The Oil Shield, FP may/june 2006


The Oil Shield

By Christopher Dickey (Newsweeks Paris bureau chief and Middle East editor).

Iran is commanding the world’s attention as the ayatollahs accelerate their race for the bomb. But the timetable for talks—or a nuclear crisis—is not being shaped by centrifuges, uranium, or reactors. It’s about the security only a barrel of oil can provide.

The poster for the recent George Clooney film Syriana, a tale of complex intrigue surrounding a fictional oil emirate, shows a bound and blindfolded CIA agent with the words “Everything is connected” emblazoned on the duct tape that gags him. The movie is a confusing pastiche, but that adage is worth remembering, especially when considering the ongoing crisis over Iran’s nuclear program.

For almost four years now, efforts by Europe and the United States to curb Tehran’s nuclear designs have vacillated between threats and appeasement. In February, after much intense, highly publicized diplomacy by Britain, France, Germany, and the United States, the board of governors of the International Atomic Energy Agency (IAEA)—including Russia and China—was persuaded to report Iran to the U.N. Security Council. The move seemed to raise the threat of sanctions, yet all parties were quick to call such talk premature. As diplomacy continued, so did the pace of Iran’s nuclear research, opening the prospects for chronic confrontation that could last years with no clear resolution.

Why the hesitation to take stronger action? One reason is certainly that China and Russia have been reluctant partners in the business of pressuring Tehran. China expects to sign long-term agreements for Iranian oil worth an estimated $100 billion. Russia is building nuclear reactors in Iran for which it is receiving billions of dollars as well. But the West, including the United States, has an even stronger and more direct incentive to talk instead of act: Any misstep in the campaign to deter Iran from developing nuclear technology that might be used for an atomic bomb could lead to an explosion in the cost of oil.

The Iranians know that, of course, and as soon as President Mahmoud Ahmadinejad took office in August, the regime began performing as if a higher law—supply and demand—would protect it no matter how much it provoked the international community. As Iran’s delegate to the IAEA, Ali Asghar Soltanieh, said bluntly in March, Tehran estimates that “the United States has the power to cause harm and pain, but the United States is also susceptible to harm and pain. So if that is the path that the U.S. wishes to choose, let the ball roll.”

The basic arithmetic is simple. There is just barely enough oil in today’s market to meet the global demand for about 85 million barrels a day. With almost all oil producers pumping every drop they can get out of the ground or from under the sea, a margin of roughly 1.5 million barrels a day is left over. Iran exports about 2.7 million barrels a day. If an international embargo, a military attack, or a political decision in Tehran took that Iranian oil off the market, prices could well soar from the current price of around $60 a barrel to $90 a barrel or higher. Adjusted for inflation, that would equal or surpass the oil shocks of 1973 and 1979. Painful indeed.

“There are no sanctions on the oil sector in Iran that will not hurt the whole world at the same time,” says Pierre Terzian, founder of the Paris-based group Petrostratégies. One of the most influential oil industry analysts in the United States, who asked not to be quoted by name, agrees: “Right now, the Iranians are in a strong position and they know it. The tight market and high prices provide them not only with a shield but with the high cards. It gives them leverage they didn’t have a couple of years ago.” And while the threat of an oil shock deters strong action against Iran, the income generated by current prices gives the regime huge amounts of cash with which to woo foreign support. “The Europeans, especially, will not put up with $100-a-barrel oil,” says Abbas Milani, director of the Iran program at Stanford University. At the same time, he said, “the Chinese will not give up their $100 billion deal. The Russians will not give up billions on nuclear reactors.”

But Iran’s leverage isn’t likely to last. Supply and demand—and Saudi Arabia—will see to that. The current high prices encourage oil-producing countries to ramp up production wherever possible, while discouraging some of the growth in consumption. The Saudis, meanwhile, have begun a strategic program to boost not only their production but their control over that thin margin of spare capacity in the global market that gives them a huge influence on prices.

For many years, in times of crisis, the Saudis could literally turn on the taps to stabilize world prices. After the terrorist attacks on the United States in 2001, and during the buildup to the invasion of Iraq in 2003, they did just that. Since then, however, the Saudis have fallen behind the curve. Consumption surged in China, India, and Southeast Asia. Production in Iraq, which was expected to increase after the invasion, actually declined dramatically in the midst of the unexpected insurgency. Unrest in Nigeria and labor strife in Venezuela occasionally disrupted supplies.

In 2005, the Saudis launched a $50 billion program to reassert their power in the markets. By the summer of 2009, they expect to increase their overall production capacity from 11 million barrels a day to 12.5 million barrels, which should restore their ability to keep about 3 million barrels in reserve. When that happens, world oil markets will be much less vulnerable to a drop in Iranian oil exports; Iran will be much more vulnerable to international pressure. “There’s a window of opportunity of two or three years, not more, for this ‘oil protection,’” says Terzian.

So Iran is in a hurry to push ahead with its nuclear program before its oil shield is lost. The current crisis began last year, when it decided to end the voluntary freeze on its nuclear enrichment activities that had been negotiated with Britain, France, and Germany. “We were forced to fight the Europeans’ policy of wasting time,” Iranian Foreign Ministry spokesman Hamid Reza Asefi told a news conference in March. (When that deal was first negotiated, the price of oil was $30 a barrel; when it was rejected, the price was at $50; when enrichment activities actually recommenced this year, the price stood at $60.)

“Iran has made some sort of calculation, of which oil is a part, that they can win,” says David Albright, a physicist and former weapons inspector who now runs the Institute for Science and International Security in Washington, D.C. But what is winning? Is the goal to have a nuclear weapon for its own sake? Or to attack Israel, as Ahmadinejad’s many intemperate statements suggest? Or, is the objective of the Iranian regime essentially to assure that the reign of the ayatollahs continues, using the nuclear threat, among others, as a means to that end?

Tehran’s course is designed to cover the regime with a diplomatic shield, or a nuclear one, or both, before the oil shield is weakened. Iran’s former nuclear negotiator, Hassan Rohani, recently cited India, Israel, North Korea, and Pakistan as countries that have nuclear weapons, or claim to, and are protected as a result. The clear implication was that Iran hopes to join those ranks, even if it says it has no intention of building a bomb. (Most likely it will become a “virtual” nuclear weapons state, known to have the ability to produce an arsenal even if it chooses not to, believed to have the bomb, even if it never tests it.) “The regime talks in terms of red lines, and I don’t think giving up the nuclear program is a red line they would pass,” says Milani. “They see it as the sine qua non of their survival.”

The reign of the ayatollahs in Iran, the oil-production capacity of Saudi Arabia, the stabilization of Iraq, the proliferation of nuclear weapons around the world: Everything is, indeed, connected.

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