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Why Iran oil cutoff could be suicidal

By David R. Francis / March 27, 2006



Iran's nuclear standoff with the United States, Europe, and other nations has led to considerable speculation of $100-per-barrel oil and $4-per-gallon gasoline in the US. Such high prices might kick off a worldwide energy crisis and recession.

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The West already suspects that Iran's uranium enrichment program is a cover for bombmaking. To try to put a stop to it, the United Nations Security Council could impose sanctions, or even riskier, the US or Israel might attempt to knock out Iran's nuclear facilities with an air or missile strike.

In retaliation, Iran could act against its own best economic interests and slash oil exports. Last September, the head of Iran's powerful Revolutionary Guards warned that "any sanction against Iran" could push the price of oil to $100 a barrel.

"It would be easy to see oil trading at $100 a barrel," says Milton Ezrati, an economist with Lord Abbett, a mutual-fund company in Jersey City, N.J. But if oil traders view the action by Iran as merely a short-lived "diplomatic stunt," he says, oil would rapidly head back toward today's $62 a barrel price.

Mr. Ezrati warns that a long-term action would cause energy prices to soar. That would set back the incipient recoveries in Europe and Japan and seriously slow the US economy as well.

Many Iranians say they are being treated unfairly by the US and its allies, that they are subject to a double standard. This is reflected in the questions being asked widely by the media and in blogs throughout the Middle East, notes A.F. Alhajji, an economist at Ohio Northern University in Ada.

"Why is Israel allowed to have nuclear bombs while Iran is not allowed to have even as much as a research program that some experts believe might lead to building a nuclear bomb? Why are Israeli actions against the Palestinians and the Lebanese considered 'self defense,' while the actions of Palestinians and Lebanese are considered 'terrorist' acts? Why can Iran not intervene in Iraq when the US and its allies have already occupied the country? Why has Iran been deprived of its economic rights by [two-decades old] economic sanctions?"

The US and its allies may well have answers to such questions. But Professor Alhajji wonders if domestic political pressures in Iran resulting from inflamed nationalism might force the Iranian government to retaliate by cutting its oil exports. Alternatively, given the country's high dependence on oil revenues, Iran could instruct its operatives in Iraq to sabotage Iraqi oil exports from the port of Basra. Shiites are the dominant religious group in both Iran and southern Iraq. That would reduce world oil supplies by about 1.1 million barrels per day (b.p.d.), a drop of 1.3 percent.

A US or Israeli airstrike could lead to outright war - "all bets are off," notes Alhajji. Iran might also try to block oil shipments through the Strait of Hormuz, threatening the vital oil exports of Saudi Arabia, Kuwait, and the Gulf States.

The economic stakes are huge for everyone in this quarrel. Aware of this, adversaries are continuing to talk, reportedly including direct discussions between the US and Iran over Iraq.

For Iran, the use of its own oil as a bargaining chip has limited value. Iran gets 90 percent of its government revenues from oil. Its exports of about 2.5 million b.p.d. amount to 80 percent of its total exports. Oil provides some 40 percent of Iran's gross domestic product.

Yet Iran is the only major producer of oil to suffer from a budget deficit. The Iranian public, notes Alhajji, is heavily dependent on government subsidies for staple goods and fuels. From 1980 to 2005, Iran's population grew by 22.4 million and now stands at 68 million. Its daily oil output during that period rose by only 600,000 barrels.

So a cut in oil exports by Iran would be risky at home. "If they are willing to commit suicide, they could do it," says Alhajji.

The blow to the US would not be so severe. Hurricane Katrina shut off 1.5 million b.p.d. from the Gulf of Mexico, but oil prices rose only $10 a barrel. Any Iranian embargo could be countered by more exports from other OPEC nations and tapping the US Strategic Petroleum Reserve.

Alhajji says an Iranian embargo might raise crude prices initially by $20 a barrel before they fell back toward $60.

The result would be an energy crisis in Iran, which depends substantially on imported gasoline from Europe, but not a worldwide threat, predicts Alhajji.

Last week the American Petroleum Institute said US commercial crude oil reserves in February were the highest since May 1999. That sounds reassuring. But Alhajji notes those record oil reserves would cover only three days of imports.

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