Pakistan Observer

Iran stalemate and oil price

A R Chowdhury

Wednesday, February 08, 2012 - TENSIONS between the United States and Iran these days are as high as theyíve ever been in years. With Iran threatening to block US ships from entering the Persian Gulf, and the United States imposing sanctions, the stage seems to be set for a protracted confrontation.

Add to this, fears that Europeís new embargo on Iran, set to start in July, could spark tensions in the region; also the increased likelihood that Israel could launch an attack on Iranís underground nuclear facilities over the next few months.

So how would the world cope with an Iranian oil crisis, if it came to that?

The West wants to prevent Iran from developing a nuclear weapon. The plan, for now at least, is to use sanctions as pressure hoping that the resulting economic pain might induce the Iranian regime to give up any thought of a weapons programme.

The Iranians, not surprisingly, donít like being squeezed. The latest sanctions idea is to make it hard for Iran to sell its oil. In theory, that should hurt as the country depends heavily on oil revenue.

What weíre seeing around Iran right now is largely an economic war. Despite the military overture of the stalemate, whatís happening with Iran may be more of an economic confrontation than a military standoff. Even Iranís military threats have economic significance; the more the Iranians talk about closing the Strait of Hormuz, the more oil traders get unnerved. Oil prices jump. Forcing oil prices up is a way to hurt the US and European economies.

So what impact will the current stalemate have on the oil price in the international market? The main driver of global oil prices so far this year has been concern about the potential disruption to supplies from the Middle East as a result of tensions with Iran. Going forward, I can think of three possible scenarios: a gradual tightening of economic sanctions on Iran, an escalation of the crisis to a military conflict, or, more positively, a reduction in tensions if Iran scales back its nuclear ambitions.

The immediate focus is the tightening of economic sanctions. In principle, sanctions against Iran could result in the withdrawal of a significant amount of supply from global markets thus raising the price of crude oil in the international market.

However, the impact on global prices is likely to be diluted by three main factors. First, sanctions will only be implemented gradually and with plenty of room to maneuver. Second, a gradual tightening of sanctions would allow more time for the market to adapt.

Saudi Arabia has signalled that it has ample spare capacity to help meet any shortfall while Libyan production continues to come back on stream more quickly than many had anticipated. In the meantime, the threat of EU sanctions may well force Iran to accept lower bids from other buyers, notably China, thus putting downward pressure on global prices.

A third factor that is not so widely discussed is that European countries, and particularly the southern economies who currently trade most with Iran, are likely to require less oil anyway as the region slides back into recession.

The upshot is that we would see the first scenario (a gradual tightening of sanctions on Iran) as broadly neutral for global oil prices. But this situation is also unlikely to be sustainable because of the huge pressure that the loss of oil revenues would put on the Iranian economy, which is already fragile. The issue then becomes which way the Iranian regime would jump.

The worst case is that Iran decides it has little more to lose and attempts to disrupt supplies through the Strait of Hormuz. This could lift the price of Brent crude oil in the international market as high as $150 per barrel from the current price of about $110, although only temporarily. But neither side would want tensions to spiral this far out of control. The Iranian regime is very unlikely to seek a military conflict that ultimately it would be sure to lose, not least given the huge suffering of its people during the war with Iraq in the 1980s. The US, especially under a Democratic President, will talk tough in an election year, but will not want to risk another spike in oil prices either.

I therefore eventually expect Iran to make sufficient concessions for sanctions to be eased. This would add to the downward pressure on oil prices from weakening global demand and a worsening of the crisis in the euro-zone, with Brent crude oil price ending this year at around 100 US dollars per barrel.

How would this affect Bangladesh? If international oil price stays at the current level, I donít see any additional adverse effect on our economy. However, the possibility of an escalation of tension in the Middle East is always there. If that happens, all bets are off! Courtesy - TDS.

[The writer is a Professor and Chair, Department of Economics Marquette University. E-mail: abdur.chowdhury]

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