Wednesday, October 29, 2008

Iran's Oil Shield Slips

Between the US election and the gyrations of the financial markets, some important implications of the declining price of oil haven't received the attention they deserve. A case in point is the effect on Iran's geopolitical posture, particularly with regard to its nuclear program. Many articles have considered the impact of lower oil prices on that country's economy and its influence in the greater Middle East. However, as global demand for oil slows and its price sinks toward $60 per barrel, the effectiveness of Iran's implied threat to suspend oil exports in response to aggressive sanctions or a military strike on its nuclear facilities also erodes. This should create an opportunity for some very assertive diplomacy by the next administration, backed by a much more credible recourse to force. Given the progress of the visible parts of its nuclear program, this could be our last chance to prevent Iran from developing nuclear weapons.

A recent Washington Post op-ed by two former US Senators, one from each party, described the threat posed by a nuclear-armed Iran, along with a set of principles for addressing this challenge vigorously and promptly. Several years ago I took a detailed look at the rationale for Iran to build an entire nuclear fuel cycle for civilian purposes and found it wanting. The world's second-largest natural gas reserves provide it with a much more cost-effective means of generating additional power for its economy, without exposing the country to international sanctions or potential attack. Notwithstanding the findings of a controversial US National Intelligence Estimate last year, the simplest explanation for Iran's tenacity in pursuing uranium enrichment is the option that creates for building nuclear weapons. Nor has the International Atomic Energy Agency been able to gather enough information within Iran to rule out this scenario. This interpretation also aligns nicely with Iran's extensive work on ballistic missiles, which without the extreme accuracy of US missiles looks like a very expensive way to deliver conventional explosives.

Until recently, Iran has held all the cards. With the US focused on wars in Iraq and Afghanistan, Iran successfully played off Russia and China against other UN Security Council members that sought tougher sanctions to back up their diplomatic efforts to halt the nuclear program. And as oil prices went from high to astronomical, the consequences of a disruption in Iranian oil exports became increasingly unbearable and unthinkable for the US and the world economy. While still potentially quite disruptive and hardly to be invited lightly, that prospect looks much less dire today.

Iran exports a bit more than 2 million barrels per day (bpd) of oil. For most of the last four years, that quantity exceeded the sum of global spare oil production capacity, rendering Iran's contribution indispensable. That is no longer the case. Just last week OPEC announced production cuts that could cover all but 900,000 bpd of Iran's exports, with further cuts in prospect. Any shortfall beyond that could be made up from the US Strategic Petroleum Reserve, which could supply the difference for up to two years, if necessary. Oil prices would rise, though prompt releases from the SPR would limit the magnitude of any spike. In other words, if the Iranian government has assumed that the dreadful prospect of an Iranian oil embargo was sufficient to deter any measures strong enough to force them to give up their nuclear program, or to disable it on the ground, they should reconsider. Their ace-in-the hole looks more like a 10 or a Jack, today.

These altered circumstances should not be construed as providing a green light for air strikes on Iran's nuclear facilities. That option should remain a last resort, due to its many adverse consequences beyond oil. At the same time, because this and a number of less-violent steps suddenly look feasible, it might induce Iran to negotiate, prompted by the realization that it has more valuable things at stake than a uranium-enrichment program, including the health of an economy that is critically dependent on oil revenue and on imports of petroleum products that its own refineries cannot produce in sufficient quantity to satisfy domestic demand without rationing. While not exactly a silver lining of the present global crisis, this constitutes an opportunity that Western governments cannot afford to ignore, because its consequences will endure long after the present financial and economic problems have been resolved.

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