lynch has dropped Dubai state-controlled Dragon Oil as a client because of its ties with Iran, sources close to the matter said, in a sign the United States may be using its clout with bailed-out banks to achieve foreign-policy goals.

Dragon Oil said on August 17 that BoA Merrill Lynch, an investment banking unit of Bank of America, the beneficiary of a $45 billion state bailout, was no longer advising it on ongoing takeover talks.

"Merrill Lynch have had to relinquish the mandate following an internal issue with Bank of America," a spokesman at Dragon said.

A spokeswoman for Merrill said the bank had withdrawn for "internal legal reasons." She declined to elaborate, but said there had not been an issue with Dragon itself.

Dragon is now being advised by HSBC, a global bank with headquarters in Britain.

Sources close to the matter said the reason was that Dragon has ties with Iran, which Washington accuses of seeking to build an atomic bomb.

"Merrill had to give it up because of the Iran link," one source said.

Dragon produces oil in Turkmenistan and routes 90 percent of its production through Iran to international markets. It does not have oil or gas fields in Iran.

U.S. sanctions prohibit U.S. companies from investing in Iran or advising Iranian companies but it is unclear what law Merrill could have broken by advising a company which simply buys and sells oil with Iran, analysts said.

"This is a sign the is U.S. being more aggressive.... It seems the U.S. is using its stakeholdings to execute foreign policy," one analyst, who asked not to be named, said.

Implications

The U.S. government has extended $45 billion in bailout funds to Bank of America Merrill Lynch -- none of which has been paid back -- and is perceived as having broad influence in its governance, having overseen a board shake-up.

Merrill Lynch witnessed an exodus of dealmakers at the start of the year after Bank of America took it over in a deal that was closed under pressure from U.S. regulators, but lately started snapping up some senior officials.

In the past, oil companies with operations in Iran, such as Royal Dutch Shell Plc and Norway's StatoilHydro have had no difficulty in securing advice or funding from U.S. investment banks.

Merrill's withdrawal could have implications for the energy trading units of U.S. banks that have received taxpayer help, because many of their counterparties will trade in crude from Iran, one of the world's biggest producers.

Dragon chief executive Abdul Jaleel Al Khalifa said he was not concerned about the U.S. sanctions.

"It has been there for many years and we lived through it," he told Reuters in a telephone interview.

However, he added that Dragon, which is majority-owned by Dubai state-owned Emirates National Oil Company, could market its crude through other channels if the Iran option was closed to it. "We have a Plan B in place," he said.

Citigroup Inc, which has a large energy trading unit, and is active in advising oil and gas companies, said in late July it will give the U.S. government a 34 percent equity stake as part of the latest federal bailout.

The U.S. has been stepping up the pressure on Iran to drop its nuclear program by trying to make it hard for the country to do business internationally. Even non-U.S. companies have been pressed not to trade with Iran.

The U.S. Senate in July voted to ban firms that sell gasoline and other refined oil products to Iran from also receiving Energy Department contracts to deliver crude to the U.S. Strategic Petroleum Reserve.
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