Tehran's Trump Card

Clifford Kupchan, Los Angeles Times:

Iran's key ally in the current nuclear crisis is not Russia or China. It's oil. Tehran can easily drive up prices and is already beginning to do so to rattle the West. As the crisis escalates, Washington's diplomatic partners will become gravely worried about their energy supplies. In the end, Iran's petro power will probably trump Western diplomacy.

Just look at what's happening: Tehran's bravado announcement April 11 that it had mastered key nuclear technology drew censure from world capitals. But it also drove oil prices to more than $70 a barrel on fears that increasing tensions or future military strikes might disrupt Iranian exports and damage Western economies. Prices have risen more than $8 a barrel in less than three weeks, primarily because of Iran.

Tehran's oil leverage is formidable, flowing from its role as the world's fourth-largest producer of oil and its strategic location abreast the Strait of Hormuz, through which 20% of the world's production passes. Iran produces 4 million barrels of oil a day, about 5% of world production, and exports 2.5 million barrels. And it has used oil to build a web of relationships that make key countries dependent on its supplies. READ MORE

Today, Iran supplies China with 4% of its oil, France with 7%, Korea with 9%, Japan with 10%, Italy with 11%, Belgium with 14%, Turkey with 22% and Greece with 24%. Those dependencies will create increasing unease over U.S. attempts to pressure Tehran. If the U.S. continues to seek economic sanctions against Iran in the nuclear crisis — or if it continues to hint at the possibility of military action — Tehran will increasingly use petro power in three ways.

First, it is likely to reduce exports to spook oil markets. Iranian leaders ranging from radical President Mahmoud Ahmadinejad to technocrat Oil Minister Kazem Vaziri-Hamaneh have already threatened to do so. Initially, Iran might temporarily withhold symbolic export volumes (say, 300,000 barrels a day.) That would increase oil prices more than similar cuts by another country because, given Iran's provocative policies over the last year, the markets will worry about Tehran's next steps.

If the crisis deepens, Iran will seek to intimidate U.S. partners and hike world prices by cutting long-term contracts to provide oil. Japan is an especially vulnerable and probable target, but so are European countries.

The second way Iran could use petro power is by threatening to disrupt tanker traffic through the strait. The threat alone would be enough to hike oil prices, even if Tehran would probably take such a drastic step only if attacked. Iran recently staged a seven-day military exercise called Great Prophet, with 17,000 troops from the elite Revolutionary Guards and the unveiling of several new weapons — including a high-speed, sonar-evading torpedo. The flaunting of the latter was widely interpreted in military circles as a boast that Iran could disrupt or even close the strait by threatening to sink passing oil tankers.

Companies that insure tankers certainly took note. Iran could wreak havoc on price and supply simply by making tanker insurance prohibitively expensive. Oil prices rose about $3 a barrel during the exercises and have risen since. Key nations got the message too; oil-thirsty China in particular fears any use of force that could disrupt its supply. Similar Iranian exercises in the future are likely, as this one clearly succeeded.

Third, even if Iran takes no overt step, it symbolically flexes its muscles in the oil markets every time it claims an advance in its nuclear program. Tehran's announcement that it had enriched uranium drove up oil $1.82 a barrel in three days because of heightened fears of clashes with the West. Iran's "pedal-to-the-metal" policy on acquiring a nuclear fuel cycle will push up oil prices throughout 2006. If Iran, as planned, enriches more uranium and installs 3,000 centrifuges at its Natanz facility this fall, international fears of military conflict will grow and oil prices will rise even further.

In these three ways, Tehran can — and almost certainly will — build an "oil wall" against U.S. efforts to enlist international partners to keep Iran from getting a nuclear weapons capability.

There are limits to Iranian petro power. Threats to close the strait carry only partial credibility, as Tehran's oil revenues are its lifeline — accounting for 80% of export revenues and 50% of the government's budget. What's more, the U.S. could use force to open the strait. And if Iran were to cease exports or hike oil prices too far, Saudi Arabia could increase production to make up part of the difference. Still, Tehran's ability to manipulate markets and cause supply disruptions will remain formidable.

Secretary of State Condoleezza Rice has warned that the United Nations must soon take strong action to curb Iran's nuclear ambitions. If that fails, Washington will likely seek a "coalition of the willing" to do the job. But to succeed in either forum, the U.S. needs stiff spines in Japan, Europe and even China. Tehran's oil could well force Washington to act alone, if it acts at all.

By Clifford Kupchan, CLIFFORD KUPCHAN is a director at Eurasia Group, a political risk consulting firm.