Tag: oil

Iran’s Economy, With and Without a P5+1 Agreement

The haggling between Iran and the so-called P5+1—the permanent members of the United Nations Security Council, plus Germany—is scheduled to come to a close on Monday, November 24th. The two parties each want different things. One thing that Iran would like is the removal of the economic sanctions imposed on it by the United States and its allies.

After decades of wrongheaded economic policies, Iran’s economy is in terrible shape. The authoritative Economic Freedom of the World: 2014 Annual Report puts Iran near the bottom of the barrel: 147th out of the 152 countries ranked. And the “World Misery Index Scores” rank Iran as the fourth most miserable economy in the world. In addition to economic mismanagement, economic sanctions and now-plunging oil prices are dragging Iran’s structurally distorted economy down. So, it’s no surprise that Iran would like one of the weights (read: sanctions) on its economy lifted.

Just how important would the removal of sanctions be? To answer that question, we use the Institute of International Finance’s detailed macroeconomic framework. The results of our analysis are shown in the table and charts below the jump.

Oil Price Blues (Read: Dangers) for Some

As the price of crude oil continues its downward tumble towards $80 per barrel, I am reminded of a similar scenario from near the end of the Cold War in the 1980s. When Saudi Arabia announced in 1985 that protecting oil prices was no longer its main priority, oil production surged and prices fell off a cliff, briefly plunging below $10 per barrel, as I had correctly predicted.

Lower prices delivered a fatal blow to the Soviet economy, which ended up seeing $20 billion per year in oil revenues evaporate. The resulting fiscal shortfalls proved to be a dagger in the heart of the U.S.S.R.

On October 1st of this year, Saudi Arabia’s national oil company announced that it had abandoned a policy of price protection and would start to focus on protecting its market share. Combined with falling global demand and rising supplies elsewhere, oil prices have fallen accordingly. This has put a squeeze on eight of the world’s top oil producers. States like Iran, Venezuela, and Iraq can only balance their current budgets at oil prices ranging from $110 to $135 per barrel (so-called break-even prices).

If oil prices stay below $90 per barrel for any length of time, we will witness massive fiscal squeezes and regime changes in one or more of the following countries: Iran, Bahrain, Ecuador, Venezuela, Algeria, Nigeria, Iraq, or Libya. It will be a movie we have seen before.

Falling Oil Prices Put Producers Between a Rock and a Hard Place

Over the last few months, the price of Brent crude oil lost over 20% of its value, dropping below $90 just yesterday and hitting its lowest level in over two years. In consequence, oil producers will no longer be able to rely on oil revenues to pay their bills. The fiscal break-even price – a metric that determines the price per barrel of oil required for a nation to balance its budget at current levels of production – puts the problem into perspective.

Using data from Bloomberg and Deutsche Bank, I prepared a chart showing the break-even prices for the world’s major oil producers and the price on Brent crude. Over the past six months, Brent crude fell far below the break-even price for eleven of the top oil producers in the world; Iran, Venezuela, Nigeria, and even Saudi Arabia can no longer finance their governments’ largess through oil revenues.

The combination of oil markets flying into a perfect storm and excessive government spending puts most of the world’s oil producers between a rock and a hard place, where they will stay for some time.

U.S. Trade Policy Attacks U.S. Energy Policy, Both Hurting

First there were oil and gas export restrictions, then pipeline injunctions, now import restrictions on the steel needed for exploration and extraction.  Washington is coming from all angles to kneecap the energy boom sparked by the horizontal drilling and fracking revolutions – a once in a generation supply-side shock, which otherwise promises to attract a flood of foreign investment and serve as a wellspring of economic growth and job creation.
 
The most recent assault on our “All of the Above” energy policy comes via our fantastically self-destructive trade policy. Last Friday, in a final antidumping determination, the U.S. Department of Commerce found exporters from nine countries to be dumping “Oil Country Tubular Goods” (OCTG) – a class of steel products used primarily in oil and gas well projects – in the U.S. market. The most important foreign source of OCTG in the case was South Korea, whose exporters were found NOT to be dumping in the preliminary determination issued back in February.
 
But in the intervening months, the U.S. steel industry and the Congressional Steel Caucus impressed upon the bean counters at Commerce that the methodology they used for the Korean preliminary determination was inferior to an alterative they favored.  Without getting too into the weeds here, as tends to happen when exposing the dishonesty of the antidumping regime, suffice it to say that the revision from 0% dumping margins to 10%-16% for Korean exporters was primarily the result of Commerce changing its estimate of what the home market profit rate “should be.”
 
For the preliminary determination, that estimate was based on Korean OCTG producers’ experiences (with OCTG and other products).  For the final determination, Commerce changed its estimate to one based on a University of Iowa graduate student’s estimation of the profit experience of a single Argentine OCTG producer named Tenaris.  That’s right!  The cost of steel for U.S. oil well projects will rise – maybe 16% – because some student was messing around with @functions on Microsoft Excel.
 

Climate Impact of the Keystone XL Pipeline

After a couple of months during which larger issues were grabbing headlines, the Keystone XL pipeline is back in the news again.

Recall that in the fall of 2011, Congress attempted to force the Obama Administration to come to some sort of a decision on the pipeline—a project that would deliver oil from Canada’s Alberta tar sands to a pipeline junction in Steel City, Nebraska and then ultimately on to refineries in Illinois and along the Gulf Coast. President Obama rejected the pipeline application in January 2012, citing the Congressional deadline as being too tight to allow for a thorough assessment. TransCanada Corporation, the pipeline’s operator, last September proposed a new route through Nebraska which avoided the environmentally sensitive Sand Hills region which was one the largest local environmental concerns of the originally proposed pipeline route.

The rumors were that this new proposed route, and the promise of new jobs and economic activity, were now tipping the administration in favor of the giving the go ahead to the pipeline.

Last Wednesday, the New York Post reported that EPA head Lisa Jackson (a vocal opponent of the pipeline) was stepping down in a huff because she was convinced that Obama was soon going to green-light the project.

Last Friday, Nebraska’s Department of Environmental Quality released its study of the new route and proclaimed that it could have “minimal environmental impacts in Nebraska” if properly managed and that construction of the pipeline would result in “$418.1 million in economic benefits and would support up to 4,560 new or existing jobs in the state,” (though some jobs would be temporary) and annual local property tax revenues of between “11 million and 13 million” for the first year of evaluation. The U.S. State Department is conducting its own report because the pipeline will cross the U.S./Canada border. That report is expected any day now.

Yesterday, a group of protestors stormed the TransCanada offices in Houston, Tx, chaining their ankles, and for added measure, apparently supergluing their hands together. A statement from the group said that they were “representatives of a desperate generation who have been forced into this position by the reckless and immoral behavior of fossil fuel corporations such as Transcanada.” Bill McKibben’s 350.org is organizing a much larger-scale protest for Washington, D.C., and the White House next month.

The outcry is not really about local environmental concerns, but as NASA’s James Hansen (who himself was arrested outside the White House back in 2011 protesting the pipeline) put it, if the pipeline is built it will be “game over” for the climate.

With all this outcry, just how bad for the climate do you think the pipeline (or rather it contents) will be?

Argentina’s Point of No Return

The most important development this week in Latin America is the decision of the Argentine government to seize control of Yacimientos Petrolíferos Fiscales (YPF), the country’s largest oil company. On Monday, President Cristina Fernández de Kirchner announced the expropriation of the controlling stake of YPF that is owned by the Spanish company Repsol. The Spanish government, backed by the European Union, has announced that it will take retaliatory measures against Argentina, noting that “all options are on the table.” The Economist Intelligence Unit has a very good analysis on the case and the implications for Argentina.

The big question after Fernandez’s overwhelming reelection last fall was whether she would deepen the economic model she and her late husband (and predecessor) implemented since arriving to power in 2003—marked by high government spending, tight economic controls on industries, and selective nationalizations of businesses—or instead change course given the growing signs of exhaustion: high inflation, growing fiscal deficit, increasing capital flight, fall in foreign direct investment, the weakening peso, etc.

Any doubt is now gone. With the nationalization of YPF, Argentina firmly joins Venezuela, Ecuador, and Bolivia in the club of Latin American nations that espouse high-octane economic populism. In the upcoming months, we can expect more protectionist measures, further controls on the economy and, once the government runs out of the money that it seized in the past three years from the private pension funds and the Central Bank’s reserves, we should not be surprised if it moves to take control of the banks.

Things will only get worse for Argentina.

Iran’s Bluster and Weakness

Iran this week punctuated 10 days of naval exercises in the Strait of Hormuz and threats to close it with a warning to U.S. Navy ships to stay out of the Persian Gulf, which requires passage through the strait. The tough talk may have temporarily juiced oil prices, but it failed to impress militarily. Recent news reports have cited U.S. military officials, defense analysts, and even an anonymous Iranian official arguing that Iran likely lacks the will and ability to block shipping in the strait. That argument isn’t new: Iran’s economy depends on shipments through the strait, and the U.S. Navy can keep it open, if need be. What’s more, the Iranians might be deterred by the fear that a skirmish over the strait would give U.S. or Israeli leaders an excuse to attack their nuclear facilities.

The obviousness of Iran’s bluster suggests its weakness. Empty threats generally show desperation, not security. And Iran’s weakness is not confined to water. Though Iran is more populous and wealthier than most of its neighbors, its military isn’t equipped for conquest. Like other militaries in its region, Iran’s suffers from coup-proofing, the practice of designing a military more to prevent coups than to fight rival states. Economic problems and limited weapons-import options have also undermined its ability to modernize its military, while its rivals buy American arms.

Here’s how Eugene Gholz and Daryl Press summarize Iran’s conventional military capability:

Iran … lacks the equipment and training for major offensive ground operations. Its land forces, comprising two separate armies (the Artesh and the Islamic Revolutionary Guard Corps), are structured to prevent coups and to wage irregular warfare, not to conquer neighbors. Tehran’s air force is antiquated, and its navy is suited for harassment missions, not large amphibious operations across the Gulf. Furthermore, a successful invasion is not enough to monopolize a neighbor’s oil resources; a protracted occupation would be required. But the idea of a sustainable and protracted Persian Shi’a occupation of any Gulf Arab society—even a Shi’a-majority one like Bahrain—is far-fetched.

Despite Iran’s weakness, most U.S. political rhetoric—and more importantly, most U.S. policy—treat it as a potential regional hegemon that imperils U.S. interests. Pundits eager to bash President Obama for belatedly allowing U.S. troops to leave Iraq say it will facilitate Iran’s regional dominance. The secretary of defense, who says the war in Iraq was worth fighting, wants to station 40,000 troops in the region to keep Iran from meddling there. Even opponents of bombing Iran to prevent it from building nuclear weapons regularly opine on how to “contain” it, as if that required great effort.

Some will object to this characterization of Iran’s capabilities, claiming that asymmetric threats—missiles, the ability to harass shipping, and nasty friends on retainer in nearby states—let it punch above its military weight. But from the American perspective—a far-off power with a few discrete interests in the region—these are complications, not major problems. Our self-induced ignorance about Iran’s limited military capabilities obscures the fact that we can defend those interests against even a nuclear Iran at far lower cost than we now expend. We could do so from the sea.

The United States has two basic interests in the region. The first is to prevent oil price spikes large enough to cause economic trouble.  Although it’s not clear that an oil price shock would greatly damage the U.S. economy, we don’t want to chance it. That is why it makes sense to tell Iran that we will forcibly keep the strait open.

Iranian nuclear weapons would merely complicate our efforts to do so. For safety, both naval ships clearing mines there and tankers would want Iranian shores cleared of anti-ship cruise missiles and their radars, although doing so is probably not necessary to keep strait cargo moving. The possibility of nuclear escalation makes attacking those shore-based targets tougher. But the risk of escalation is mostly Iran’s. By attacking U.S. ships, Iran would risk annihilation or a disarming first strike. Given that, it is hard to see how nuclear weapons make closing the strait easier.

The second U.S. goal in the region is to prevent any state from gathering enough oil wealth to extort us or build a military big enough to menace us. The vastness of our military advantage over any combination of Middle Eastern states makes that fairly easy to prevent. The difficulty of Iran credibly threatening to stop exporting the chief source of its wealth makes the problem even smaller. Indeed, the odds of Iran becoming an oil super-state by conquest are so low that we probably do not need to guarantee any nearby state’s security to prevent it. For example, if Iran swallowed and magically pacified Iraq, the resulting state, while a bad thing, would create little obvious danger for American safety or commerce. Still, if we did defend Iraq’s borders, carrier-based air power along with Iraqi ground forces would probably suffice to stop Iranian columns at the border. The same goes for Kuwait and Saudi Arabia.

Because threats of nuclear attack better serve defensive goals, an Iran armed with nukes would not meaningfully change this calculus. Iran’s neighbors would not surrender their land just because Iran has nuclear weapons, if history is any guide. And U.S. guarantees of retaliatory strikes could back them up, if necessary. Nukes might embolden Iran to take chances that a state worried about invasion would not. But the difficulty of subduing a nationalistic country of 75 million people already deters our invasion.

The current contretemps with Iran is no reason for “maintaining our military presence and capabilities in the broader Middle East,” as the secretary of defense would have it. Removing U.S. forces from Iran’s flanks might strengthen the hand of the Iranian minority opposed to building nuclear weapons, though it is doubtful that alone would be enough to let them win the debate anytime soon. But even if Iran does build nuclear weapons, we can defend our limited interests in the region from off-shore.

Cross-posted from the the Skeptics at the National Interest.