Foreign Policy Blogs

Is Treating Iran as a “Rational” Actor Pushing Oil Prices Higher?

Strait of Hormuz. Washington Post

Over the weekend, Chairman of the Joint Chiefs of Staff Martin E. Dempsey commented that at this stage the U.S. did not believe Iran had decided to pursue the development of nuclear weapons per se and that it was a “rational” actor. Obviously, this assessment is based on Iran’s past behavior and I tend not to disagree. What it does not tell us is anything about Iran’s future behavior. The international community is putting more and more punitive measures in place. The annualized inflation rate hit 19.1 % (according to the latest Central Bank of Iran (CBI) release) by the end of the Persian month of Mehr (Sept. 23 – Oct. 22, 2011) and shortages in some goods and services are a daily reality. All these measures and the resulting economic hardship within Iran does not make Iran more likely than before to seek a negotiated settlement of the nuclear issue. We should actually view the rising price of oil as a direct and calculated result of Iran’s “rational” behavior.

Given the economic hardship and the need to reallocate subsidies in the domestic economy, Iran, which holds the world’s fourth-largest proven oil reserves and the world’s second-largest natural gas reserves and according to the EIA, exported 4.2 million barrels of crude oil per day in 2010. The country is still very much dependent on high oil prices. Thus, a “rational” actor in Iran’s shoes would use rhetorical saber- rattling to stir up tensions and fear in the oil market to increase its only real source of revenue. Today, crude oil futures for April 2012 delivery traded intraday at a nine-month high- up nearly 4 % to $106.24 (NYMEX). The national average price of a gallon of gasoline is continuously heading higher and may soon hit $4 and up.

Many commentators argue climbing oil prices underscore the oil market’s jitters about disruptions to Iranian supplies. Liam Denning, for example, discussed in his WSJ article that besides Iran blocking the Strait of Hormuz – a key world oil transit choke-point- other possible supply disruptions due to geopolitical risks such as South Sudan’s dispute with Sudan, the unrest in Syria, the volatile political situation in Iraq, and riots and strikes in Kazakhstan, are all eating away at daily world oil production and tightening the global oil supply further. Indeed, such volatility can lead at least to temporary higher prices.

However, this is exactly what the Iranian regime has in mind: namely, only an imaginary supply disruption to drive up prices further while still being able to export its crude oil. The Iranians are smart enough to understand that any challenge to the peaceful maritime system and free international trade in the Strait of Hormuz would be met with the naval capabilities of the United States– the guarantor of the maritime global common, thereby securing open sea lanes necessary for international trade– and it would be an unnecessary self-inflicted wound.

Only a total loss of Iran’s 4.2 million barrels per day of oil production (data from EIA, Nov. 2010) – which would be a hit to global supplies in itself– and an accompanying loss of revenue for the Iranian regime over an extended period of time would turn Iran into an “irrational” actor. As far as the EU embargo is concerned, we should expect Iran to offer its “new” free capacity to India or China, thus redirecting its oil but not removing it from the market.

In sum, if we continue playing this high-stakes game without realizing how strategic the Iranians are playing the game, the West will pay a very high price. I do not only mean the price of oil but the price we may pay economically with a possible relapse into recession given the state of the world economy and the fragile U.S. recovery. Now, some might argue that the Iranians will pay dearly too. Unfortunately, this is only half right; the Iranian population has become used to years of economic hardship. Their government made a deliberate decision to go down the nuclear path, which shows Iran’s commitment.

The United States has no interest in having its slow and fragile economic recovery derailed, especially not in an election year. The Keystone pipeline project however, might even become an interesting topic in the U.S. presidential debates later this year if gas and oil prices remain high over the summer. The solution? In general, the best “solution”, depending on what your goal is, for the Iranian problem would be a lower oil price, maybe around $70 a barrel. Lower oil prices could create more problems in many countries in terms of financing subsidies to keep their populations politically at bay given how dependent some oil-exporting countries are on their respective energy sectors for financing their budgets. Moreover, the U.S. should contemplate tapping its Strategic Petroleum Reserve with a capacity of 727-million-barrels.

 

Author

Roman Kilisek
Roman Kilisek

Roman Kilisek is a Global Energy & Natural Resources Analyst.
His research focuses on global energy politics, mining, infrastructure and trade, global political risk and macroeconomics. He is fond of using scenario development and analysis.

He has lived on three continents and traveled to over 40 countries around the world. He now lives and works in New York City.

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