U.S. Must Mandate Zero Oil Exports for Iran

The momentum to restrict Iranian oil exports has stalled, and it is time for Congress to eschew a more gradualist approach and mandate zero oil exports with zero waivers. This, along with more concrete military pressure, could increase the otherwise slim chances for success in expected new talks with Iran. U.S. lawmakers and Obama Administration officials should not fear the impact on the oil market, which can manage a cutoff of Iranian oil revenue better than can Tehran.

Iranian oil exports have fallen but plateaued, to less effect than commonly understood. Oil exports dropped 22 percent in 2011-12 to 1.7 million barrels per day (mmb/d), but exports in the first half of this year roughly equaled those in the second half of last year. The drop last year followed the European Union’s oil embargo, and some countries cutting back to receive waivers from the Obama Administration. Existing U.S. sanctions allow waivers for countries “significantly reducing” Iranian crude purchases, which the Administration interprets as roughly a 20 percent cut.

In fact, 2012 was quietly one of Tehran’s most profitable years ever in terms of oil export revenue. High oil prices meant Iran earned about $60 billion, its fourth-highest annual earnings ever, and only a 17 percent drop from its prior five-year average (which included four of its five previous highest totals). This accounted for half of the government’s 2012 budget.

Meanwhile, Iran has drawn extremely close to acquiring the capability to produce a nuclear weapon before detection by international observers.

This suggests the urgency of shifting to a much more aggressive posture. New legislation in the House of Representatives to reduce Iran’s exports by 1 mmb/d leaves the decision of how to implement additional “significant reductions” to Iran’s customers. It also allows waivers if these countries continue reducing purchases every six months. This merely perpetuates the current trend of gradually increasing pressure.

Instead, lawmakers should target all Iranian oil exports and permit no waivers, which is what the proposed Senate bill, the Iran Export Embargo Act, does.

The oil market can take it. Diminished Iranian oil exports and increased global consumption in 2012 were more than offset by increased available global supply—from rising oil production in North America and the Middle East—so that global spare production capacity actually grew a net 400,000 barrels per day to an estimated 2.9 mmb/d (based on Department of Energy data). Spare production capacity influences prices. Current levels are much higher than in 2008, when virtually no production cushion existed and prices skyrocketed, but slightly slower than in 2009 when prices were lower.

This year, diminished Iranian oil exports and rising global oil consumption is expected to roughly be offset by increased supply elsewhere. Next year, we calculate that if Iranian oil exports declined to zero, and supply and demand changed according to DOE estimates, the net effect would be the same spare production capacity as we have now. In sum, cutting off Iranian oil exports will simply maintain the current oil market balance.

There would be risks. Nearly all global spare capacity is concentrated in Saudi Arabia, and Riyadh might be overstating its true capacity. Further, the market remains jumpy, given several potential supply risks unrelated to Iran. In the event of disruption, the United States and its allies would have to consider releasing strategic petroleum reserves to combat any recidivist temptation for countries to resume imports from Iran.

Such risks must be compared to the alternative—the much higher price of inaction. A nuclear Iran would heighten expectations of potential future disruptions resulting from instability, thus increasing the risk premium added onto oil prices. Our previous analysis as part of a Bipartisan Policy Center task force we directed last year indicates such expectations raise oil prices up to 25 percent over one year and up to 50 percent over three years. The impact on oil prices and the U.S. economy would be even greater if a nuclear Iran led to actual conflict and sustained supply disruption.

Although the oil market can manage an Iranian oil export cutoff, it won’t be easy to achieve, even if such U.S. legislation becomes law. The Obama administration can reinforce the effectiveness of such legislation by conveying in clear and concrete terms to buyers of Iranian oil, such as China, that the United States will unquestionably take military action to prevent a nuclear capable Iran, or support Israel if it chooses to strike, and that this would cause a temporary cutoff of much of the Persian Gulf oil upon which these countries depend. The administration should also explain how a nuclear Iran would lead to higher oil prices.

With time running out as Iran approaches nuclear weapons capability, the United States must adopt a zero-tolerance policy for Iran’s oil exports.

Originally appeared in The Weekly Standard on July 25, 2013