The oil boom’s foreign policy dividend

By John Hannah and Nouriel Roubini
July 19, 2013

The domestic benefits of the U.S. oil production boom are well documented — everything from the creation of high-paying jobs to sending less money to foreign oil producers.

Less well appreciated are the geopolitical benefits. U.S. oil production has already paid foreign policy dividends in at least one vital area: It has paved the way for stronger sanctions on Iran by helping to keep the global oil market well-supplied and minimizing oil price volatility.

This development is timely and instructive.

By the first half of 2014, according to credible estimates, Iran is likely to be able to covertly produce enough highly enriched uranium for one nuclear device in as little as seven to 10 days — before it could be detected by the international community. While it remains unclear how close Iran is to nuclear weapons capability, the consensus is that the window for preventing it from happening is closing.

The most effective way to inflict economic pressure on Tehran, most analysts say, is to target the Iranian petroleum industry. Crude oil exports account for between 60 percent and 70 percent of government revenue, more than $600 billion over the past decade. Yet for much of the history of the Iran sanctions program, simple steps that could have constricted or even eliminated this cash flow were not taken.

Across the globe, oil demand had been growing quickly, spare production capacity was low, and new supplies were harder to find. So the world market needed Iranian oil, and petroleum-dependent economies across the globe — including the United States — were afraid of the devastating price shocks that could have accompanied any effort to remove barrels from the market.

This dynamic began changing dramatically in 2012. Most important, oil production surged in nations outside the Organization of the Petroleum Exporting Countries — particularly in the United States and Canada, where combined oil output grew by nearly 1.3 million barrels per day and outpaced global demand growth. Other factors were also key, notably Saudi Arabia’s decision not to cut crude production as Libyan output returned to the market following the fall of the Muammar Gaddafi regime in 2011.

At the same time, global oil demand growth had slowed substantially, with much of the euro zone facing an economic crisis and stagnant growth in the United States. By mid-2012, the market was facing the surprising prospect of a sizeable glut in oil supplies.

These developments were critical in allowing the United States to implement new, tougher sanctions in early 2012 that drove year-over-year Iranian crude exports down by nearly 15 percent in the first quarter alone. A complete European embargo, effective July 1, 2012, had a more dramatic effect — cutting Iranian crude exports by nearly 60 percent in the third quarter. All told, Iranian crude production in 2012 fell to its lowest level since 1989. For the first time, Western sanctions began to inflict real pain on Iran’s economy.

Despite the loss of up to a million barrels per day of Iranian crude in 2012, global oil prices were not damagingly volatile. Over the last five months of 2012, when significant Iranian supplies were coming off the market, prices traded in a narrow band between $107 and $116 per barrel, and the average weekly price change was just 1.6 percent.

Even with production shortfalls due to instability in Iraq, Libya, Nigeria, and a handful of other key countries, the global oil market has remained balanced in 2013, and Iranian crude exports have continued to fall. The International Energy Agency now expects non-OPEC oil supplies to grow by 1.2 million barrels per day this year — largely due to the United States. Meanwhile, global oil demand is expected to increase only by a relatively modest 930,000 barrels per day.

While it appears that negotiations with Iran regarding its nuclear program will recommence following the recent election of President Hassan Rohani, further economic pressure will likely be needed. If so, oil markets could manage it. Increased production in Saudi Arabia and other Gulf States — combined with the willingness to deploy U.S. and European strategic inventories if necessary — would allow the market to absorb the loss of additional Iranian oil supplies, starving the regime of cash and crippling its economy.

Analysts disagree about how long oil markets can withstand the loss of Iranian oil supplies. Markets will inevitably tighten, perhaps as soon as mid-2014. Yet, time is running out on peaceful options to prevent Iran from developing nuclear weapons. Favorable oil market conditions, led by the surge in U.S. production, have opened a unique window to strengthen sanctions and maximize pressure on Tehran to abandon nuclear ambitions. Policymakers, who rightly seek to avoid being forced to choose between living with a nuclear Iran or going to war, should be prepared to seize this opportunity before it is too late.

PHOTO: Roughneck Brian Waldner is covered in mud and oil while wrestling pipe on a True Company oil drilling rig outside Watford, North Dakota, October 20, 2012. REUTERS/Jim Urquhart 

7 comments

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But…but…but… the politicians all said if we “Drill baby drill” that our gas prices would go down. What fools most people are.
It is a good thing though that it has stabilized the oil prices globally.

Posted by tmc | Report as abusive

so, the logic here is……if oil prices start to drop, attack Iranian oil supplies, reduce their access to world markets…..and the price will remain ‘stable’.

Posted by Robertla | Report as abusive

Oil futures are going straight up daily, as the US economy has improved (the stock market seems to agree). Whatever perceived benefit from the acknowledged ‘dirtier’ US and Canada production is simply a misguided bet on the weather – one bad gulf storm will give Iran an instant market, a bad US storm season will even buy them insurance

Posted by auger | Report as abusive

Wow, both of the writers are stupid and dillusional.
IRAN IS A NUCLEAR POWER. PERIOD.

There is nothing the world can do about it.

Posted by KyleDexter | Report as abusive

@ tmc. Your ire would be better directed at the OPEC (Saudi, Iran, UE) and nationalized oil companies who fix the minimum price and royalties for oil. The U.S. domestic majors control less than 3% of the world’s reserves.

And, for the past few years, the domestic price of oil has been trading at a (significant) discount to international prices due to the “drill baby drill” you are criticizing. And the cost of natural gas has declined during that same period.

Also, there was a recent Forbes article documenting that the largest U.S. oil companies pay an effective tax rate of 39% -51% of revenues in taxes–in some cases they pay more in taxes than they show in bottom-line profit.

Posted by COindependent | Report as abusive

Indeed @COindependant, you are correct. My comment was more in satire than fact. My ire is to the politicians and sophist rather than the energy corporations. I find it both funny and tragic when the media explains why gasoline prices just went up gain this month.

Posted by tmc | Report as abusive

I don’t understand why it is so bad for Iran to have Nuclear stuff. Let them poison themselves just like America has poisoned everything with this substance. America has set off near a thousand nuclear explosions, let them have a go at it. Then they can open up Cancer Treatment Centers there as well.

Posted by 2Borknot2B | Report as abusive