Would Iran Use The Oil Weapon?

With WTI at $70/barrel or above and US retail gasoline at $6/gallon, Iran could use its oil as a weapon in the event of UN sanctions or US attack. Ian Bremmer, president of the Eurasia Group and a senior fellow at the World Policy Institute wrote in the International Herald Tribune of Aug. 27 that developed nations' reliance for energy on some of the world's most politically volatile states - Iran, Venezuela, Russia, Sudan - creates ideal conditions for "extortion" which favour "some of the world's most unsavory regimes".

From Wal-Mart's CEO blaming lower-than-expected earnings on rising energy costs to reports that the IMF foresees high oil prices helping to dampen growth prospects for the eurozone, more and more analysts are warning that only the timing and the scale of the impact are now in doubt. Bremmer saw two reasons that oil had become an effective weapon. First, there is very little spare production capacity in global oil markets. Both OPEC and major non-OPEC countries are producing at close to full tilt. Global markets are likely to remain tight for at least the next two or three years, and Chinese energy demand will continue to rise sharply. Even small interruptions in output put disproportionate upward pressure on oil prices. Second, "petro-states are rethinking their assumptions about the elasticity of global demand for oil". When oil sold for $30/b, they accepted the conventional view that substantial price hikes might lower demand - and hurt their bottom lines - as importing states actively looked for new sources of oil, energy alternatives and other ways to cut fossil-fuel consumption. Now that oil sells for well above $65/b, without a sharp drop in demand so far, energy exporting states are changing their minds.

Bremmer said: "Some now believe they can push the price still further and increase profits without a drop in demand. The danger is that these factors make it much more likely that an oil producing state with a political axe to grind will cut output to certain customers (or at least threaten to do so), essentially take a small amount of oil off the market, and profit from the resulting price hike. This sharply increases the market power - and political leverage - of oil-exporting states, even for marginal producers. That makes diplomatic disputes with these countries more difficult to resolve. In fact, it's already happening".

Iran's new President Mahmoud Ahmadi-Nejad says he mistrusts Western states and that Iran will continue to develop its nuclear programme. Bremmer warned that if Iran was referred to the UN Security Council, it "may threaten to divert oil exports away from countries that support the United States (Japan and Britain, in particular)". Iran's Supreme Leader Ayatollah Ali Khamenei "may be less interested in market stability than in achieving political and security goals". Bremmer added: "So when Iran says it has options if the Bush administration chooses to escalate the conflict, it may well be right. Of course, if Iran overplays its hand, it raises the probability of a US or Israeli strike on an Iranian nuclear facility. That eventuality would certainly push oil prices higher. Even if it becomes obvious that energy prices are slowing global growth, there may be little oil-dependent states can do in the short term..."