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Comment | Iran's Economy: Once More to the Precipice

by ANDREW SCOTT COOPER

16 May 2012 23:53Comments

"We're broke. Everything seems doomed to grind to a standstill, and meanwhile many of the programs we had planned must be postponed."

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Andrew Scott Cooper is the author of The Oil Kings: How the U.S., Iran and Saudi Arabia Changed the Balance of Power in the Middle East. Dr. Cooper has worked at the United Nations and Human Rights Watch. He holds advanced degrees in history and strategic studies from Columbia University, the University of Aberdeen, and Victoria University.
[ comment ] In January 1977, with those fateful words, the last emperor of Iran, Mohammad Reza Shah Pahlavi, described the devastating impact of collapsing oil revenues on the Iranian economy and his own monarchy. Two weeks earlier, Saudi Arabia had announced that it would rather flood the market with cheap oil than allow OPEC, led by the Shah, to enact a higher price. In the confusion that ensued, Iran's oil production plummeted 38 percent, or two million barrels a day, in just nine days. By the summer of 1977, Iran had lost billions in oil revenues. The government was forced to implement a harsh austerity budget that ruined businesses, put thousands of people out of work, and shook middle-class confidence in the regime's ability to manage the economy. In October, the first street protests that heralded the fall of the monarchy erupted in Tehran.

Now, 35 years later, an abrupt plunge in Iran's oil exports comes as a stark reminder that the men who succeeded the Shah have apparently learned nothing from his downfall. The golden rule of Iranian politics has not changed: oil remains the greatest source of strength, but also the Achilles' heel of the Iranian state. The survival of the Islamic Republic, like the Peacock Throne it replaced, is still far too dependent on economic forces beyond its control.

The Shah's successors have repeated another of his tactical errors by underestimating the willingness of their regional rival Saudi Arabia to use oil as a weapon to break the back of the Iranian economy. This should come as no surprise to the mullahs. In a hard-hitting speech delivered last year to NATO officials in Britain, Prince Turki al-Faisal, the former head of Saudi intelligence, explained that Iran's heavy reliance on a single stream of income left the regime in Tehran vulnerable to manipulation of the oil markets. The Saudis, he affirmed, were quite prepared to unleash their vast oil reserves to drive down the prices that paid for Iran's petro-boom, financed its nuclear program and generous state subsidies, and subsidized pro-Iranian militias throughout the Middle East.

One year later, how close are the Saudis to following through on Prince Turki's threat to flood the market? How well placed is Iran's economy to withstand a protracted economic war with the world's most important oil producer and exporter?

The answers to these questions are not as straightforward as they might appear. Oil production statistics, especially for Saudi Arabia, often lack precision. The pricing fluctuations of recent years have left even seasoned analysts scratching their heads. Are prices being driven by supply and demand, by speculation, or by political risk factors -- or by a combination of all three? Regardless, industry analysts concur that something very unusual has been going on of late in the oil markets:

* Saudi Arabia is producing more oil (9.9 million barrels a day) than at any time in the past 30 years. Saudi Arabia is "firing on all cylinders," reports Fortune, deliberately flouting its OPEC production quota and even drilling "retired oil patches to squeeze out any extra oil that might still be underground."

* The Saudis have opted not to sell all their surplus production on the open market but instead stockpile most of it at home and in the United States, which curiously is taking "the lion's share" of the Saudi production increase, according to Reuters. This is despite the fact that U.S. demand for imported oil fell this year, as it has fallen sharply each year of the Great Recession.

Stockpiling oil when prices are high is "economically counterintuitive," observes the Financial Times. So what is going on here? If the Saudis do not intend to take the oil to market, and if the Americans do not intend to consume it, what do they intend to do with it?

Then there is Iran. In the aftermath of the latest round of punitive sanctions imposed by the West, Iran's oil-dependent economy is slowly but inexorably facing strangulation. The country is now so financially isolated that its banks and businesses are blocked from moving money in or out of the country. The ripple effects are being felt throughout Iranian society. Unemployment and inflation are rising. The national currency is in freefall. Poverty is on the increase. Family incomes are falling.

Most ominously in a country where oil pays for 55 percent of the national budget -- which is predicated on oil not falling below $90 a barrel -- Iran's petroleum sector is in shambles. Customers of Iran's heavy-grade fuel oil have quietly reduced their purchase orders lest they be accused of breaching the U.S.-led sanctions regime. The European Union ban on imports of Iranian oil, which formally takes effect July 1, will impact about a quarter of Iran's total export earnings from oil. Countries in Asia, including China and India, have not only sharply cut back their orders of Iranian oil, they are haggling for a cheaper price.

So far, at least, President Mahmoud Ahmadinejad has compounded the scale of the unfolding fiscal catastrophe by stubbornly refusing to acknowledge the economy is in crisis. "Our economy does not have any problem," he recently declared. The president also insisted that Iran was still on target to earn $90 billion in oil revenues this year. Yet a recent poll of oil traders concluded that Iran could lose a staggering 50 percent of its oil revenues in 2012.

Perhaps as a result of the president's official denial, Iran's national oil company has not significantly reduced production to adjust to the abrupt collapse of its market share. It is also very expensive to close down and then restart petroleum facilities. The result: Iran's land-based petroleum storage facilities are brimming with an estimated 23 million barrels of unsold oil. Millions more barrels of oil are being housed aboard giant tankers that prowl the world's sea lanes "with nowhere to go."

The strategic objective seems to be to make Iran's economy scream. A senior U.S. Treasury official recently observed that Iran is "increasingly isolated -- diplomatically, financially and economically.... The value of their currency, the rial, has dropped like a rock. That has had a significant impact on Iran's ability to pay for materials for the nuclear program, and, more broadly, it puts pressure on the leadership."

While it is true that the Islamic Republic of 2012 is a very different place from the Shah's Iran of 1977, it is equally true that no country -- let alone one with a sullen and increasingly impoverished urban populace -- can withstand for long an assault on its primary revenue stream without experiencing a degree of social unrest and political discontent.

The last time the Saudis intervened in the oil markets was in 2008. Fearing the collapse of U.S. banks and financial networks, President George W. Bush appealed to King Abdullah to open the spigots and offer price relief to Western consumers. In the last six months of 2008, the price of a barrel of oil plunged from $147 to under $35, dealing a massive and unexpected financial blow to Iran.

Although Ahmadinejad's government absorbed the losses, the outbreak of anti-regime protests the following year suggests a causal link between turbulence in the oil markets, economic distress, and social and political unrest. It was a lesson the Shah learned to his bitter regret 35 years ago. To paraphrase economist Jahangir Amuzegar, the Islamic Republic -- like the monarchy it succeeded -- still rests on "oily legs."

Iran cannot keep stockpiling oil forever -- but then neither can the Saudis. At some point, one side will call the other's bluff. The Iranians may soon be forced to sell their stockpiled millions at a discount. The Saudis may decide to flood the market with their own stockpiled oil at exactly the same time to magnify the scale of Iranian financial losses.

In my next column, I will discuss the Saudi side of the ledger. Over the past year, some oil industry analysts have speculated that the Saudis have lost their ability to swing the oil markets and influence prices as much as they would like to. The emergence of other energy producers in South America and Central Asia leads them to question Saudi Arabia's petro-power. Other experts question whether Saudi Arabia can afford to lose the billions of dollars in oil revenues that would result from a flooded market at a time when the kingdom has gone on one of the biggest spending sprees in modern history.

For the Iranians, much will hinge on if, and when, the Saudis decide to make their move.

related reading | 2012 Iranian Oil Survey | Iran Business Expert: 'Crisis Shaking Foundations of Social Order' | To Survive: Hope Hits the Bottom Line

Copyright © 2012 Tehran Bureau

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