Iran - The Melt Down

Iran is in a world of hurt according to Dr. Nimrod Raphaeli in an article published by The Middle East Media Research Institute on October 30th.

At its two-hour emergency meeting in Vienna on October 24, the Organization of Oil Petroleum Exporting Countries (OPEC) decided to lower crude production by 1.5 million barrels/day (b/d), effective next month.

The reduction in production was OPEC's response to plummeting crude prices, which peaked at $147 a barrel last July but are now hovering in the mid-$60s a barrel, and appear to be trending downward.

Trending lower is right. The current trading range is $55 a bbl. and I have seen it as low, in trading, as $50 a bbl. And this is just the beginning of the economic collapse. So I expect to see prices going even lower with further production cuts as well. OPEC has had problems in the past maintaining supply discipline when prices are low. The temptation to cheat and try to squeeze out some extra dollars at the expense of the other members is great. Generally the Saudis maintain discipline and the rest of OPEC not so much.

So where is Iran in all this? They are definitely price hawks and here is why:

A recent study by the International Monetary Fund (IMF) has suggested that in order for Iran to balance its budget, the price of crude oil must not fall below $95 a barrel. The equivalent figure for Saudi Arabia is $50 per barrel and for the United Arab Emirates and Qatar even lower. One should keep in mind that Iranian oil sells at a discount compared with the higher quality benchmark West Texas Intermediate.

Countries whose economies rely on the production of natural resources, such as oil, generally establish a stabilization fund for retaining windfall profits, such as when oil went over $140 a barrel, to be used in time of economic shocks, such as a sharp decline in the price of the commodity.

Iran has established such a fund to be managed by its central bank. It would appear, however, that President Ahmadinejad has dipped into the till too often, causing the departure/resignation of two consecutive governors of Iran's central bank in a little over one year. The assets of the Iranian stabilization fund are kept secret; however, a member of the Majlis (parliament) recently revealed that it has a balance of $7 billion, which would just about cover the cost of imported gasoline for one year.

And why is Iran importing gasoline? It lacks refining capacity for one. One reason for that is that it subsidies gasoline. Gasoline in Iran costs under 50¢ a gallon. Another reason it lacks refining capacity is that instead of spending on infrastructure, Iran prefers to spend its money on foreign adventures. Supporting Hizballah in Lebanon, Hamas in Gaza and various insurgent groups in Iraq - among others. That is why Ahmadinejad has to dip into the till. Wars cost money. It appears that they may become more costly than Iran can afford at least long term.

And how about Iran's economy? It is not doing well internally.

Oil revenues comprise 80% of Iran's foreign exchange. If oil prices continue to plummet in the face of the world's worsening economic crisis - a crisis which may be just in its early stages - Iran, unlike the Arab oil-producers with hefty sovereign wealth funds to cushion their national economies, could face politically destabilizing events that could threaten the survival of the regime.

On the economic front, Iran could resort to terminating oil subsidies and restricting the import of non-essential consumer goods to conserve foreign currency. In fact, news from Iran last week suggests that both steps are under consideration.

Iran may also seek to reintroduce a 3% value-added tax (VAT) which it was forced to suspend after shopkeepers in the politically influential bazaars closed shops in protest, arguing that the VAT would further aggravate inflation which reached 29.6% in October.

The inflation rate is a problem. It is about 2.2% a month, barely tolerable for those living from hand to mouth. However, rates like that discourage investment in production capacity which ultimately makes inflation rise all the faster. A business would have to have a 40% or 50% rate of return in a year to make investments worthwhile in that kind of climate. And even that is problematic if the government decides to run the printing presses faster. What does the money get invested in? Currencies that are inflating at a much lower rate for one. Tangible goods for another. One thing you do not do in a situation like that is park your money in a bank.

What do countries which have a history of foreign adventures typically do in a situation like that? That is pretty obvious. They engage in foreign adventures. One foreign adventure they might try is cranking up their insurgent cadres in Iraq. However, they would face an ever strengthening American trained Iraqi Army. The army that cleaned the clock of Iran's cats paw, the Mahdi "Army", in Basra this past year. In addition Iran needs its Army to maintain internal order so using it for an attack on Iraq is probably not a good idea. Not to mention that such an attack would gather the wrath of the American Army.

So really, they are stuck between a rock an a hard place. It will be interesting to watch while the rest of the world goes into an economic meltdown.

Cross Posted at Classical Values