Whatever its accuracy, a newspaper story about a menacing comment by Iran’s new president underscores an economic verity too frequently forgotten when oil prices are high: It’s very difficult to make money from oil by not selling oil.
The Khaleej Times of the United Arab Emirates on Oct. 1 quoted Iranian President Mahmoud Ahmadi-Nejad as saying his country might refuse to sell oil if the United Nations Security Council pressed scrutiny of Iran’s nuclear program. The International Atomic Energy Agency soon will forward its finding that Iran has not complied with the Nuclear Nonproliferation Treaty.
Question marks
Almost immediately, according to an Oct. 3 account by the Financial Times, the story sprouted question marks. Ahmad-Nejad’s office denied that he had been interviewed by the UAE paper but didn’t dispute the incendiary quotes. The newspaper said confusion might have arisen because the writer of the article in question was a contractor who usually worked for another publication.
In any event, mere speculation about loss to the oil market of Iran’s 2.6 million b/d or so of exports is troubling. Idle production capacity, now less than 2 million b/d, wouldn’t cover so large a deficit. To balance the market, oil would have to pour out of storage, and demand would have to fall. Prices would rise from already high levels, further straining economies of oil-consuming countries buffeted by more than 2 years of oil price increases.
To Iran, or any other major exporter wanting to shake up global affairs, the currently strained oil market is ripe for manipulation. And with international pressure growing over its nuclear program-which few observers outside the Islamic Republic consider benign-Iran must feel strong temptation to strike back. Yet striking back means not selling oil. And not selling oil means not collecting oil revenue.
Iran can’t afford that. In 2005, according to the US Energy Information Administration, oil revenue accounted for 80-90% of the Islamic Republic’s total export earnings. It funded 40-50% of the government’s budget, in chronic deficit despite high oil prices because Iran tranquilizes domestic politics with deep food and fuel subsidies. To cover the swelling costs, the government is preparing to tap cash reserves earmarked for other purposes. It’s unlikely to trim the expensive subsidies because doing so would provoke riots.
Would a country in this kind of fiscal strait give up $130 million/day in oil revenue to make a political point? Stranger things happen, of course. That they sometimes do explains the expenses consuming countries incur to maintain strategic oil inventories, which can certainly outlast Iran’s need for money.
Iran isn’t the only oil exporter that might consider assaulting the economies of consuming nations with price hikes manufactured by production cuts. It just provides a handy illustration of the no-sale, no-money principle because it’s a major exporter perennially at odds with western consumers and the only one recently to let the oil weapon’s hilt show. The formula works universally, though: Oil not sold equals revenue not collected. Few oil exporters can afford not to collect oil revenue for very long. And most of them understand that along with the short-term sacrifice of forgone cash flow comes the long-term loss of markets for their oil.
Suspicion of manipulation
The principle applies as well below country scale. During the oil crises of the 1970s, newspaper reporters spotting tankers anchored outside New York Harbor speculated that cargo owners were delaying deliveries to await future price increases. They paid no attention to the many costs, including interest on capital tied up on unsold goods, that accumulated while ships waited to unload or to the revenue not collected in the meantime. The possibility that someone might have been manipulating prices obscured strong reasons to doubt the suspicion. Even now, the suspicion surfaces when prices are high enough to capture popular attention-the very conditions under which not selling oil in hand makes the least sense.
To speculators and maverick governments alike, misjudgments on these matters can be very costly. The no-sale, no-money principle in fact explains much about physical oil markets, including the outgrowth of nonphysical markets for futures contracts, options, and other derivative instruments. And failure to grasp the concept explains much about oil politics, including habitual government mistakes.✦