More trouble looms for Iran

From Commentry Magazine, 4June 2012, by Emanuele Ottolenghi:

When OPEC meets later this month for its ministers’ summit, price-hawk Iran will confront a new reality – for the first time since the beginning of international sanctions against the regime in Tehran, oil prices are in free fall.

In the last few days, Brent Crude is finally trading below $100, a barrel benchmark. Crude traded at the New York Mercantile Exchange was trading today around $83 a barrel.

For Iran, this is bad news.

For years, the regime was able to somewhat cushion the combined impact of externally imposed sanctions and self-inflicted economic mismanagement thanks to high oil prices. No more.

There are several reasons why prices are falling ...

...Global economic slowdown influenced prices downward significantly. The steady expansion of Iraqi output is another game changer. The nearly completed recovery of Libyan oil is a significant psychological barrier that is now coming down to ease the pressure on markets. And last, but not least, a new pipeline designed to bypass the Strait of Hormuz is about to come online in the United Arab Emirates. The pipeline will reduce export costs for oil produced by Abu Dhabi and avoid exposing it to the hazards of an Iranian attempt to seal the Strait in the event of a conflict.

Another element is that sustained price hikes, over time, encourage further exploration because, at such prices, extraction of crude in remote locations becomes lucrative. Eventually, more oil comes into the market, affecting supply upward and contributing to price reduction. Finally, markets have discounted risk by moving away from Iran’s oil, even before the EU-imposed oil embargo sets in on July 1. Proof that Iran’s oil is less relevant to global markets is the fact that Iran’s oil production is actually declining, with no significant impact on pricing.

All this means that oil prices are likely to remain low and likely to leave Iran in a pickle.

After all, Tehran is already finding it difficult to export – it is selling at a discount to a number of customers who have difficulty paying or fear political repercussions of doing business with Iran. It is accepting yuan and rupees payments from China and India – an element likely to limit Iran’s ability to use the revenue for anything other than purchasing products on the Indian market. Looming sanctions on oil exports and on insurance and reinsurance of crude carriers will corner Iran more and more – probably forcing Tehran to offer further discounts to prevent further flight among its customers.

And here’s the rub. Iran’s budget is pegged to an $85 a barrel oil price.

With prices below that benchmark and Iran having to offer further discounts or being dragged into barter agreements to avoid dollar payments that could trigger U.S. sanctions, it is very likely the regime will have less and less funds available to keep its power base happy.

Trouble is brewing then, and offering a facile compromise on nuclear matters to this regime at this juncture would be a terrible mistake. Sanctions are slowly working – but we should keep using them less to extract an impossible deal and more to undermine the regime in Tehran.