Co-authored by Nouriel Roubini
The domestic benefits of the U.S. oil production boom are well documented — everything from the creation of high-paying jobs to sending less money to foreign oil producers.
Less well appreciated are the geopolitical benefits. U.S. oil production has already paid foreign policy dividends in at least one vital area: It has paved the way for stronger sanctions on Iran by helping to keep the global oil market well-supplied and minimizing oil price volatility.
This development is timely and instructive.
By the first half of 2014, according to credible estimates, Iran is likely to be able to covertly produce enough highly enriched uranium for one nuclear device in as little as seven to 10 days — before it could be detected by the international community. While it remains unclear how close Iran is to nuclear weapons capability, the consensus is that the window for preventing it from happening is closing.
The most effective way to inflict economic pressure on Tehran, most analysts say, is to target the Iranian petroleum industry. Crude oil exports account for between 60 percent and 70 percent of government revenue, more than $600 billion over the past decade. Yet for much of the history of the Iran sanctions program, simple steps that could have constricted or even eliminated this cash flow were not taken.
Across the globe, oil demand had been growing quickly, spare production capacity was low, and new supplies were harder to find. So the world market needed Iranian oil, and petroleum-dependent economies across the globe — including the United States — were afraid of the devastating price shocks that could have accompanied any effort to remove barrels from the market.
This dynamic began changing dramatically in 2012. Most important, oil production surged in nations outside the Organization of the Petroleum Exporting Countries — particularly in the United States and Canada, where combined oil output grew by nearly 1.3 million barrels per day and outpaced global demand growth. Other factors were also key, notably Saudi Arabia’s decision not to cut crude production as Libyan output returned to the market following the fall of the Muammar Gaddafi regime in 2011.
At the same time, global oil demand growth had slowed substantially, with much of the euro zone facing an economic crisis and stagnant growth in the United States. By mid-2012, the market was facing the surprising prospect of a sizeable glut in oil supplies.
These developments were critical in allowing the United States to implement new, tougher sanctions in early 2012 that drove year-over-year Iranian crude exports down by nearly 15 percent in the first quarter alone. A complete European embargo, effective July 1, 2012, had a more dramatic effect — cutting Iranian crude exports by nearly 60 percent in the third quarter. All told, Iranian crude production in 2012 fell to its lowest level since 1989. For the first time, Western sanctions began to inflict real pain on Iran’s economy.
Despite the loss of up to a million barrels per day of Iranian crude in 2012, global oil prices were not damagingly volatile. Over the last five months of 2012, when significant Iranian supplies were coming off the market, prices traded in a narrow band between $107 and $116 per barrel, and the average weekly price change was just 1.6 percent.
Even with production shortfalls due to instability in Iraq, Libya, Nigeria, and a handful of other key countries, the global oil market has remained balanced in 2013, and Iranian crude exports have continued to fall. The International Energy Agency now expects non-OPEC oil supplies to grow by 1.2 million barrels per day this year — largely due to the United States. Meanwhile, global oil demand is expected to increase only by a relatively modest 930,000 barrels per day.
While it appears that negotiations with Iran regarding its nuclear program will recommence following the recent election of President Hassan Rohani, further economic pressure will likely be needed. If so, oil markets could manage it. Increased production in Saudi Arabia and other Gulf States — combined with the willingness to deploy U.S. and European strategic inventories if necessary — would allow the market to absorb the loss of additional Iranian oil supplies, starving the regime of cash and crippling its economy.
Analysts disagree about how long oil markets can withstand the loss of Iranian oil supplies. Markets will inevitably tighten, perhaps as soon as mid-2014. Yet, time is running out on peaceful options to prevent Iran from developing nuclear weapons. Favorable oil market conditions, led by the surge in U.S. production, have opened a unique window to strengthen sanctions and maximize pressure on Tehran to abandon nuclear ambitions. Policymakers, who rightly seek to avoid being forced to choose between living with a nuclear Iran or going to war, should be prepared to seize this opportunity before it is too late.