February 7, 2007 No.

Is Iran’s “Oil Weapon” A Doubled-Edged Sword?

Arnon Gutfeld
Department of History, Tel Aviv University

If the United States organizes effective economic sanctions against Iran or especially if
the Bush Administration decides on military action against Iran’s nuclear facilities, Iran
may try to strike back with its “oil weapon,” to suspend oil exports and disrupt oil traffic
in the Straits of Hormuz, through which pass about 40% of the world’s oil trade.
Activation of this threat might push the price of oil as high as $200 per barrel, with
unimaginable damage to western and Japanese economies.

Western economies are undoubtedly hostage to some degree to the flow of oil from the
Persian Gulf, in general, and from Iran, in particular. At the same time, Iran itself is
hostage to massive oil exports in order to sustain its economy and underpin the huge
subsidies it provides to the military and civilian society. Between 80 and 90% of Iran’s
exports and close to 50% of its budget come from oil sales, and without oil exports, Iran
would be bankrupt. Even with high oil prices, Iran’s economy has recently come under
severe strains – inflation, double-digit unemployment, and per capita income levels lower
by about 25% that those of the 1970s – and a fall in oil prices, like the drop of about 30%
in the last six months, only exacerbates the situation.

Iran has to import about a third of its petroleum. It has been dependent on imported
distillates since the destruction of much of its refining capacity during the Iran-Iraq war,
and it holds only about 45 days of petroleum stocks. A cutoff of oil revenues would force
the government to control and distribute food to the population, to reduce the budget of
an army already desperately short of spare parts, and to cut back drastically its support for
allies in Iraq, Syria, Lebanon, the Palestinian Authority and various terrorist organizations
around the world.

Despite the fact that Iran is the fourth-largest natural gas exporter in the world, declining
oil prices signal a serious long-term problem for the country and its political
establishment. Oil revenues have provided the Iranian establishment with much of its
political influence within the country, because they enable it to provide massive energy
subsidies to the population. They also underlie Iran’s political influence throughout the
Middle East. But the reliability of future oil export revenues is quite problematic. Iran
now consumes about 40% of its oil production. Every year brings a drop of about 10% in

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the volume of exports and predictions are that exports will fall by half by 2010 and
virtually dry up by 2015. In the last two years, Iran has been unable to produce the quota
allocated to it by OPEC and it has failed to invest the amounts needed to maintain
existing fields. A crisis will result from sharp increases in domestic oil consumption,
neglected development of new reserve fields and especially the failure to develop or even
repair the deteriorating infrastructure of existing fields, which results in the loss of
millions of barrels during the production process. Iran desperately needs its current oil
revenues and therefore leaves nothing for the National Oil Company to maintain or repair
infrastructures. Oil profits are also spent on a series of projects that contribute nothing to
recurrent investment in the energy industry.

Consequently, Iran may well need nuclear energy for peaceful purposes. But the Iranian
Oil Minister has recently admitted that the growing controversy over Iran’s nuclear
program has reduced the willingness of banks and other investors to put money into
Iranian projects. There is also a general hostility in Iran to foreign investments; a variety
of regulations and laws actually alienate potential investors. The United States, through a
variety of pressures on potential investors, also deters and prevents investment in Iran.

Some experts believe that Iran will find a way to solve its production problems before the
crisis reaches a peak. They point to the fact that oil revenues this year will reach $50
billion and also that Iran has large foreign currency reserves that could find their way to
the necessary infrastructure investment projects. The International Energy Agency (IEA)
estimates that Iran will need to invest $165 billion in order to meet the oil and natural gas
production goals it has set for 2030.

Recently published studies stress Iran’s economic vulnerability. Since 1979, the
population has doubled; it now stands at 68 million and is growing by half a million per
annum. The labor force numbers 22 million and grows at a rate of 3.3% per annum, and
Iran needs to produce 700,000 new jobs each year just to maintain its current
unemployment rate of 12%.

As a result, the west may actually be better able than Iran to tolerate a shutdown of
Iranian exports. Concerns about sanctions or military action against Iran are connected to
Iranian threats to send thousands of suicide bombers against coalition forces in Iraq or
against the west, to blockade the Straits of Hormuz, or to bomb oil fields in the Emirates
or Saudi Arabia. To these are added threats to rain down a torrent of missiles on Israel.
These are threats that the United States, the west, and Israel may have to confront sooner
or later, and some argue for confronting them sooner rather than waiting for the situation
to become even more daunting.

Russia and China have large investments in Iran’s oil infrastructure and the United States
is working to convince them that the best way to protect those investments is to restrain
the Iranian leadership. But as long as Russia and China are not convinced that the U.S.
might choose a military option, they will apparently do little to press Iran to moderate its
behavior.

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If Iran tried to block the Straits and Hormuz and bomb oil fields throughout the Gulf, the
results could be disastrous for the Arab countries, for the west, but most of all for Iran
itself, and it is not at all clear that Iran would be prepared to risk total destruction. But
since such a scenario cannot be categorically precluded, a central question remains: How
willing are the United States and other industrialized countries to act in order to reduce
their dependency on imported energy from this part of the world?

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