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Straits of Hormuz, Iran's Nuclear facilities, oil trade

Is Iran's "Oil Weapon" A Doubled-Edged Sword?

By Arnon Gutfeld, Department of History, Tel Aviv University

Wednesday, February 7, 2007

If the United States organizes effective economic sanctions against Iran or especially if the Bush Administration decides on military action against Iran's nuclear facilities, Iran may try to strike back with its "oil weapon," to suspend oil exports and disrupt oil traffic in the Straits of Hormuz, through which pass about 40% of the world's oil trade. Activation of this threat might push the price of oil as high as $200 per barrel, with unimaginable damage to western and Japanese economies.

Western economies are undoubtedly hostage to some degree to the flow of oil from the Persian Gulf, in general, and from Iran, in particular. At the same time, Iran itself is hostage to massive oil exports in order to sustain its economy and underpin the huge subsidies it provides to the military and civilian society. Between 80 and 90% of Iran's exports and close to 50% of its budget come from oil sales, and without oil exports, Iran would be bankrupt. Even with high oil prices, Iran's economy has recently come under severe strains – inflation, double-digit unemployment, and per capita income levels lower by about 25% that those of the 1970s – and a fall in oil prices, like the drop of about 30% in the last six months, only exacerbates the situation.

Iran has to import about a third of its petroleum. It has been dependent on imported distillates since the destruction of much of its refining capacity during the Iran-Iraq war, and it holds only about 45 days of petroleum stocks. A cutoff of oil revenues would force the government to control and distribute food to the population, to reduce the budget of an army already desperately short of spare parts, and to cut back drastically its support for allies in Iraq, Syria, Lebanon, the Palestinian Authority and various terrorist organizations around the world.

Despite the fact that Iran is the fourth-largest natural gas exporter in the world, declining oil prices signal a serious long-term problem for the country and its political establishment. Oil revenues have provided the Iranian establishment with much of its political influence within the country, because they enable it to provide massive energy subsidies to the population. They also underlie Iran's political influence throughout the Middle East. But the reliability of future oil export revenues is quite problematic. Iran now consumes about 40% of its oil production. Every year brings a drop of about 10% in the volume of exports and predictions are that exports will fall by half by 2010 and virtually dry up by 2015. In the last two years, Iran has been unable to produce the quota allocated to it by OPEC and it has failed to invest the amounts needed to maintain existing fields. A crisis will result from sharp increases in domestic oil consumption, neglected development of new reserve fields and especially the failure to develop or even repair the deteriorating infrastructure of existing fields, which results in the loss of millions of barrels during the production process. Iran desperately needs its current oil revenues and therefore leaves nothing for the National Oil Company to maintain or repair infrastructures. Oil profits are also spent on a series of projects that contribute nothing to recurrent investment in the energy industry.

Consequently, Iran may well need nuclear energy for peaceful purposes. But the Iranian Oil Minister has recently admitted that the growing controversy over Iran's nuclear program has reduced the willingness of banks and other investors to put money into Iranian projects. There is also a general hostility in Iran to foreign investments; a variety of regulations and laws actually alienate potential investors. The United States, through a variety of pressures on potential investors, also deters and prevents investment in Iran.

Some experts believe that Iran will find a way to solve its production problems before the crisis reaches a peak. They point to the fact that oil revenues this year will reach $50 billion and also that Iran has large foreign currency reserves that could find their way to the necessary infrastructure investment projects. The International Energy Agency (IEA) estimates that Iran will need to invest $165 billion in order to meet the oil and natural gas production goals it has set for 2030.

Recently published studies stress Iran's economic vulnerability. Since 1979, the population has doubled; it now stands at 68 million and is growing by half a million per annum. The labor force numbers 22 million and grows at a rate of 3.3% per annum, and Iran needs to produce 700,000 new jobs each year just to maintain its current unemployment rate of 12%.

As a result, the west may actually be better able than Iran to tolerate a shutdown of Iranian exports. Concerns about sanctions or military action against Iran are connected to Iranian threats to send thousands of suicide bombers against coalition forces in Iraq or against the west, to blockade the Straits of Hormuz, or to bomb oil fields in the Emirates or Saudi Arabia. To these are added threats to rain down a torrent of missiles on Israel. These are threats that the United States, the west, and Israel may have to confront sooner or later, and some argue for confronting them sooner rather than waiting for the situation to become even more daunting.

Russia and China have large investments in Iran's oil infrastructure and the United States is working to convince them that the best way to protect those investments is to restrain the Iranian leadership. But as long as Russia and China are not convinced that the U.S. might choose a military option, they will apparently do little to press Iran to moderate its behavior.

If Iran tried to block the Straits of Hormuz and bomb oil fields throughout the Gulf, the results could be disastrous for the Arab countries, for the west, but most of all for Iran itself, and it is not at all clear that Iran would be prepared to risk total destruction. But since such a scenario cannot be categorically precluded, a central question remains: How willing are the United States and other industrialized countries to act in order to reduce their dependency on imported energy from this part of the world?

INSS Insight is published through the generosity of Sari and Israel Roizman, Philadelphia

















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