April 24, 2006
Monday

Steaming drivers furious at $3-a-gallon gas can direct at least part of their anger at the row between the United States and Iran, which experts agree helps increase prices by frightening investors - and there isn't much anybody can do about it in the short term.

Most of America's options on Iran offer little promise of lowering prices, according to several foreign policy experts, and some could push them still higher.

Several warned against radical short-term fixes, such as tapping the nation's strategic petroleum reserve, and they predicted that even if tensions don't diminish, the price of oil will - in time.

"Remember, this will play out over months, if not years," said Anthony Cordesman, an expert on energy and the Middle East at the private Center for Strategic and International Studies in Washington. "If the president commits the SPR to deal with a panic, the end result could be a very costly way of damping a panic that would fade in any case."

Cordesman and other experts take the long view on oil prices, which were soaring well before the showdown with Iran over its nuclear ambitions.

Prices on the world market have doubled in the past three years, propelled by growing demand in Asia. Speculative investors have jumped into the oil market, pushing prices even higher.

With international supplies stretched thin, a drop in production or exports by any oil-exporting country can hurt businesses and consumers around the globe. Any potential threat to production gives oil traders a reason to bet that prices will rise higher.

Traders look at the saber-rattling between Washington and Tehran and see a clear signal to buy. It's not that Iran's 2.7 million barrels of daily exports will disappear - but the mere possibility of a future disruption is enough to drive up prices.

"We're not short on supply - we're potentially short if something were to happen," said Stephen Jones, a principal at the Purvin & Gertz energy consulting firm in Houston.

Iran offers no shortage of reasons for traders to fear a drop in production. Military action by the United States could chop off production for a while, as it did in Iraq. Economic sanctions against Iran, in the unlikely event Russia and China would play along, could also stem the flow.

Or Iran could take action of its own - government officials there have vacillated between promising to meet export obligations and dropping hints of a halt in the flow of oil as part of its diplomatic wrangling with the West.

"It doesn't mean there's an imminent threat," Jones said. "But people don't like the in-your-face discussions."

Aside from the possibility of a U.S. military action - something the White House insists it is not seeking, though it has not ruled the option out - there are reasons to doubt other supply-stopping actions will take place anytime soon.

U.S. sanctions in place since 1995 already prohibit American oil companies from buying Iranian oil or financing development of Iran's oil fields. But a number of other nations, led by Japan, China and Italy, all need Iranian fuel for their own economies, and are wary of additional international sanctions.

In fact, as Cordesman noted in a recent report, four of the five permanent members of the U.N. Security Council - the United States is the fifth - have strong and growing trade ties with Iran. Imports from Iran to China increased 389 percent between 2000 and 2004.

Less dramatic steps - threatening to tap the U.S. strategic reserve, for example, or positioning minesweepers near the Strait of Hormuz, in case Iran mines that vital waterway - could push oil prices higher, said Khalid al-Rodhan, the co-author with Cordesman of the Center for Strategic and International Studies report.

"You also can send the message that we're afraid this will actually impact the supply of oil," he said. "This will provide (traders) with one more reason to be fearful."

Iran has its own reasons not to stem the oil flow.

"Iran has only two exports: One is oil, and the other is pistachios," Cordesman said. "Pistachios don't exactly pay off all that much."

Crude oil sales to Japan, China, South Korea, Taiwan and Europe brought Iran roughly $43 billion last year, according to U.S. government estimates. Nearly half of the Iranian government's budget comes from oil exports.

With its income surging, Iranian officials have expressed pleasure with oil's new high prices and suggested they should be even higher.

For all the money Iran makes on crude, the country could make more. Its oil-field operations are considered old and inefficient by international standards, squeezing less petroleum from reserves than would be possible with modern equipment and practices. Iran's oil production of roughly 4 million barrels per day is one-third lower than it was before the Islamic revolution of 1979. The Iranian government badly wants to increase production, a goal that would require heavy foreign investment. But international oil companies have been cautious about pumping money into Iran. Its laws bar direct foreign ownership of oil assets, and the government's hostile relations with the West scare off many potential investors.

"It's likely that Iran's economic dependence on its own oil exports is greater than our dependency on its oil exports. Then you have to ask who has the most political will," said Michael O'Hanlon, senior fellow at the Brookings Institution. "Maybe in the end, they would cave before we would."

But if the goal of U.S. policy is to keep oil prices from spiraling still higher, such brinksmanship might not be necessary. Concern about Iran is not the only reason prices are high - there are also problems in Iraq, Nigeria, Angola and Venezuela, as well as increasing global demands and supply bottlenecks exacerbated by declining refining capacity and last year's hurricanes. All of which means prices are likely to remain high for a while.

And even if tensions over Iran remain high, the market is likely to adapt, the experts said - meaning that without some new crisis pushing prices higher, the upsurge could mellow out eventually. "Unfortunately, what will never stop is (that) the market is rational in the long run, and childishly irrational in the present," Cordesman said. "I think we need to be very careful, no matter what we do."

The one thing that might make a difference in the market, said Cliff Kupchan, director of Europe and Eurasia analysis for the Eurasia Group, a political-risk consulting firm, is something the White House has seemed unwilling to do: Engage Iran in direct talks over the nuclear issue.

"I'm not convinced that talks would lead anywhere," Kupchan said. "(But) in the short to medium term, they would take the pressure out of the system that's driving oil prices."

Even if the Bush administration sits down with Iran on other issues, such as regional security, that could help ease investor jitters, Kupchan said. "In my own view, if those talks are at all successful, they will quickly become talks about the nuclear issue, and I think that's what investors would suspect," he said.

Other analysts said they doubted talks could have a significant effect on oil prices, noting that other global factors are much more important. In the near term, at least, Kupchan agreed.

"Fundamental supply-and-demand relationships would lead to a tight market in any case. Given the Iran crisis on the back of that fact, I would expect continually rising prices ... because of an 'Iran premium,' throughout 2006," he said. "This show ain't over."

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