The Weapon Iran May Not Want to Use
Withholding Oil Exports Could Wreak the Most Havoc at Home

By Steven Mufson
Washington Post Staff Writer
Friday, May 19, 2006

In 1967, after Israel trounced its Arab neighbors in the Six-Day War, five oil-producing Arab countries used what they called the "oil weapon" and cut off supplies to the United States and its European allies. But the weapon turned out to be a dud. The United States increased its production by a million barrels a day, and more modest boosts by three other oil-producing nations defused the crisis.

Now, as the U.N. Security Council ponders sanctions or other tough measures to punish Iran for developing technology could be used for making nuclear weapons, Iran's president and interior minister have threatened to deploy the oil weapon -- and people are taking it seriously.

Oil traders and others are worried. Many believe that Iran's oil weapon could prove more useful than any nuclear weapon it might develop. Using a nuclear weapon would assure Iran's destruction. Using the oil weapon, by trimming exports to jack up oil prices and holding the world economy hostage, could bring influence, concessions and, if handled adroitly, tens of billions of dollars in extra revenue without any direct military conflict.

European diplomats, eager to avoid testing Iran's willingness to resort to that weapon, have been crafting a package of incentives rather than punishments to convince Iran to give up its uranium enrichment program.

But sources said that senior policymakers within the Bush administration and their French and British counterparts have come to the conclusion that Iran would continue to sell oil abroad even in the face of heightened economic and diplomatic pressure from Western powers. Administration officials have considered and discounted the possibility that Iran would shut in oil supplies, robbing world markets of much-needed crude.

Experts on Iran point to a number of reasons it might be reluctant to cut oil exports. Oil accounts for 85 percent of Iran's exports, according to an International Monetary Fund report issued last month. Revenue from those exports makes up 65 percent of government income. And Iran uses a good chunk of that money to raise public-sector wages and to subsidize its own gasoline prices, one way to keep domestic discontent in check when unemployment is running at more than 12 percent and inflation at 13 percent.

"If you think a little beyond the moment when this happens, the credibility of the country as an economic partner will go down the drain," said Giandomenico Picco, a consultant who was a mediator during the Iran-Iraq war. "The economy as a whole will be affected, not just because of lack of income." Picco said that already some European banks are reluctant to do further business with Iran and that some petrochemical projects might be delayed.

Moreover, the politics of cutting off exports are muddy for Tehran. In recent years, Iran has shifted its oil exports away from the West. It sells substantial amounts to China and India, though U.S. allies such as Japan, Italy and France are still the major buyers. None is sold to the United States because of sanctions dating to the 1979 hostage crisis. All oil is fungible and even selected export cuts will affect market prices regardless of the customer; the symbolism of hurting Japan, China and India to retaliate against sanctions imposed by the United States and its allies would be fuzzy.

So far, Iran's President Mahmoud Ahmadinejad seems to be banking on the oil weapon even as European countries try to avoid testing it. On Wednesday, he rejected a potential European offer of incentives, including a light-water nuclear reactor, to give up uranium enrichment. "Do you think you are dealing with a 4-year-old child to whom you can give walnuts and chocolates and get gold from him?" Ahmadinejad told thousands of people in central Iran.

The reason Iran has any leverage is the change in the world oil balance. As recently as four years ago, the world had 7 million barrels a day of spare oil production capacity, but today that cushion between supply and demand is smaller than Iran's 2.5 million barrels a day of exports. Losing Iran's exports would spell disaster, with soaring prices and limited supplies.

"There is no cushion that is that great," said Edward Morse, executive adviser of Hess Energy Trading Co. in New York. Saudi Arabia's spare capacity could cover 1.2 million to 1.5 million barrels a day of any shortfall, though that would be heavy oil unsuited for many refineries. Morse added, "If there were peace in Iraq or Nigeria, they could produce more. But there isn't peace in either place."

Fear of the oil weapon is "one of the reasons the U.N. Security Council is tiptoeing around this one," said Gary Sick, who dealt with Persian Gulf affairs at the Pentagon and then the National Security Council through most of the 1970s. "I think this is something that's got to be in people's minds and I assume in the minds of folks in Washington. The price of gas is not making them real popular. If they thought about that price going up another $1 a gallon, that has got to be a sobering thought."

Mere tension between Tehran and the West has added, by some estimates, $10 to $15 a barrel to the price of crude oil. That's been a boon to Iran, which announced on Tuesday that its oil revenue this year would hit $55 billion, up $10 billion from the previous year. Every day, Iran is making $156 million in oil sales.

Youssef Ibrahim, a longtime journalist and consultant on Middle East oil-producing nations, said: "They've got the oil weapon now. This is the ideal situation for them." Iran could also disrupt oil exports by other countries in the Persian Gulf, either by mining the gulf, firing a missile or simple sabotage; even if the damage were slight, a spike in insurance rates would effectively shut down much of the oil exports in the area. Outside the oil markets, Iran could also foment greater violence or unrest in Iraq and Afghanistan.

Some people familiar with Iran believe cooler heads among the supreme religious clerics will prevail and that Iran would not use the oil weapon unless the United States launched a military attack. "When it gets down to their sources of revenues, they get pretty conservative," Sick said. "At the time of the revolution they behaved differently, but they discovered that that didn't work. They've been trying very hard to put themselves back on a rational basis."

Many Iran experts believe oil is more of a shield than a weapon.

"I think that the issue of Iran using oil as an economic weapon has been highly exaggerated," said Abdulsamad al-Awadi, the former head of European operations for Kuwait Petroleum Corp. "From talking to a lot of their officials, I don't believe that they would use the oil weapon unless they were attacked."

Al-Awadi doubts that the United States could convince other countries to impose economic sanctions. "Iran is not North Korea, which can be isolated," he said.

Iranians themselves seem worried about possible conflict, as well as about Ahmadinejad's ideological criticisms of the stock market and banking system. Iranian government officials have told foreign consultants that about $200 billion has flowed out of Iran to overseas money centers such as Dubai in the United Arab Emirates. The Iranian stock exchange has dropped 7.5 percent this year, on top of double-digit declines last year, despite the tremendous inflow of money from oil sales. Every other stock exchange in the region has risen sharply.

Meanwhile, the signals from Iran's government remain mixed. While some Iranian officials, including the oil minister, have played down the likelihood of restricting oil output, other Iranian officials have kept that tension high. "If sanctions are imposed, we will definitely use the oil tool and other tools and we will stop at nothing," the interior minister, Mostafa Pourmohammadi, told reporters in March. Last week, the country's chief nuclear negotiator, Ali Larijani, told a news conference, "We are not interested in using oil as a weapon . . . but if the conditions change it could affect our decision."

Staff writer Dafna Linzer contributed to this article.

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