Sunday, January 28, 2007

Reverse Oil Weapon?

There was a great article in the December 26, 2006 edition of the Proceedings of the National Academy of Sciences by Roger Stern that has largely flown under the political radar in Washington. Using open-source, non-Farsi materials on the Iranian oil industry, Stern explores Iran's argument for developing nuclear power in the face of its vast oil resources. His thesis is that the declining productivity of Iran's state-controlled oil industry and the exploding costs of domestic energy subsidies will cause its oil exports to completely evaporate somewhere between 2012 and 2022. Iran, therefore, does has a significant interest in pursuing nuclear energy to stave off this inevitable economic crisis in Tehran.

The report is short, but pretty wonky. Stern's math is pretty solid and his case is fairly convincing given how badly the Ahmadinejad administration has bungled oil politics in Tehran over the past year and a half. The article's only weakness is that it assumes that the Iranian government won't make the difficult choice of cutting domestic fuel subsidies when push comes to shove on the budget. Analysts said the same thing about Indonesian President Susilo Bambang Yudhoyono's administration back in 2005, but he managed to cut his country's substantial fuel subsidies twice without too much trouble.

That being said, the most intriguing part of the article, however, is the author's musings an American 'oil attack' on Iran:

Iran's petroleum crisis is a strategic opportunity. Unless price increases, export erosion seems likely to reduce the regime's monopoly rent stream. Such a dynamic seems propitious for some policy to compound the regime's self-inflicted problems. A nonviolent, economic attack on monopoly price is such a policy.

A price attack implies measures that would erode market power and hence reduce price. Market power exerted through OPEC investment restraint is responsible for most of the difference between the $4- to $10-per-barrel competitive price and market price, which has been much higher for most of the past 33 years. This difference underwrites the Islamic Republic, the need for U.S. force projection in the Gulf, and many other security problems (4). An analogous target in a military campaign would be an adversary's industrial capacity. Market power should be understood in this way, as inseparable from the threats it underwrites but also more vulnerable.

A price attack implies forced adoption of fuel-efficient technology by importing states. The resulting fuel efficiency (f-e) improvement would have to reduce demand by enough to force cartel producers to defend price, which they would do by reducing supply. Equitable sharing of supply cuts is an inherent problem for any cartel that lacks an enforcement mechanism for market sharing agreements.


The most efficient policies to force f-e would be fuel taxation, cap and trade mechanisms (for horsepower, emissions, or miles traveled), or fleet f-e standards. Given what appears to be a decreasing price elasticity of gasoline demand in the U.S., some combination of standards and taxation might be most successful. The burden of new taxation could be partially offset by reductions to payroll or other taxes. Although the optimal price attack policy cannot be known, present U.S. energy policy is nonoptimal in that it ignores price. Energy policy has been adopted in response to the imaginary problem of oil dependence (4), which has reduced it to a quest for tax preferences by domestic producers.

Whatever policy might be adopted to mount a price attack, light-duty vehicles (LDVs) would be the source of most demand reductions because they are the least efficient among all oil-demand technologies. Unfortunately, Americans are not savers, new car consumers least of all. Indeed, car consumers may discount f-e savings almost to zero. Yet, although f-e may be unattractive to consumers, a policy to force adoption would be akin to a mandatory savings plan like social security but with higher returns.

I think this is the first time that someone has ever explicitly tied energy conservation together with foreign policy and national security. I don't know if the federal government could change conversation policy rapidly enough to impact Tehran, while at the same time minimizing its impact on U.S. economy. One thing's for sure though, this conservation-foreign policy link is definitely a lot more rational than the old "energy independence" meme.

This kind of puts those over-the-top "driving SUVs supports terrorism" commercials made by Americans for Fuel Efficient Cars in a whole new context though.

1 comment:

Siddharth said...

Thought you'd find this news item interestinng...

Iran to prepare 'shadow budget' for emergencies

Wednesday, February 07, 2007 - ©2005

Related Pictures

LONDON, February 7 (IranMania) - Iran has said it was drafting a parallel budget for next year, which would come into force in the event of an "extraordinary incident" affecting its heavily oil-dependent economy, AFP reported.

The so-called "shadow budget" assumes an oil price of less than $30 a barrel, compared with $33.7 in the actual budget proposed by President Mahmoud Ahmadinejad in January for the new year starting March 21.

"We are preparing a shadow budget based on the oil price of under $30 per barrel in case an extraordinary incident happens on the international arena," the deputy head of state-run Management and Planning Organisation, Ali Askari, told reporters Tuesday.

He did not specify what such an incident might involve.

Falling global crude prices are a major concern for Iran at time when the UN Security Council has imposed sanctions on Tehran for its refusal to suspend sensitive nuclear activities.

The sanctions are targeted not to affect the wider economy but the United States has threatened to tighten up the penalties if Iran does not comply. It is also pressuring European banks to limit their dealings with Tehran.

Although Washington emphasises the standoff should preferably be solved through diplomacy, it has also never ruled out military action to thwart Iran's nuclear programme.

Askari said that the budget was based on economic growth reaching about 7% in the coming year compared with the current year's predicted rate of 5.7%.

Unemployment is predicted to be 10.6% next year, compared with 11.3% this year while the (official) inflation rate is predicted to fall from 12% to about 11%, the official added.

Ahmadinejad has promised to use only oil export income from a 33.7 dollars per barrel oil price for the annual budget, with any surplus revenue saved in a stabilisation fund to back the economy in case of oil price fluctuations.

Even with that low base price, MPs and analysts believe such accounting only works on paper and fear that the government will inevitably use more oil revenues for current expenditure by dipping into the stabilisation fund.

Askari put the withdrawal from the Oil Stabilisation Fund (OSF) in the current Iranian year so far at $21.2 bln, covering three supplementary bills beyond the original budget.

He added that there was a fourth bill still awaiting parliamentary approval.

"In the last month (December 2006), the fund held $1.3 bln. In the next year, the budget has only foreseen (withdrawals of) $10.6 bln from the OSF (for current expenditure)," Askari added.

Ahmadinejad's second annual budget has come under heavy criticism for being unrealistic.

But Askari defended the government's economic policies.

"The budget bill is only a prediction and not definitive. We do not predict any additional budget for now and the government is expecting not to make any new decision ... but if necessary, we will have to do something."

Experts argue that revenues from taxes, bonds and privatisation are less than half than budget predictions in the current year, explaining why the government has had to look for money beyond the original budget.

Iran's economy is heavily dependent on oil revenues, which account for 80% of total export earnings and cover more than 50% of the state budget.