The Unintended Consequences of an Oil Embargo on Iran

[Copy of my post on The Monkey Cage]

On January 30, the European Union will decide whether to place an oil embargo on Iran in an attempt to dissuade it from its nuclear weapons ambitions. This would add to the existing sanctions recently put in place by the United States and Europe on financial transactions with the Iranian central bank. The trouble with such an embargo is that it could drive Iran into the waiting arms of the Chinese.

While the nuclear nonproliferation goal is certainly laudable, policymakers need to weigh the potential benefits of the sanctions against their costs – some of which are not well understood. Currently, most attention focuses on two issues. The first is the transaction costs associated with European refiners needing to switch to other suppliers. The plan to phase in the embargo should make these costs manageable.

The second is Iran’s threat to close the Straits of Hormuz in reaction to such sanctions. Such a threat could be very damaging, but it is also fairly unlikely, as Caitlin Talmadge points out. This threat should not be ignored, but neither should it be the sole focus.

The real problems are the potential unintended consequences. The market for oil is global. In the absence of a genuinely multilateral action, a European embargo on Iranian oil will only cause Iran to find new customers in Asia, especially in China. China’s growing thirst for oil and other resources is such that it will happily absorb such supplies, especially if they come at a discount.

EU countries bought about $15 billion worth of oil from Iran in 2010, according to UN data. An embargo would shift that business to China instead, deepening the relationship between Iran and China. What easier way to ensure China continues to protect Iran from UN sanctions in the future?

Worse still, the more successful the embargo is, the more it will deepen Iran’s relationship with China. An embargo has the potential to impose two kinds of costs on Iran. First, in the short-term, Iran’s previous oil sales to Europe will be disrupted while it reorients its sales to new customers. Yet previous embargos suggest that a re-jiggering of oil flows can be done quickly, in a matter of weeks. And to the extent that the EU embargo is done gradually, Iran will be able to reduce this disruption.

So the main cost to Iran of an embargo would be the discount it would have to offer to new customers to replace its previous sales to Europe. This is the second kind of cost, and it could be long-term. Yet either these discounts are small, in which case the sanctions are not hurting Iran much, or the discounts are large, which will create a very profitable relationship for Iran’s new customers – and thus one that they would be loath to give up. The largest new customer for Iran is likely to be China, and hence the problem. The EU oil embargo could enamor the Chinese to their Iranian oil suppliers.

Just as importantly, oil embargos have a long history of futility and unintended consequences.

The embargo on Iraq’s oil after Saddam Hussein’s invasion of Kuwait in 1990 is a case in point. The sanctions were ineffective, laden with corruption, and had perverse consequences. It was ineffective because its chief target, Saddam Hussein, hung on to power until after the sanctions had ended. It was corrupt because it created opportunities for graft in the United Nations, causing a scandal that went all the way up to then-Secretary General Kofi Annan. And it had perverse consequences because it principally hurt lower- and middle-class Iraqis, depriving them of basic economic necessities.

Similarly, the United States imposed a unilateral oil embargo against Libya in the 1980s, and made little headway in changing the Qadhafi regime’s behavior until the UN imposed multilateral sanctions in the 1990s. The UN sanctions were targeted at Libyan elites and government officials, and included travel bans and financial restrictions – but not an oil embargo. Over time, the UN sanctions appear to have taken a significant toll, contributing to Qadhafi’s eventual decision to give up his nuclear weapons program.

None of this necessarily means that the EU is wrong to impose an embargo on Iran. Particularly if the embargo can generate significant leverage in the short-term, perhaps by engendering an increased sense of global isolation among the Iranian public, it might be justified in the name of nuclear non-proliferation.

Yet oil embargoes should not be undertaken lightly, as they frequently generate significant unintended consequences. Policymakers contemplating one should have their eyes wide open.

Is Now the Time to Leave Afghanistan?

Osama bin Laden is dead. Is now the right time to leave Afghanistan?

I ask because I think the decision to keep troops in Afghanistan has been agonizing for many Canadians and Americans. I have argued with people in both of my homes about whether our troops should still be there, almost ten years after invading.

The reasons to leave are powerful. The human cost of the mission is terribly high, both in terms of Western troops/aid workers and Afghan victims of the war. The financial and political costs are high, too. And it's debatable how much good we're doing in terms of 'nation building' or even preventing future terrorist attacks.

But I have usually argued that, on balance, there were still sufficiently good reasons to stay. Simply put, the job wasn't finished: Osama bin Laden was still at large, the Taliban were still awful, and running away would have given the jihadis greater scope to commit evil.

Does bin Laden's death change that equation? I'm not sure, but it's certainly possible. Until now, one of the real costs of leaving was the image of NATO cutting and running when the going got tough. With Osama dead, there is now a window of time open in which NATO could leave Afghanistan with its head held high. It would still be a mistake to say 'mission accomplished', given all the wreckage of Afghanistan and the turmoil that is likely to accompany NATO's departure, but Osama's death is a tangible victory to show for NATO's efforts.

Of course, Osama bin Laden's death is probably more symbolic than a real blow to al Qaeda's operations. I don't want to equate Osama's death with victory over terrorism. Still, it's a major milestone.

And I emphasize that it is really a window of time. If NATO continues major combat operations in Afghanistan for a significant period of time even after Osama is dead, the window will close.

Now is the time to think hard about the rationale for the operation. I'd love to hear what others think. Is now the time to leave Afghanistan?

Really bad ideas on energy

One thing that you can always count on about the US political process is that it will generate a few good ideas and a great many bad ones. Energy policy is a perennial source of the bad ones, and right now is no exception. Let's pick one from both the Democrats and the Republicans.

First, some of the Dems seem to think that the US should tap the Strategic Petroleum Reserve (SPR) because the current troubles in the Middle East are driving up gasoline prices here in the US. This is a ridiculously dumb idea.

The whole point of having an emergency reserve like the SPR is for ... uh, emergencies. An extra thirty-five cents per gallon at the pump is emphatically not an emergency. In fact, for anyone who cares about providing economic incentives for the development of renewable energy sources and new cars, high oil prices are actually a very important market signal. The US government absolutely should not blunt that signal by tapping the SPR.

Just as importantly, the SPR should be preserved for a true emergency, such as the kind of major oil disruption that could occur if Saudi Arabia experienced something like the conflict we're seeing in Libya. Given that there is a reasonable probability that we haven't seen the last of the revolutions in the Middle East, now is precisely the time when we should be extra careful with oil reserves.

Ok, what about the Republicans? Well, some of them seem to be seriously considering Newt Gingrich as a presidential candidate. Even if we were to look past the raging hypocrisy that Mr. Gingrich displayed when he tried to impeach Clinton for having an affair even as he was having one himself -- and I can't imagine why we would look past it -- I'd still have a dim view of Gingrich's candidacy because of his ideas for energy policy.

Gingrich is the author of a 2008 book entitled, "Drill Here, Drill Now, Pay Less." He is, in short, the "intellectual" force behind the chants of 'drill, baby, drill' that we heard in the 2008 campaign. The idea of America obtaining "energy independence" by replacing foreign oil imports with US oil production is profoundly unrealistic. At least within the foreseeable future, the US is completely incapable of self-sufficiency in oil.

Moreover, policies that try to rapidly expand US oil production are much more likely to do harm than good. Too much haste in developing offshore resources, for instance, could lead to another spill akin to the BP disaster in 2010. Even if we get lucky and avoid an accident, what exactly would the US gain by depleting its own geological reserves at a rate far faster than the rest of the world?

So here's my recommendation: let's bundle up Gingrich and the geniuses who want to tap the SPR, and see if we can trade them to Qadhafi for a little peace in the Middle East.

Libya unfolding

For over 40 years, Muammar Qadhafi has had a way of surprising the world. This time, the surprise is on him. His people are rising against him.

As I write, the government is reported to have lost control of Benghazi, Libya's second city, and much of the eastern part of the country along with it. Still, Benghazi has long been a site of anti-Qadhafi protests, so it was even more remarkable that the protests reached the capital, Tripoli, a few days ago.

Qadhafi wasn't the only one surprised. Recently I noted that the oil-rich autocrats in the Middle East had a firm hand on power, even with turmoil in oil-poor states Egypt and Tunisia. But now the protests have spread to Bahrain, Algeria and especially Libya. (Bahrain isn't oil-rich but tends to act like a petrostate because of subsidies from Saudi Arabia.)

I should have noted the fact that petrostates have not one but two characteristics that are relevant for current events. On one hand, oil gives incumbents political power, so incumbent leaders remain in office far longer than in non-petrostates (Africa's longest leader until recently was the president of oil-rich Gabon; when he died in office after 43 years in office, Qadhafi became Africa's longest serving leader). On the other hand, oil tends to weaken political institutions in petrostates (through patronage and corruption), meaning that they also have a higher proclivity towards civil wars than non-petrostates: think Nigeria, Angola, Algeria. This creates an odd paradox: is oil a force for stability or instability? Political scientists are still working that one out -- and clearly the debate is not just theoretical.

For the time being, let me just draw attention to two differences between Libya and Egypt or Tunisia. First, Libya has oil. Second, Libya has Qadhafi. Both of these are going to make the confrontation in Libya a good deal more bloody than its counterparts in Egypt and Tunisia.

Libya's oil money allows Qadhafi to afford an extensive security apparatus, and a patronage network for a hard core of regime supporters. It also allows him to hire foreign mercenaries to fight the protesters, in the event that some or all of the Libyans in his army defect. All of these things make it harder for the protesters, and violence more likely. There is even the possibility that the protesters might be able to get foreign mercenaries of their own, drawn by the promise of oil money once the government has been toppled.

Libya also has Qadhafi, and he is no Mubarak. Mubarak was personally corrupt and clearly enriched himself at the expense of his people. Qadhafi is a megalomaniac. Characteristically, he said yesterday on Libyan television: “Muammar Qaddafi is history, resistance, liberty, glory, revolution.” This is a man for whom being the "Brother Leader" is central to his identity, not just a means to get rich. That makes him even harder to dislodge.

Qadhafi's son, Seif, promised 'rivers of blood' in the event of a civil war. Civil wars are rarely if ever won on the battlefield. It is the loyalty of the armed forces that usually determine the outcome, as it did in Egypt. The loyalty of Libya's armed forces is already showing cracks and strain. Still, it has not yet broken, and even if it does, Qadhafi might have enough mercenaries to make up the difference.

The outcome of the Libyan struggle is far from certain, but I fear the prospect of 'rivers of blood' looms mightily.

Governance in the Middle East

Across the Middle East, common people are standing up to their governments in protest even as I write. This demonstration of resolve for self-governance, in protest of corruption, tyranny, and repression, is nothing short of inspiring.

Of course, the outcome of these protests is still far from clear. Democracy and good governance is far from certain, even if the current autocrats are ousted from power. And even if democracy does emerge, it will need a combination of great leadership and great luck to stabilize and take root.

Still, these protests are an opportunity the likes of which has not been seen in decades.

Being a scholar of global oil politics, I cannot help pointing out which countries are experiencing these opportunities, and which ones are not. Tunisia and Egypt, which have relatively little oil, have had the most significant protests; their oil-rich neighbors Libya and Algeria have not. The leaders in Jordan, Syria, and Yemen have been shaken; the monarchs in Saudi Arabia, Kuwait, and the other Gulf states have not. What's the common denominator? The oil-rich autocrats have a firm hand on power; the states with little or no oil are experiencing popular protests of far greater magnitude.

There are exceptions, of course: the government in oil-rich Iraq has also been shaken by the outbreak of protests. But then, I think it is fair to say that Iraq is exceptional in a lot of ways, and stability was not its strong suit even before the protests in Tunisia.

At the risk of only moderate simplification, the lesson ought to be clear: so long as the global economy remains dependent on oil, it continues to fund autocracy in the Middle East.

US: Follow up on the oil-drilling decision

In late March, I wrote a blog entry arguing that Obama's offshore oil drilling decision was a terrible one. Obviously I cannot claim to have foreseen April's massive oil spill in the Gulf , but it has brought to light some of the things I was talking about.

Specifically, in March I wrote: "In theory, the Department of the Interior will regulate the oil exploration to protect the environment. But there is really no reason not to expect regulators to be captured by the oil industry in exactly the same way that regulators were captured by the financial industry in the years leading up to the 2008-09 financial crisis."

Now the New York Times is reporting evidence of exactly this kind of regulatory-capture:
http://www.nytimes.com/2010/05/08/us/08agency.html?hp

To its credit, the Whitehouse has temporarily suspended its March decision to authorize more offshore drilling. But it should go further: reverse it completely. It was a bad idea then, it's a bad idea now. Only now, its obvious that it's a bad idea.

US: Obama's terrible decision on oil drilling

I must admit, I just don't see what public benefit the Obama administration believes it will generate by opening large portions of the US coastline to oil exploration.

The private benefits to oil companies, of course, could be huge. And perhaps that's the whole explanation behind the decision right there.

Yet when announcing the decision today, Obama made noises about this decision being a step towards American energy security, and part of a long-term energy strategy. So let's examine those claims.

First, this decision is supposed to be sensitive to environmental concerns. In theory, the Department of the Interior will regulate the oil exploration to protect the environment. But there is really no reason not to expect regulators to be captured by the oil industry in exactly the same way that regulators were captured by the financial industry in the years leading up to the 2008-09 financial crisis. Environmental watchdog groups are unlikely to be able to muster much resistance, precisely because any damage done to the environment will be dozens of miles off coast and therefore invisible to local residents.

Second, the decision supposedly helps America's energy security. But as Obama points out, the US has less than 2 percent of global reserves but consumes 20 percent of global production. Drilling now only means that America's dwindling reserves will be used faster.

Even worse, the decision does harm to America's energy security. It gives US industry a greater stake in oil, thereby perpetuating the cycle of political resistance to policies and technology that would shift America away from oil. It delays even further the day when the US car and truck fleet runs on electricity, natural gas, or a renewable biofuel.

Finally, despite being sold as a temporary stop-gap, exploratory drilling is unlikely to happen for at least five years and commercial production is even further away. So instead of providing a short-term, temporary supply of oil, Obama's decision instead sends a long-term signal to world markets that there is less incentive to invest in oil production in other parts of the world.

In theory, Obama's move might be part of a larger strategy for getting a meaningful climate change law passed by Congress. Yet it's unclear the current Senate bill on climate counts as "meaningful", even if it does pass. And if this is a political overture from Obama to independents or Republicans, it seems like a terrible time for an attempt at bipartisanship: senior Republican Senators have already sworn to refuse cooperate with the Administration, and are already condemning today's decision.

So color me skeptical: it looks very much like energy strategy and environmental concerns are being thrown under the bus for short-term economic interests. Not that we should be surprised, of course.