Thursday, January 5, 2012

The Costs of Playing Chicken with Iran

The West is pleased at the thought that the pain of tightening economic sanctions on Iran to punish for its reported development of atomic weapons appears to be bearing fruit.  Otherwise, how to explain Tehran’s increasingly aggressive statements to close the strategically important oil chokepoint Strait of Hormuz, which transited nearly 17 million barrels of oil per day in 2011, and threats against US ships in the Persian Gulf. 

But tightening the noose around Iran’s petroleum sector may ultimately miss the West's main goal, and worse, backfire on its fragile economies, beginning of which was already felt at the gas pumps.  As the second largest OPEC oil producer, Iran’s daily supply of 450,000 barrels to the European Union (EU) would clearly find its market in Asian customers, China and India.  A response of oil markets to the possible supply disruption from Iran was a jump in prices on January 4, 2012.  Brent crude reached $113.97 on January 4, 2012, highest since November 14, 2011, with a prospect to rise further as EU draws closer to implementing the sanctions. 

In the given situation, Western countries seem to be as irrational as the Iranian government (further proof of uselessness of the rational actor theory), as their choices of action are hardly rational at the time of delicate domestic economic recovery and a multitude of colossal debt crises.  While stable (read - low) oil prices are not necessarily guarantors of economic growth, economists caution that a sudden rise in oil prices had preceded nine out of previous 10 recessions in America.  According to a 2000 report by the International Monetary Fund, “a $5 permanent increase in oil prices cuts world GDP growth by 0.25 percent over the first four years. But the impact on the U.S. was a larger 0.3 percent, reflecting this country’s high per-capita energy use.”  Given a possible economic backlash from sanctions on Iran, can the US afford to bite the bullet and survive the high oil prices?  It does not look like it can afford it right now.

Further, the West’s reliance of Saudi Arabia’s excess capacity and growing production from Libya and Iraq to salvage the situation is a hard bet.  Recovery of production capacities of post-war Libya and Iraq are inevitably subject to existential domestic political and security threats, raising the specter of their uncertainty as reliable suppliers in the short to medium-term.  Meanwhile, an OPEC swing producer, Saudi Arabia, faces close to 7 percent growth per year in domestic demand for oil and gas.  The Joint Organizations Data Initiative (JODI), which provides official oil output numbers from its 90 member-countries, shows that Saudi Arabia “produced 9.4 million barrels a day of oil (mbd) in October 2011 and consumed 2.0 mbd.”  Although the Kingdom indicated it could produce up to 12.5 mbd, it is unlikely that it can maintain this production level for a long time. 

Lastly, economic sanctions to punish an enemy can yield some results, but often are less than effective.  According to a 1992 study of the US Government Accountability Office (GAO) on 27 cases of post-World War I economic sanctions “the measures are more successful in achieving the less ambitious and often unarticulated goals [...] however they are usually less successful in achieving the most prominently stated goal of making the target country comply with the sanctioning nation’s stated wishes.”  Given that the sanctions by the United Nations and Western countries have been directly aimed at forcing Iran to suspend its nuclear enrichment program, it is unlikely that falling short of that goal would be acceptable to the West, while Iran is increasingly defiant and provocative.  But it is also not likely that an escalation of the conflict to a point of war or risking the economic recovery with high oil prices would be acceptable and economically affordable to the West either.   

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