Over a Barrel
Trade sanctions could prompt regime change in Iran.
BY WILLIAM P. KUCEWICZ
Friday, June 2, 2006 12:01 a.m. EDT
Condoleezza Rice, in signaling a new U.S. willingness to negotiate with Iran, also warned that "international isolation and progressively stronger political and economic sanctions" would follow if Tehran defies its international obligations by continuing to develop nuclear weapons. Although the likelihood of those sanctions increased yesterday after the Iranian regime rejected the U.S. offer, it has been the threat of such sanctions, and the crippling effect an international embargo would have on Iran's economy and exchequer, that have always been the likely catalysts for any possible negotiation.
There's simply no getting around the fact that you can't eat petroleum. Iran's 132.5 billion barrels in proved oil reserves--10.2% of the world total--are of little benefit unless they're earning money. A trade embargo would hit Iran especially hard, because its economy and government budget are inordinately dependent on petrodollars. Oil shipments account for about 25% of GDP, represent 90% of total export earnings and provide as much as 50% of fiscal receipts.
Further, the country imports about one-third of its gasoline. Additional gasoline supplies and other oil products are refined in Tehran from 60,000 barrels a day (bbl/d) in imported crude that arrives via pipeline from the Caspian Sea in a swap arrangement. In Iran, gasoline, like foodstuffs, is heavily subsidized--to the tune of $3 billion this year--as part as the regime's strategy to buy off public opinion. With gasoline retailing at just 40 cents a gallon, consumption, not surprisingly, has been growing by 8% to 10% a year.
The regime already feels the pinch of unilateral sanctions, first imposed by Bill Clinton and extended by President Bush, that forbid U.S. companies and their subsidiaries from doing business with Iran. Additionally, the Iran-Libya Sanctions Act of 1996 authorizes mandatory and discretionary sanctions against non-U.S. companies investing more than $20 million a year in Iran's oil and natural gas industries. The effectiveness of the restrictions can be measured by the volume of Iranian crude oil output. In the six months ended March, Iranian production was down 1.3% from a year earlier versus a comparable gain of 1.5% for OPEC, excluding Iran and Iraq. Compared with the six months ended March 2002, Iran's output in the latest six-month period was up 13.4% against a 21.7% increase for the eight members of OPEC sans Iran and Iraq.
Iran's below-average oil production is explained by a shortage of investment capital. Its 40 producing oilfields need modernizing. Recovery rates are a meager 24% to 27% compared with a 35% world average. But Iran doesn't have the capital to pay for upgrades. In fact, it has been counting on foreign investment to help it boost production from last year's 4.2 million bbl/d (of which 3.9 million bbl/d was crude oil) to a targeted five million bbl/d in 2010 and eight million bbl/d by 2015. Tehran further hopes, with foreign help, to expand its oil refining capacity by 50% to 2.2 million bbl/d by 2008. Sanctions would put the kibosh on these ambitious plans.
U.S. bans on technology transfers also have frustrated Iran's efforts to develop its massive natural gas reserves, the world's second largest. U.S. companies dominate natural gas liquefaction, and most liquefied natural gas (LNG) plants in the world use U.S.-licensed processes. Iran is limited to non-U.S. technology and so far hasn't built a single LNG facility. The cost: $11 billion in foregone annual earnings from one natural gas field alone.
What Tehran knows, and what the outside world has yet to grasp, is that an international trade embargo would hurt Iran infinitely more than it would hurt the U.S.
For oil-importing countries, even though Iran exports roughly 2.7 million bbl/d in petroleum, a complete cutoff of these shipments could be offset in large measure by increased OPEC and non-OPEC output, greatly diminishing the dreaded prospect of $100-a-barrel oil. Saudi Arabia has the most untapped capacity, in the order of 1.3 million to 1.4 million bbl/d. Other OPEC members, according to the International Energy Agency, have spare capacity of 1.1 million bbl/d, not including Iraq's estimated 700,000 bbl/d. With a total of 2.4 million to 3.1 million bbl/d in idle capacity, OPEC alone could offset a loss of Iranian exports. Furthermore, global oil consumption is anticipated to grow in the range of 1.4 million to 1.6 million bbl/d this year, while new supply is expected to increase by 1.2 million to 1.3 million bbl/d. Much of the imbalance is expected to be covered by OPEC exports of LNG.
Oil's fungibility notwithstanding, Asia in general and Japan in particular would be hardest hit by a cutoff of Iranian crude. (The U.S., Canada, Britain and Germany, among others, no longer import Iranian oil.) China has already taken steps in response to high oil prices that could lessen the effects of an Iranian trade embargo. It has eliminated tax rebates on gasoline exports, raised gasoline, diesel and jet fuel prices by 3% to 5% and levied higher taxes on larger vehicles. Chinese electric power generators, too, are scaling back on oil use.
Besides, it's not like we haven't been through this before. Following the 1991 Gulf War, Iraqi oil exports fell by some 2.3 million bbl/d to a mere 61,750 bbl/d between 1991 and 1996. Even now, Iranian exports are way below their pre-revolution high of 5.5 million bbl/d, which was equal to 19.2% of OPEC's 1974 crude and products shipments. Thirty years later, Iran shipped three million bbl/d, or 11.7% of OPEC exports.
To be sure, there are other risks to global oil supply--notably in Nigeria, Venezuela, Ecuador, Chad, Russia and Iraq. But should it be necessary, the U.S. could always play its trump card--namely, the Strategic Petroleum Reserve. Established after the 1973 OPEC oil embargo, the reserve has a current inventory of 688.6 million barrels of oil, sufficient to provide about two months of U.S. import protection. Were, say, 500,000 bbl/d to be siphoned off to partially offset a loss of Iranian crude, the stockpile would last more than three-and-a-half years.
Iran doesn't have the world over a barrel. It's the other way around. The economic and fiscal squeeze of new trade sanctions could indeed become so painful as to prompt regime change.
Mr. Kucewicz edits GeoInvestor.com.
(Editor's note: Iran's proven oil reserves are 132.5 billion barrels, not trillion as this article originally stated.)
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