Iran over a barrel

William Kucewicz:

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 trillion 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.

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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.

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It would also benefit the Russians who are net exporters. China would have to find other suppliers and it is reasonable to expect that Russia again might be that supplier.