This week's missile launch shows the possible downside of crippling sanctions.
After a 15-month suspension, negotiations over Iran's nuclear program will resume this weekend in Istanbul. The five permanent members of the U.N. Security Council plus Germany hope to make progress on an agreement that will block Iran from any path to a nuclear weapon, something Tehran has stated it doesn't want. Years of talks have achieved almost nothing. U.S. and European negotiators might have slightly higher hopes for this round. For the first time, sanctions are causing a drop in Iran's oil exports, adding to the threat of Israeli air strikes on Iran's nuclear complex -- both sources of leverage Western negotiators previously lacked.
Iranian President Mahmoud Ahmadinejad presented a brave face over the prospect of a global embargo of Iranian crude oil. On an April 10 visit to Hormozgan province, Ahmadinejad declared, "I should say that we have so much funds that even if we don't sell for two, three years the country will still be managed easily."
Accepting for the moment Ahmadinejad's claim of two to three years of cash reserves, one wonders whether he has planned for what happens after that. Iran's standoff with the West has already dragged on for nearly a decade and another two years or more would seem unremarkable. Meanwhile, Iran's oil revenues are falling and could drop much lower as the embargo on Iranian oil expands and investment in the oil sector dries up. Western leaders will welcome the leverage they believe this will create for them. But the consequences for the broader Iranian society are likely to be grim. For one possible scenario, Western leaders might want to look to this month's other nuclear flashpoint -- North Korea.
According to the U.S. government's Energy Information Agency (EIA), crude oil accounts for nearly 80 percent of Iran's exports and half of its government revenue. That revenue will decline sharply this year. The International Energy Agency (IEA) forecasts that Iran's oil exports are expected to decline by 800,000 to a million barrels per day starting this summer, down from daily exports of 2.2 million barrels per day in 2011. This could reduce Iran's foreign exchange earnings from oil by a third to almost half later this year.
Iranian leaders had hoped that tight global supplies of oil combined with high prices would make the removal of Iranian oil from the market unacceptable. However, IEA's March 2012 oil market report included a rapid rebound in Libya's production, a jump in Saudi Arabian pumping, and smaller output increases in Iraq, Angola, and Nigeria that are offsetting the export decline from Iran. Meanwhile, weaker than expected economic growth in Europe and China may be limiting for the moment the global demand for oil, making the removal of Iranian exports from the market even more feasible.
Economic sanctions are also inflicting increasing damage on Iran's long run oil production potential. Iran's oil fields suffer a natural output decline rate of 8 to 13 percent per year, a higher production decline rate than most other oil fields around the world. Continuous reinvestment in upstream production is required to offset this natural decline. However, sanctions on Iran's oil industry and banking system are curtailing the foreign partnerships that the Iranian oil industry has relied on. EIA's latest short-term energy report, published on April 10, forecasts that Iran's oil production will decline by about 500,000 barrels per day by the end of this year, down from 3.55 million barrels per day at the end of 2011. In 2010, Iranian crude oil production hovered around 3.7 million barrels per day. Should the EIA forecast for 2012 hold, Iran's oil output will have declined nearly 18 percent in two years, with further substantial declines likely to follow should sanctions continue to restrict foreign investment in Iran's oil industry.
With these trends in place, it is not unreasonable to contemplate the end of net oil export from Iran within a few years. Although one should be cautious about extrapolating, if Iranian oil production declines at about a ten percent annual rate (in line with EIA's current forecast and the rough natural decline rate for Iran's fields), Iranian production could be down to two million barrels per day sometime in 2015. That would approximately match the country's daily consumption, leaving nothing for net exports. The result would be disastrous for government finances, foreign exchange earnings, and presumably the larger economy.
With this outlook for oil revenues and foreign exchange earnings, Iranian society will have to brace for deepening hardship. The disputed presidential election in June 2009 resulted in a sharp crackdown on dissent. Iran's internal security forces may have to further expand their vigilance should growing economic dislocation result in further unrest.
Western leaders are assuming that economic privation -- the result of their sanctions regime -- will compel a change in Tehran's calculations regarding its nuclear program, but the North Korean experience is not a supportive case study. In the face of crippling sanctions and political isolation, the leadership in Pyongyang has concluded that its nuclear and missile programs are its most valuable bargaining chips -- indeed, a failed test of a long-range missile and a possibly imminent nuclear weapon test show that Pyongyang is pressing on with these priorities regardless of the international consequences. Meanwhile, North Korea's internal security forces, the most repressive in the world, have successfully suppressed any grumbling over the country's collapsed economy. North Korea's economy is a basket case due to both international sanctions and the regime's need to maintain tight political control over society, but that has reinforced, not lessened, the government's repressive tendencies.
Is Iran on the road to becoming the next North Korea? As with Pyongyang, Tehran's nuclear and missile programs are important symbols of prestige, politically popular, and provide an otherwise poorly-armed country with negotiating leverage in a dangerous neighborhood. If this is the view of Iran's leadership, the prospects for a lasting deal with the West would be as poor as they have been with North Korea. To produce their own leverage, Western leaders prefer economic sanctions, which end up striking the broader population rather than the regime itself. And as with North Korea, economic sanctions could gradually compel the Iranian government to institute a police state with a command economy as a means of maintaining internal control. Just like North Korea, the result for Iran could be isolation, crushing internal repression, and economic collapse.
With this bleak outlook, Western policymakers may figure that time is on their side. They must be assuming that the leadership in Tehran will not be able to survive an economic collapse or that it will it not be able to erect the internal security apparatus necessary to maintain control, should deepening economic dislocation result in rebellion.
In this, Western leaders are implicitly asserting that North Korea is a one-off case, not replicable elsewhere. They may be right, but it seems that Iranian society may have to suffer through the experiment in order to find out.
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