Looming Iran Showdown Gives Oil Traders New Worry

Jad Mouawad, The New York Times:

As world leaders and diplomats debate how to deal with Iran's nuclear ambitions, the worry among analysts these days is the fate of the country's oil sector. The prospect of sanctions against Iran might have been easily shrugged off a few years ago, when the world sat comfortably on millions of barrels of untapped oil capacity. But the picture today is quite different. Iran exports more oil than the world's current spare capacity.

The lurking fear among many oil analysts is a darker version of what happened in Iraq: a diplomatic or military confrontation with a major Middle East oil producer, leading again to disruptions in supplies and provoking a substantial spike in oil prices.

If for any reason exports from Iran, which pumps twice the oil that Iraq does, suddenly stopped, other producers would not be able to make up the loss - in contrast to 2003, when Saudi Arabia and Kuwait cranked up output to make up for the drop in Iraqi exports after the U.S.-led invasion.

These concerns are not completely ill-founded. President, Mahmoud Ahmadinejad hinted last weekend that Iran might be willing to use the "oil weapon" - that is, curbing oil exports - if faced with international sanctions. At the same time, some members of the U.S. Senate said Tehran should be sanctioned regardless of the consequences for oil prices. READ MORE

Such talk may turn out to be part of the negotiating tactics on both sides. But it is fanning waves of anxiety in oil markets, which have been rattled since Jan. 3, when Iran announced its decision to resume a nuclear research program that had been suspended since an agreement was reached with France, Germany and Britain in late 2004.

The announcement led to a breakdown with European negotiators and raised the likelihood of international action against Iran.

While U.S. and European negotiators are campaigning to have the standoff handled by the United Nations Security Council, Russia and China are urging more talks.

Oil markets have reacted strongly. Crude oil prices on the New York Mercantile Exchange have risen more than 9.5 percent since the beginning of the year. They rose 23 cents or 0.4 percent to $67.06 a barrel on Friday. Prices, which dropped to $55 in November, are again headed toward record levels.

Other factors have contributed to the recent price rally. Nigeria's main oil-producing region is experiencing unrest, and forecasters expect growth in demand to be strong this year. But as the confrontation over its nuclear research program swells, Iran is increasingly the biggest risk for oil markets this year.

With about 10 percent of the world's reserves, Iran is the second-largest producer within the Organization of the Petroleum Exporting Countries, where it helps shape the cartel's pricing policy. The country pumps four million barrels of oil each day and exports two-thirds of it, mainly to Japan and China.

Analysts said Iran's standing in the oil markets permits it to assert itself more than others seeking to develop a nuclear program.

"Why are the Iranians pushing so aggressively instead of biding their time, like North Korea did?" said Ian Bremmer, president of the Eurasia Group, a political-risk consultancy based in New York. "The obvious answer is that Iran is in a far stronger position. Iran can respond in ways that can be very painful to the international community. Iran has leverage."

Frank Verrastro, the head of the energy program at the Center for Strategic and International Studies in Washington, said the international community must answer tough questions in considering Iran's position.

"How do you punish an international actor when it produces a commodity that everyone needs?" he said. "What can get Iran's attention without inflicting pain on everyone else? Up until now, it has been a huge game of chicken."

Given the overall tightness in global energy supplies, analysts said, it is unlikely that Iran's oil exports will be embargoed. But alternatives, like banning foreign investments or transfers of oil industry technology, might cripple Iran's petroleum sector.

Iran has also been paying close attention to Asian customers, particularly China and India, to offset the growing hostility from the West.