RISKY
BUSINESS
The oil weapon and Iran By Peter Kiernan
In an address to the Iranian nation last weekend, Supreme Leader Ayatollah Ali
Khamenei referred to the security of energy supplies in the Persian Gulf region
being affected in the event of "the slightest mistake over Iran" made by the
United States. This subsequently prompted intense speculation about whether
Iran would use the "oil weapon" to fend off pressure being placed on the
Islamic Republic over its nuclear program.
Would Iran withhold crude-oil exports or perhaps target oil tankers in the
Persian Gulf in response to US air strikes on Iranian nuclear facilities?
Similarly, in the wake of last week's conditional offer by the US to join in on
negotiations with Iran, speculation is mounting on what
kind of action the United Nations Security Council would take if talks
irreparably break down between UN permanent members and the Islamic Republic.
Will an embargo on Iran's oil exports be implemented or, alternatively, will
exports of gasoline to Iran be banned?
It's hard to get around the energy equation to the current standoff given the
existing high-oil-price environment. Iran is the second-largest producer in the
Organization of Petroleum Exporting Countries (OPEC) and an oil power in the
Persian Gulf, a region with nearly two-thirds of the world's crude-oil
reserves.
But while Iran does have a trump card as a major oil producer, this is more
likely to be of defensive - rather than of offensive - value for the Islamic
Republic. Iran's strategic leverage will likely negate the chances of UN
sanctions involving the export of Iran's oil; but despite the supreme leader's
recent comments, Iran would also be reluctant to withhold its oil exports
unless as an absolute last resort. Risks are involved for both sides should oil
be dragged into an imbroglio over Iran's nuclear program.
Currently Iran produces about 3.8 million barrels per day (mbpd) - about 4.5%
of total global supply of 85.1mbpd - of which 2.5mbpd is exported, with the
remainder used for domestic consumption. Given the sensitivity of oil markets
to supply disruptions in a US$70-per-barrel price environment, UN sanctions on
Iran's oil would cause prices initially to escalate and threaten the health of
the global economy, particularly given that OPEC's spare capacity doesn't even
cover what Iran exports. In a lower-price environment and with a greater OPEC
cushion, oil sanctions against Iran would be less risky, but the US and its
European allies do not have this luxury.
Furthermore, significant resistance at the UN Security Council level to
sanctioning Iran's oil would come from Russia and China. Both powers have
expressed strong reservations about sanctions, including those involving a ban
on petroleum exports. Meanwhile, China would especially resist any ban on
investment in Iran's energy sector given its recent deals.
Although much attention is paid to China's growing reliance on Iranian crude, a
nearly 5% cut in supplies resulting from sanctions against Iran's exports would
affect all oil consumers given that prices would sharply spike. Furthermore,
nations that have closer relations with the US than China - such as Japan,
India and some European states - are also significant buyers of Iranian oil.
The Security Council might instead consider banning exports of fuel products to
Iran to place pressure on the Islamic Republic. Although Iran is the
second-largest producer in OPEC, its domestic refining capacity does not meet
local demand, and it must import about 170,000bpd of gasoline, which costs it
as much as $4 billion a year. But again unanimity at the Security Council on
this issue will not be easy, and any sanctions imposed are likely to target the
regime rather than the Iranian populace.
Suppose Iran uses an oil weapon of its own? Ayatollah Khamenei's recent
reference to energy supplies was fairly vague and mentioned in the context of
retaliatory action only. In April 2002, the supreme leader urged a collective
embargo from Islamic oil exporters to protest an Israeli military assault in
the Palestinian territories, but this went unheeded (Iraq did cease its oil
exports for one month back then, but oil prices were barely affected). If Iran
withheld its oil, it would do so alone.
In 2002, oil prices were in the mid-$20-a-barrel range, but with prices now
three times that level and with Iran's oil income expected to be more than
double what it was four years ago - $50 billion in 2006-07 compared with $19
billion in 2002-03, according to the International Monetary Fund - some Iranian
officials might be tempted to consider a cessation of oil exports should
nuclear negotiations degenerate into an all-out confrontation. The Washington
Post reported that Iran's top nuclear negotiator, Ali Larijani, had said at a
recent news conference, "We are not interested in using oil as a weapon ... but
if the conditions change it could affect our decision."
Initially markets will panic on the fear of Iranian oil going offline given
their current sensitivity to any kind of geopolitical crisis involving an
oil-producing country. But oil-consuming nations have a card up their sleeve to
tackle a sustained shortfall in supply resulting from Iran opting out of the
market - their own reserves of petroleum. According to the International Energy
Agency, total government and industry stocks of crude oil and refined products
held by its member states (countries in the Organization for Economic
Cooperation and Development) amounts to about 4 billion barrels. If markets do
not settle from a disruption in Iranian supply, there are reserves available to
cover the shortfall for a considerable period.
These ample reserves would not make the UN Security Council treat the issue of
banning Iran's oil lightly but do have to be factored in by the Islamic
Republic if it considers banning oil exports for a longer period, particularly
given that income from oil and gas exports comprise two-thirds of government
revenue. Although Iran's fiscal health has improved markedly in the past three
years, it still needs to dip into its oil stabilization fund to pay for
gasoline imports.
Nevertheless, Iranian officials can still generate anxiety just by talking
about an oil ban. This keeps markets jumpy and helps ward off the idea that
sanctioning Iran's oil exports is a viable option while prices remain buoyant.
Overall, Iran's key role in the global oil market protects it from draconian
economic measures being taken against its energy sector. But at the same time
Iran's own use of the oil weapon would put its longer-term interests at risk
(in terms of lost revenue and market share). The use of oil as a political
football would likely result in an own-goal for either side.
Peter Kiernan is an analyst on Middle East and energy issues for AALC, an
international consulting firm based in the Washington, DC, area.
