Iran Subsidy Reform to Soften Fuel Sanction Punch

Iran’s parliament is poised to vote next week on a government bill that would cut energy and food subsidies and could make the Islamic Republic less vulnerable to sanctions.

The measures could also deepen unpopularity for a conservative government that faced riots when it introduced a gasoline rationing scheme in 2007.

Iran is the world’s fifth-largest crude oil exporter but its refineries cannot produce enough fuel for its home market. Its subsidized gasoline is among the world’s cheapest, encouraging rapid demand growth and leaving it dependent on imports.

These expose Tehran to international supply chains and make it susceptible to tougher Western sanctions if the United States and its allies should target fuel suppliers.

Cutting subsidies could eat into demand and lower the need for imports, depending on how far Iran drives up the price. Higher prices could also make smuggling Iranian gasoline less profitable and in the longer term improve vehicle efficiency.

“It could have an impact if they follow through,” said one Middle East oil products trader. “These cars they manufacture are not fuel efficient. Plus one of the biggest problems in Iran is smuggling.”

But any impact may take time, as the government intends to phase out the subsidies gradually.

The magnitude of the bill has already led parliament to extend debate into next week, delaying a vote that was scheduled to take place on Tuesday. A public holiday on Wednesday gives parliament a long weekend before the debate resumes. It was unclear when the vote would take place.

Sanctions would be aimed at halting Iran’s nuclear program, which the West suspects is seeking to develop nuclear weapons. Tehran has vehemently denied it.

Critics in Iran say cutting subsidies on fuel and food would stoke inflation and, as well as being a buffer against sanctions, it could also be seen as a victory for Iran’s foes.

If Iran were reacting to the possibility of gasoline sanctions, then the threat itself could already be working, said Mark Dubowitz, executive director of the Washington-based Foundation for the Defense of Democracies. Dubowitz monitors Iran’s gasoline imports.

“Gasoline sanctions are not a silver bullet,” Dubowitz said. “They may however be silver shrapnel and shrapnel also wounds. Any decision by the regime to cut gasoline subsidies is likely to drive up inflation…”

The government claims it would swap universal subsidies that mostly benefit the rich to targeted subsidies for the poor. It plans to give cash payments to those that qualify.

The impact may be felt less keenly as inflation has eased. Central bank figures on Tuesday showed the year-on-year rate fell by almost 4 percentage points in September to 9.3 percent.

BUDGET

Subsidies have placed a heavy burden on the federal budget. Iran has said it will need an additional $6.5 billion from the federal budget to cover fuel imports during the fourth quarter this year and the first quarter next.

But it needs the money for other projects, including expansion of its own energy sector to produce more fuel. Sanctions have stopped Western companies investing and even slowed the flow of cash from Asian firms less concerned by Western opprobrium.

“Maybe this is a decision of necessity rather than choice,” said Al Troner, president of Asia Pacific Energy Consulting in Houston. “Because it is quite apparent that a number of high priority projects are now impacted not by a lack of foreign investor interest but a simple lack of cash.”

Subsidies put “extreme pressure on the budget,” economics professor Ebrahim Hosseini-Nasab said. But he also said that it was important to phase them out gradually and to ensure that those who feel the cuts the most are compensated.

“It is a sensitive issue. I think the government has tried to be very careful,” he said.

President Mahmoud Ahmadinejad is consolidating his position after his disputed re-election in June. The bill in parliament may still change, but MPs approved the outlines of a subsidy reform bill on Sunday. That was a marked change from seven months ago, when parliament threw out a plan.

Ahmadinejad, who came to power in 2005 pledging to share out Iran’s oil wealth more fairly, has argued the subsidy reform bill would help “implement justice and remove discrimination.”

During his first four-year term, opponents accused the government of profligate spending of petrodollars when oil prices were soaring until mid-2008, diminishing Iran’s room for maneuver once they started sliding.

Iran imports around 100,000 to 120,000 barrels per day (bpd) of gasoline. Demand is growing at 6 percent per year as 700,000 new cars hit the roads each year.

Iran also imports smaller quantities of diesel for transport and for heating, around 30,000 bpd.