Playing the oil card
Iran and the U.S. agree on one thing: Oil is the ultimate weapon.
NEW YORK (FORTUNE Magazine) - Washington and Tehran don't agree on much these days. But in their conflict over Iran's nuclear program, both seem willing to use oil as a political weapon.
The U.S. believes that sanctions on Iran's energy exports might force Tehran to renounce its uranium-enrichment ambitions. Iran hopes its threats to withhold some or all of those exports will persuade the international community to back off.
If the two sides can't agree on who would be punishing whom by playing the oil card, the likelihood of diplomatic resolution may be even more remote than is commonly accepted.
One thing is certain: A substantial reduction in Iran's energy output - whether pushed or pulled from the market - would have a significant impact on global oil prices. Iran is the fourth-largest oil exporter in the world, behind only Saudi Arabia, Russia, and Norway. It sells more than 2.5 million barrels a day and is believed to have about 10 percent of the world's proven reserves. Many analysts say a supply cut could combine with other market pressures (explosive demand growth in China and India, unrest in Nigeria, concerns that this year's hurricane season will again damage U.S. refinery capacity) to quickly drive prices up to $80 to $100 a barrel.
Is either side bluffing? Iran's threat to pull oil off the market is not an empty one, in part because the regime has few other weapons at its disposal. It has the means to foment greater unrest in Iraq or to use its Hezbollah and Palestinian allies to strike at Israel.
But Tehran won't be able to openly claim credit for either of those indirect forms of protest. Iran's leaders - who want to visibly assert their defiance of the West, rally badly needed domestic support for the regime, and divide international opinion - have only the country's energy exports with which to influence the outcome of the diplomatic conflict.
Of course, were Iran to completely cut off its oil supply, it would badly damage its own economy. The country earns half of its revenue and more than three-quarters of its hard currency from oil. In addition, a total shutdown would harm many of Iran's friends (such as China), though it would also increase oil income for those who are net exporters of oil (such as Russia and other OPEC members).
But there are a number of incremental steps Iran can take that would rattle those who depend on affordable energy without sinking its own economy. If Iran cut 200,000 to 300,000 barrels a day, oil markets would react not only to the fall in supply but also to fears of what Tehran might do next.
The U.S. isn't bluffing either. Although Iran is a net exporter of oil, it is a net importer of refined products. Washington calculates that if it could cut off the supply of those products, including gasoline, Iran would be unable to build new refineries quickly enough to keep pace with growth in the country's demand, estimated at more than 5 percent a year. And a boycott of Iranian exports, it figures, would hurt Iran more than it would hurt the U.S.
Iran is unlikely to use its oil weapon first. But if the U.S. were to impose punitive measures - either through the United Nations Security Council or with a smaller coalition of nations - Iran would probably retaliate. And if a limited supply cut failed to ease international pressure, Iran could up the ante by cutting off supplies to a U.S. ally, as Oil Minister Kazem Vaziri-Hamaneh warned last month when he said that Iran might "reconsider its oil contracts with other states."
One possible target: resource-poor Japan, which imports 16 percent of its crude from Iran. Japan's largest oil explorer, Inpex, signed a $2 billion deal with Tehran in 2004 to develop Iran's Azadegan field, which is believed to contain the world's second-largest oil reserve. The Japanese government owns 36 percent of Inpex and hopes that the firm's investment in Iran will provide it with 260,000 barrels of crude a day by 2012. Iran's Islamic Republic News Agency has hinted that the contract could be transferred to China.
Then there is Iran's trump card. If Tehran believes that a U.S. or Israeli air strike against one of its nuclear facilities is likely, it might well stage military maneuvers in the Persian Gulf to remind the world that it can obstruct the flow of 20 percent of the planet's oil supply at the strategically vital Strait of Hormuz. Such a threat was recently made by Interior Minister Mostafa Pourmohammadi and, if followed through, could interrupt the global supply chain and trigger a sharp and immediate spike in oil prices.
Iran can't afford to take such steps lightly. A supply cut not only damages Tehran's bottom line but also limits its ability to head off economic instability. And a blockade in the Gulf could be interpreted as an act of war.
Nevertheless, Iran takes both the UN Security Council, which has urged it to suspend uranium-enrichment activities, and the threat of military action seriously. It is now more likely than at any time since the controversy began to use its oil as a weapon.
Some analysts argue that it is less dangerous for Washington to simply accept a nuclear Iran than to risk the damage that sharp Iranian production cuts - or Iranian retaliation against a U.S. or Israeli military strike - might do to U.S. interests. After all, Iran is unlikely to ever fire a nuclear missile, particularly at Israel, which could be expected to respond in kind.
But the Bush administration fears that Iran might use its nuclear program to assert political dominance in the region and sell nuclear material and expertise to other states, and possibly to terrorist groups. It's also concerned that other Middle Eastern countries (Saudi Arabia, in particular) might feel compelled to go nuclear, and that if the current regime in Tehran were to collapse under the weight of its domestic unpopularity, Iran might lose control of its nuclear assets, sending them flooding onto the international black market.
The U.S. will continue over the next several months to try to push sanctions through the Security Council. But the council is increasingly unlikely to impose them. China imports more than 11 percent of its crude oil from Iran and has considerable commercial interests in Iran's gas sector. Russia has extensive trade ties with Iran, especially in the arms trade and the civilian nuclear business. Either can veto any resolution, and both are likely to resist U.S. pressure for a vote for as long as possible.
If the Bush administration decides it cannot use the UN process to compel Iran to back down, it will probably look for other levers of political and economic coercion, including attempts to recruit a "coalition of the willing" that is prepared to temporarily cut energy and other commercial ties with Tehran. The success of such a coalition strategy would depend on the number of countries willing to join. About half of Iran's current production comprises high-sulfur crude oil that requires significant refinery capacity. If Iran were able to discourage states with such capacity to resist U.S. pressure, it could simply redirect much of its output in their direction.
Iran and the U.S. have agreed to face-to-face talks on the situation in Iraq. Although Iran says its nuclear program will not be on the agenda, the U.S. is sure to broach the subject and to search for any slack in Tehran's bargaining position.
It is unlikely to find any. Iran's willingness to talk has more to do with efforts to convince a domestic audience that it has become the go-to power on regional issues and to show that U.S. attempts to stabilize Iraq aren't going well.
When the nuclear subject is raised, the two sides are likely to reiterate their mutually exclusive positions, raising the danger that the meeting could end up hardening mutual mistrust. Though they agree that oil makes for an effective weapon, Tehran and Washington don't see eye to eye on anything else. And that's bad news for those who hope to head off substantial upward pressure on oil prices.