Sign Up

The Amazing U.S. Confusion Over Iran Oil Sanctions

How are U.S. politicians undermining their Iran santions in their pursuit of lower gas prices?

March 27, 2012

How are U.S. politicians undermining their Iran santions in their pursuit of lower gas prices?

Even if the global economy could stomach historically high gas prices, U.S. politicians assuredly can’t: $4 a gallon is at least one dollar more than any presidential candidate can tolerate. Cheap oil, if you listen to the candidates, is a national right for the American consumer.

As a result, many politicians are hoping that inventories prove to be more plentiful than believed, or that producers will magically get their act together in time to fill the shortfalls.

Alas, supply-side fundamentals are diametrically opposed to this. Problems in Yemen and Bahrain could still spread to larger producers in the Middle East, Iraq is struggling to find its post-Saddam feet, Syria is going down with Assad, and Sudan has gone into total shutdown between “North and South.”

Libya could follow suit between “East and West.” Nigeria has taken a turn for the worse in West Africa. While Hugo Chavez is running out of steam in Venezuela, Russia is desperately trying to find a viable oil formula to work under “Putin 2.0.”

Far from being politically emboldened by high oil prices, most producer states are merely looking to hold onto power. They simply aren’t in a position to moderate prices.

The good news seems to be that the Saudis appear to have been stockpiling up to 12 million barrels of international oil storage at ports in Rotterdam, Okinawa and Sidi Kerir, Egypt. That should buy some additional supply volume — and time.

The bad news is that it won’t last very long. Saudi Arabia is already pumping up to 10 million barrels per day to cover Iranian gaps. And in order to live up to the messages to moderate the market, Riyadh has found itself having to re-open fields mothballed 30 years ago. Industry rig counts are reportedly deployed at an all-time high in the Kingdom. Things are basically at full stretch.

The new “unthinkable”

Assuming the United States and the EU persist with Iranian sanctions (they are set to begin July 1), Saudi production will need to hit 11 million barrels a day to cover the Iranian gap. Physical supplies will be very tight, given that the Saudis can only muster 12.5 million barrels per day at the maximum.

With markets that tight, oil will rapidly hit $150 a barrel — and $200 a barrel will become the new “unthinkable.” Meanwhile, call options on oil futures in the U.S.-based commodities exchanges have already hit those levels.

What this means is that all the strain is on Saudi Arabia. That is a dangerous path to tread, because there is no viable alternative for international oil markets beyond Riyadh. It is almost inevitable now that the strategic petroleum reserves of the International Energy Agency (IEA) will provide the last-gasp measure to quell prices. However, the reserves are the wrong short-term tool (695 million barrels) for a long-term problem.

While this is peddled as a “strategic” option, Tehran is hedging, and will continue to hedge, its nuclear enrichment ambitions against the threat of major oil price spikes. Unless Israel triggers a war, this game will go on and on.

In short, the upshot is that the United States has impaled itself economically on its own sanctions due to short-term electioneering. If the United States were truly serious about putting pressure on Iran, the last thing it should be doing is looking for prophylactic measures to soften prices.

In fact, it should be doing the exact opposite: ratcheting up prices (with Saudi help) to force China and India to sever oil ties with Iran to forge a resolution of the nuclear question. Until this Asian-Persian oil link is broken, Tehran will continue to slowly wind down the nuclear clock.

Far from breaking such links, the United States is implicitly cementing them. For all its talk about wanting India and China to drop Iranian oil, Washington will be increasingly happy if Beijing and Delhi continue sourcing Iranian oil and stabilize prices.

That is the only way prices can be kept within a politically tolerable range for Washington. Bluntly put, the United States has badly overplayed its energy independence hand and believed its own messaging.

Back in the real world, we are stuck with production of about 91 million barrels per day, with the 100-million level looking increasingly difficult to reach. Until global supplies start hitting this mark, policy options regarding Iran will remain inherently difficult.

The sanctions logic would require letting prices rise, keeping IEA stocks in their containers and persuading the Saudis to threaten withholding oil from India and China if they don’t sever Persian oil links. That is undoubtedly an economically “aggressive” strategy. But if the United States continues its half-baked approach, all it will get is the worst of both worlds — high oil prices without any discernible effect on Tehran’s nuclear strategy.

So it’s either step things up economically, or totally step out of Iran — unless we really want to find out how much oil the Saudis do or don’t have, or witness how ineffective the IEA has become as stocks hemorrhage on the back of U.S. geopolitical weakness.

The longer the current charade goes on (probably all the way to the U.S. election day in November), the greater the chance of truly catastrophic outcomes playing out in the Middle East. In that event, $150 for a barrel of oil (a.k.a. $5 a gallon gasoline in the United States) will look cheap, very cheap indeed.

Takeaways

If the United States was truly serious about putting pressure on Iran, the last thing it should be doing is trying to soften prices.

The sanctions logic would require letting prices rise, keeping IEA stocks in their containers and persuading the Saudis to threaten withholding oil.

If the United States continues its half-baked approach, it will get the worst of both worlds — high oil prices without any discernible effect on Tehran's nuclear strategy.