Energy and a Nuclear Iran
The Islamic Republic of Iran has a new President, and he seems fully committed to seeing Iran's nuclear program through. This is hardly surprising, given the "bipartisan" support that nuclear power apparently enjoys in Iran, but it is still worrying. I recently wrote an analysis of Iran's nuclear ambitions for Geopolitics of Energy, a Canadian energy journal. The complete text of the article follows. Note that this is much longer than my usual postings.

APRIL 2005/GEOPOLITICS OF ENERGY
An Energy Perspective on Iran's Nuclear Program by Geoffrey Styles

Although the controversy over Iran’s alleged development of nuclear weapons has featured prominently in the news, the interplay between this issue and the global energy industry has generally been neglected. This is surprising, considering Iran’s status as the second largest oil producer and exporter within OPEC. There are two aspects of the relationship between Iran’s nuclear program and the energy industry that merit further consideration. The first deals with the positioning of nuclear power within Iran’s energy portfolio, while the second relates to the unique leverage that current oil market conditions give Iran in withstanding international pressure. Taken together, they suggest that the world could soon have to reckon with a nuclear-armed Iran.

An Odd Choice
Iran makes an unusual candidate for civilian nuclear power, compared to other countries with nuclear power. Most of these fall into either of two categories: those that lack other energy resources to support their economies, such as France, Japan and South Korea, and resource-rich countries that developed nuclear power as a consequence of their pursuit of nuclear weapons, including the US, former USSR, UK, and arguably China. Blessed as it is with hydrocarbon reserves, Iran does not fall into the former category, and it claims not to fall into the latter. Does it represent a unique case?

The dichotomy described above can be attributed at least in part to the large development costs associated with nuclear power plants, compared to their fossil fuel alternatives. For example, the capacity cost for a current-generation nuclear plant is between $1400 and $2000/kilowatt(1), while a natural gas combined cycle plant can be built for approximately $600/kW of capacity(2). That means that a 2,000 MW nuclear complex would cost between $2.8 and $4 billion, even though the same electricity could be produced by a gas turbine plant costing around $1.2 billion. In a country with limited capital for investment, this difference translates into less generating capacity being built over time.

Advocates of nuclear power would argue that fuel savings largely offset the high upfront costs of nuclear power over the life of a plant. Where natural gas is expensive, this would indeed be true. But natural gas is so plentiful in Iran that a more apt comparison would simply add the investment cost of developing another natural gas field for dedicated power plant supply to the cost of the combined cycle units.

At a conservative heat rate (3) of 7,000 BTU/kW, such a power plant would consume 336 million cubic feet per day of natural gas, requiring a gas field on the order of 3 trillion cubic feet (TCF) to supply it. If Iran’s finding and development cost for gas is under $.50 per thousand cubic feet, as seems likely, then the incremental capital component for gas supply would be below $1.5 billion, bringing the total gas-fired equivalent of a nuclear power plant to $2.7 billion, slightly below the low end of the nuclear estimate.

While this simple comparison might seem unfair, because it omits the costs of pipelines and other gas infrastructure, it also leaves out the much more substantial costs of nuclear fuel processing plants, spent fuel reprocessing plants, and waste storage facilities, all part of the complete fuel cycle Iran is building. In short, on the most favorable basis possible, nuclear power is more expensive than natural gas-based power, in a gas-rich country like Iran.

The Displacement Argument
A more sophisticated argument for nuclear power relies on using nuclear plants to support Iran’s hydrocarbon economy by freeing up oil or gas that could be exported to earn hard currency. The validity of this argument hinges on whether Iran’s oil and gas industry is running short of reserves or the ability to develop them.

Iran’s domestic energy consumption has been growing steadily. From a total energy consumption of 1.5 quadrillion BTUs (quads) in 1980, Iranian domestic energy use has expanded to almost 6 quads by 2002 (4), for an average growth rate of about 6% per year over this period. In fact, Iran now consumes over a third of its oil production of 3.9 million barrels per day (MBD), leaving only 2.5 MBD for export (5), though the consumption figure includes some petroleum products that are exported from Iran’s large refineries.

In spite of higher domestic use, Iran seems in no danger of running out of oil. From 1980 to 2003 its reported oil reserves grew from 58 billion barrels to 90 billion barrels, jumping again to 125 billion barrels in 2004 (6). This puts Iran’s reserves in the same league as Iraq’s, near the top of the list for both OPEC and the world as a whole. Iran is also attracting investment from a diverse group of countries to develop these resources. This includes Japan, which is helping develop the giant Azadegan field, and France’s Total and Italy’s ENI, each with stakes in major oil and gas projects (7).

In addition, as Iran’s energy consumption has grown, much of the incremental demand has been met by natural gas. While accounting for only 15% of energy use in 1980, gas now covers 45% of Iran’s total energy needs (8) and continues to expand, as well it should. Iran’s natural gas reserves, at 940 TCF (9), are second only to Russia’s and would last 350 years at current rates of production. These reserves have attracted China’s interest, resulting in a $100 billion commitment for future LNG sales (10).

From a purely economic perspective, Iran’s investments in nuclear power must be considered in competition with investments to develop its ample untapped oil and gas reserves. Iran’s finding and development costs for oil and gas must certainly be lower than the average of those facing the international oil companies, which operate in increasingly difficult geological and political environments. As a result, though lacking the actual figures known by the Iranian government, it is hard to imagine that the implied cost of natural gas displaced from the electricity sector by nuclear power would compete with incremental gas development.

Considering its resource base and the relative costs, Iran’s best alternatives for energy development consist of new oilfields for exports, new gas fields to fuel combined cycle power plants, and new gas fields to fill LNG export plants. In short, Iran’s assertion that it needs nuclear power to support its energy needs does not stand up to scrutiny.

Other Reasons
There are two other possible rationales for pursuing nuclear power, beyond weapons development. The first relates to reducing greenhouse gas emissions. Climate change has become an issue of global importance, and the ratification of the Kyoto Treaty by Russia in late 2004 put the treaty into effect in those countries that had previously ratified it. Unsurprisingly, Iran is not on this list (11).

In fact, much of Iran’s present and future economy remains tied to energy sources that emit large quantities of greenhouse gases, both in their production and ultimate consumption. While a growing body of environmentalists is coming to the realization that climate change may be a bigger environmental concern than nuclear power, which emits no greenhouse gases, this argument would not be very credible coming from Iran.

Another motivation that cannot be dismissed so lightly is national prestige. There is probably a large component of this in Iran’s nuclear power ambitions, going back to the time of the Shah. However, there are better and cheaper ways to raise prestige than building nuclear power plants and a complete nuclear fuel network. As The Economist recently noted, “The only real difference between a civilian nuclear-fuel cycle and a military nuclear fuel cycle is one of intent.” (12)

What If It Is A Duck?
In considering Iran’s nuclear program, it is important to learn some lessons from the recent experience with Iraq. In hindsight, Saddam Hussein’s post-UNSCOM program for weapons of mass destruction was a Potemkin village, a combination of external bluff and internal corruption. Therefore, it is vital to consider alternative explanations for “obvious” facts. A beast that waddles and quacks like a duck is not always a duck.

At this juncture, the evidence of a covert nuclear weapons program masquerading as a civilian nuclear power program is entirely circumstantial. The same evidence might support a scenario based on the logic of Iraq’s Ba’athists, that it is beneficial to have one’s neighbors believe one will soon have genuine WMD capabilities. But as Saddam learned to his chagrin, engaging in a "shell game" with inspectors from the International Atomic Energy Agency can be hazardous. Although it is understandable that the Iranians might feel threatened by US rhetoric and wish to safeguard their expensive equipment, drilling tunnels and moving centrifuge parts around the country (13) only increases international uncertainty, rather than decreasing it. This is exactly the wrong thing to do, unless there really is a clandestine weapons program that needs to be hidden.

From an energy and economic perspective, however, as discussed above, the visible parts of Iran’s ostensibly civilian nuclear program do not make a great deal of sense. Even divorced from Iran’s record in regional politics and its support for terrorism, the energy picture alone is sufficient to raise suspicions that Iran’s intent may be other than its leaders have stated. If these suspicions are indeed correct, then it is essential to understand just what leverage the US and EU might have over Iran, and vice versa, and much of this depends on the energy markets.

In negotiating with Iran, there are two main threats that could be brought to bear, in addition to an array of possible incentives. The first threat is that failure to open up the entire country to inspection will be met with military action. This is the same threat that was made with Iraq, and because that threat was executed in 2002, the ability of the US and its allies to carry out a similar campaign in a larger, more populous country has been greatly diminished.

In the Iraq War the US government apparently assumed that its combat forces would only be engaged for a relatively short time, replaced post-victory by coalition forces, regional forces, or a reformed Iraqi army. Instead, most of the combat power of the US remains committed to Iraq and to Afghanistan for years to come. Short of attacking Iran from Iraq, and thus risking the hard-won gains of the Iraq War, there appear to be few military options beyond air strikes. Their effectiveness would be reduced by the degree to which Iran has dispersed its nuclear facilities, and they might not be worth the attendant political costs.

The more credible threat would appear to be economic sanctions. However, the US has had economic sanctions in place against Iran since the 1980s, and they have been effective mostly against US companies, because their foreign competitors weren't under such constraints. Little impact on Iran is apparent. Any action to restrain Iran would have to be multilateral and strongly enforced, although the prospect of UN sanctions is complicated by the growing relationship between China and Iran, which includes energy, arms and consumer products (14).

Even if the European Union were willing to join the US in imposing sanctions and cutting off its substantial trade in oil and goods, the likelihood that such a threat could be carried out without Iran resorting to some form of oil export embargo is low, and all parties must surely understand this. Could the world do without Iran's oil and gas just now, if international sanctions were imposed? The current alignment of global oil supply and demand make such a disruption almost unthinkable. Iranian leverage over global crude oil markets is at a 25-year high.

Three years ago the global energy supply could and did lose production equal to Iran's without creating a severe price spike. When Venezuela's oil workers went out on strike, eliminating 2.3 million barrels per day of oil exports, other producers quickly filled the gap. Prices went up for a few months, and then came back down. Since then, though, the combination of rapid demand growth, persistent production problems in several countries, and a conservative approach to new oil investments has eliminated that cushion.

Incremental global crude oil production capacity is near zero, reflected by prices for West Texas Intermediate crude over $50, and Iran's leaders know this. They also remember the events of 1979, when the loss of Iranian exports as a result of the Islamic Revolution sent oil prices to levels that have not been matched since, in real dollars. Given a $50 dollar per barrel starting point, it is not so hard to imagine another Iranian embargo sending prices to $80 or even $100, at least until strategic reserves were tapped and markets rebalanced.

So far, the global economy has been remarkably resilient in the face of large demand-driven oil price increases, largely because it is much less leveraged to oil as an input for economic activity than it was thirty years ago. But at some level, the impact would become severe, particularly for developing countries, some of which still subsidize petroleum products for their population.

There is no denying that international economic sanctions and an oil embargo in response would exact a large cost on Iran. But just as high oil prices have raised the stakes of such an action for all parties, they have also enhanced Iran’s ability to weather such an economic storm for a period of time. Several years of higher-than-average oil prices have built up the country’s foreign exchange reserves and kept external debt low (15).

Nor do incentives appear to offer the solution, considering that Iran’s Foreign Minister was recently quoted as saying that no incentive can replace Iran’s legal right to use nuclear technology (16).

The largest uncertainty in this mix may be the potential internal political consequences of a confrontation with the international community over nuclear development. Would Iran’s reformers close ranks with the ruling mullahs or seize the opportunity to evict them from office? How would the population react? The answer seems inherently unknowable, as the post-invasion experience in Iraq suggests.

Learning to Live with It
With the negotiating options of the US and EU hampered by threats that either lack credibility or invite a trumping response, is there any real alternative to acquiescing and simply hoping that Iran’s leaders are serious when they say they have no interest in nuclear weapons? In the short run, perhaps not. And if Iran is in fact closer to achieving a functional nuclear weapon than anyone suspects, the short run could be the whole game.

In the longer term, however, time is not on Iran’s side. History suggests that high oil prices will lead to both greater energy efficiency and to new production capacity, either of conventional oil or unconventional alternatives, such as oil sands and renewable energy. Any combination of higher production and lower demand that restored a capacity cushion of 2-3 million barrels per day would not only ease prices, but also undermine Iran’s negotiating strength.

In addition, every positive development in Iraq, including the expansion of Iraq’s trained military and police forces, restores a bit of credibility to the military threat, by turning the US troop presence in Iraq from a liability into a strategic asset.

Considering how these balances might shift over the next several years, the best current option appears to be playing for time. The current US/EU “carrot and stick” approach can thus be successful, even if it does not result in the desired concessions from Iran. Simply remaining engaged and postponing the timing of any international crisis over Iran’s nuclear development opens up degrees of freedom that don’t exist today.

This approach may turn out to be nothing more than an updated version of the subtitle of the classic 1960s film, “Dr. Strangelove, Or How I Learned To Stop Worrying And Love the Bomb.” (17) However, all the other obvious approaches rely on either a much greater degree of certainty about Iran’s intentions than anyone currently possesses, or a larger appetite for enduring substantial economic pain than is evident in either Brussels or Washington, D.C.

Footnotes

1 “The Economics of Nuclear Power”, Uranium Information Centre, Ltd., October 2004.
2 “GridWiseTM: The Benefits of a Transformed Energy System”, Appendix A, Table A.1 “Generation Scenario Assumptions and Sources”, Pacific Northwest National Laboratory, September 2003.
3 Siemens Westinghouse website, Combined Cycle Plant Ratings.
4 Energy Information Agency, US Department of Energy, International Energy Annual 2002, Table E1 “World Total Primary Energy Consumption”.
5 Energy Information Agency, US Department of Energy, “Top Petroleum Net Exporters 2003”.
6 Energy Information Agency, US Department of Energy, “World Proved Crude Oil Reserves, January 1, 1980-January 1, 2005 Estimates”.
7 Energy Information Agency, US Department of Energy, “Country Analysis Brief, Iran”, March 2005, 5-7.
8 op. cit., Table 2.4 “World Dry Natural Gas Production, 1980-2002”.
9 Oil & Gas Journal, December 20, 2004.
10 op. cit., 20.
11 UN Framework Convention on Climate Change website, “Kyoto Protocol Status of Ratification”, 19 April 2005.
12 “A World Wide Web of Nuclear Danger,” The Economist, February 26, 2004.
13 Elaine Sciolino and David Sanger, “Pressed, Iran Admits It Discussed Acquiring Tools for Nuclear Arms”, New York Times, February 28, 2005.
14 Frederick Stakelbeck, “The Growing Tehran-Beijing Axis”, In the National Interest, January 2005.
15 International Monetary Fund, “IMF Concludes 2004 Article IV Consultation with Islamic Republic of Iran”, Public Information Notice No. 04/109, September 27, 2004.
16 “No economic incentive can replace Iran’s rights”, IranMania News, http://www.iranmania.com/, March 15, 2005.
17 Dr. Strangelove, Dir. Stanley Kubrick, Columbia, 1963.