Introduction

In a long series of speeches by, and live television interviews with, its most senior political and military leaders Iran has warned in no uncertain terms that, if its nuclear facilities were attacked by the United States, it will deliver a decisive blow to the attackers. To accentuate its threats Iran put on display a whole range of new weaponry systems, including locally built small submarines, flying boats, underwater missiles and mining capability, shore to sea missiles and thousands of small armed boats. While Iran may have a range of options, both military and otherwise, to retaliate against an attack on its nuclear program, it has so far identified one of these options, namely the closing of the Straits of Hormuz for the passage of oil tankers (please see Appendix). Iran’s other option is to destabilize the situation to such a degree that it will be difficult for the U.S. to maintain its presence in the country.

A. Implications of the Closing of the Straits of Hormuz

The Straits of Hormuz is a narrow, strategically important stretch of ocean between the Gulf of Oman in the southeast and the Persian Gulf in the southwest. On the north coast is Iran and on the south coast is the United Arab Emirates and Musandam, an exclave of Oman. On average between 15 and 16.5 million barrels of oil transit the Straits of Hormuz each day, roughly 25 percent of the world’s daily oil production (table 1).

Table 1: Oil Production by Gulf Countries in millions of barrels/day (bbl/d)

(July 2006)

The production figures equal exports plus domestic production. In the case of Iran, of the 3.75 million bbl/d average production, about 1.5 million bbl/d goes for domestic consumption.

In the case of Saudi Arabia, only about 60 percent of its oil exports go through the Persian Gulf (see above). Nevertheless, the implications for the closing, or even the threat of closing, of the Straits would have significant impact on the global energy market and on the price of crude oil. There will also be serious implications for Iran itself as the interruption of Iranian exports could have severe consequences for the Iranian economy.

The Implications for the Global Market

Crude oil prices behave much as any other commodity with wide price swings in times of shortage or oversupply. The closing of the Straits for the passage of tankers will create a severe shortage that would undoubtedly send shock waves both to the spot and future energy markets already beset by tight supplies and a limited spare capacity. It is anybody’s guess as to how high the price of crude oil could go if Iranian threats were materialized. Perhaps a comparison with the Arab oil embargo in 1973 during the Yom Kippur war might offer a hint. In 1972, the price of crude oil was about $3.00 per barrel and by the end of 1974 the price of oil quadrupled to over $12.00. It is far fetched to expect another quadrupling of oil prices from its present historically high price of $70-75 a barrel without triggering a world economic recession of untold consequences.

On the other hand, a sudden sharp drop in crude oil supplies and subsequent upsurge in prices will have a tempering effect on global demand through more effective conservation measures, particularly in the transportation sector. More importantly, having learned from the experience of 1973 embargo, most OECD member countries, including the United States, have built crude oil strategic reserves that could meet their consumption needs for at least six months. One should also mention the precautionary measures taken by Saudi Arabia, the largest crude oil exporter in the world, to militate against a future conflict in the Gulf.

The Implications for Saudi Arabia

Most of Saudi Arabia’s crude oil is exported from the Persian Gulf via the huge Abqaiq processing facility, which handles around two-thirds of the country’s oil output. Saudi Arabia’s primary oil export terminals are located at Ras Tanura (6 million bbl/d capacity; the world’s largest offshore oil loading facility) and Ras al-Ju’aymah (3 million bbl/d) on the Persian Gulf. However, Saudi Arabia operates two major pipelines. The East-West Crude Oil Pipeline (Petroline) which is used mainly to transport crude oil to refineries in the West Province and to Red Sea terminals for export to European markets. The petroline was expanded in 1987, during the height of the Iran-Iraq war (and specifically the "tanker war" in the Gulf), from its original capacity of 1.85 million bbl/d to its current capacity of 5.0 million bbl/d. The expansion of Petroline was constructed to maintain Yanbu, on the Red Sea, as a strategic option to Gulf port facilities in the event that exports were blocked at that end. Running parallel to the Petroline is the 290,000 bbl/d Abqaiq-Yanbu gas liquids pipeline which serves Yanbu’s petrochemical plants. In short, Saudi Arabia, the largest exporter of crude oil, will be only partly affected by the closing of the Strait of Hormuz.

The Implications for the United States

In the case of the United States, its strategic reserves will be supplemented by imported crude oil, much of it will not be affected by the closing of the Strait. The June 2006 figures for the five largest oil exporters to the United States in millions of barrels per day are Canada (1.1799), Mexico (1.1734), Saudi Arabia (1.427), Venezuela (1.008), and Nigeria (0.996). Other exporters to the U.S. are Iraq, Angola, Algeria, Ecuador and Russia. The U.S. produces about 5.2 million bbl/d. Venezuela, could shut off the supply in solidarity with the theocratic regime of Iran by the country’s socialist President Hugo Chavez who has missed no chance recently in aligning himself with forces of despotism. As pointed out earlier, the Saudi crude oil exports might also be affected but only partially. [1]

The Implications for Iran

According to the Energy Information Administration Iran’s economy relies on oil export revenues, with such revenues representing 80-90 percent of total export earnings and 40-50 percent of the government budget. Iran’s revenues from oil export in 2005 were $46.6 billion, projected to increase to $50.1 billion in 2006. These estimates are based on exports of 2.5 million bbl/d (barrel/day) of crude oil which are roughly the equivalent of 5 percent of world crude production. Total Iranian crude oil production is about 4 million bbl/d but with 1.5 million bbl/d going to domestic consumption. Before the revolutionary upheavals wrought by Khomeini Iran was exporting 6 million bbl/day, a figure which will not likely to be repeated without massive investments in the country’s oil facilities.

Iran has imported refined oil products since 1982, and these imports have been increased rapidly. Currently, Iran imports around one-third of its gasoline which, due to heavy government subsidies, sells for less than 40 cents per gallon in the domestic market, far below international levels, thereby encouraging waste and contributing to a rapid (8-10 percent per year) growth rate in gasoline consumption. In volume terms, Iran is the second largest importer of gasoline in the world after the United States. In 2005, Iran imported 150,000 bbl/d out of total consumption of 400,000 bbl/d. In 2006, Iran will consume 462,000 bbl/day and will import 188,000 bbl/d, or roughly 41 percent of total consumption. Iran buys its gasoline through a European oil trader, Vitol, with another 15 percent coming from an Indian refinery. (Aided by lax environmental regulations and cheap labor, India is building enormous refining capacity, much of its products are intended for export).

Through the summer of 2006, there was heated debate in Iran as to how to balance expanding gasoline needs and the corresponding increase in funding needed for gasoline subsidies. The National Iranian Oil Company has used nearly its entire $2.5 billion budget for gasoline imports but legislators have stated their opposition to providing the additional $3.5-5.0 billion necessary to pay for imports though the end of the fiscal year, in March 2007.

Options put forward for addressing the issue included ceasing gasoline imports in September 2007 when many contracts expire and rationing gasoline or introducing some other form of two-tier pricing mechanism may become inevitable. The shortage of gasoline is exacerbated by the smuggling of refined oil products, which could earn the smugglers, often with senior government officials’ connivance, a handsome profit. Above all, cutting oil subsidies will harm the poor elements of the Iranian society who are the strongest supporters of President Mahmoud Ahmadinejad. In short, closing the Straits could harm Iran both ways-exporting crude oil and importing gasoline.

In the meantime, the fear of conflagration as a result of Iran’s nuclear program coupled with declining confidence in President’s Ahmedinejad’s economic policies, including renationalizing certain industries and burdening them with disguised unemployment, in the estimate of Feridun Feshanraki, Chairman of FACTS Global Energy Group, have "reduced confidence levels in the Iranian economy, and investment has come to a halt." It is estimated that up to $50 billion of capital, the equivalent of one year oil revenues, has been transferred out of Iran.

The top ten Iranian crude oil export destinations are Japan (by far the largest, and almost twice the export to the second destination), China followed by South Korea, Italy, France, Netherlands, Turkey, South Africa, Taiwan and Greece. No doubt, Iran will think seriously whether it would want to harm its biggest customers because of its possible conflict with the United States.

Taking all these factors into consideration the Iranian regime will have to weigh carefully the implications for interrupting both the export of crude oil in the Gulf region and for the import of gasoline to Iran. With unemployment rates as high as 15 percent any disruption in the levels of food subsidy, as a result of the drying up of oil revenues, could trigger a serious reaction in the volatile Iranian street against the regime of the Mullahs in Tehran. For this reason, one could only speculate that Iran, after all the threats and its alleged ability to destroy anything that sails or floats in the Straits of Hormuz, might take a less risky course. This course could lead to Iraq. It will be less costly financially and it will have the added advantage of not upsetting Iran’s customers and more importantly raise the level of discontent of the poor segments of the society which are the backbone of the regime but which rely on government subsidies for subsistence.

B. Stirring Conflict and Instability in Iraq

In Iraq, the potential benefits of inflicting pain on the multinational forces, and particularly on the military forces of the United States and the United Kingdom far outweigh their cost. A foreign affairs analyst told Al-Jazeera TV, that "the allies would be unwise to expect the Iranians to exercise a calming influence over Iraqi Shi'a while they haul Iran over the coals on the nuclear issue." [2]

Iran maintains strong presence in Iraq, particularly in the south. At the moment, hundreds of elements of Iranian Mukhabarat and the Revolutionary Guards are known to have infiltrated the various Iraqi security elements, primarily in southern Iraq. Many others could arrive under the guise of pilgrims to the two holy cities of Najaf and Karbala or by crossing at will the unguarded border with Iraq. The U.S. ambassador to Iraq Zalmay Khalilzad has confirmed to the press in July that the Iranians maintain military presence in Iraq.

Two of the most powerful Iraqi Shi’ite militias, the Badr Brigade associated with the Supreme Council of the Islamic Revolution in Iraq (SCIRI) and the ever growing Jeish al-Mahdi under the leadership of the radical cleric Muqtada al-Sadr are funded and trained by Iran, and Iran can quickly stir them for action against the multinational forces as it stirred for action against Israel her other funded militia, Hizbullah in Lebanon. A recent study by Chatham House concluded that Tehran, more than Washington, controls the Iraqi street. [3] The clashes between Jeish al-Mahdi and the Iraqi army in the southern city of Diwaniya in the last week of August 2006 attests to the ability of al-Sadr and his masters in Tehran, to initiate military action at will. Jeish al-Mahdi has already established a considerable record of violence by seeking to enforce the rules of the Shari’a in the street of Baghdad and elsewhere and to deprive Iraq of its last vestiges of secularism. It has also been involved in the killings of Sunnis. If al-Sadr ever emerges as the sole leader of the Iraqi people, he will institute a Taliban-like regime.

Iran could also resort, through acts of sabotage, to interrupting the export of Iraqi oil which could deny the government an estimated revenue of about $25 billion in 2006, and the means to pay its security forces, turning them into an element of political instability and at the same time achieve the same shock wave in the global energy market by depriving it of Iraqi oil export of about 2 million bbl/d.

Conclusions

This short essay has dealt primarily with the options available to Iran in the event of an attack on its nuclear installations and the implications for the global energy market, the United States and Iran itself. It has not dealt with the trade implications in the event of closing the Strait of Hormuz not only to tankers but also to cargo ships which carry food supplies to many of the countries concerned, including Iran. Nor has it dealt with Iran’s reaction in the event sanctions are imposed on her. We do not see this as a possibility because of a certain Russian and/or Chinese veto. On balance, our assumption is that Iran will retaliate in Iraq rather in the global energy market if its nuclear facilities were attacked. It will be more effective and at the same time cheaper and safer. Above all, it will not risk an uprising by its own people if suspending exports translates into suspension of subsidies.

Iran is aspiring to play the role of the great power of the Middle East and Ahmadinejad’s challenge to President George W. Bush for a public debate on television connotes the former’s aspiration of being equal or almost equal to the latter. As the Chatham House’s study quoted earlier points out: "the presidency of Mahmoud ahmadinejad has added a complication to the dynamics of Iran’s geopolitical aspirations by introducing a brand of millenarianism to the equation which even his own compatriots find alarming." [4]

In the face of Russian and Chinese obfuscation it remains to be seen whether the United Nations Security Council will take any action against Iran with the expiration of the deadline given to Iran and set for August 31, 2006.

The recent decline in crude oil prices might indicate that the mythical "market" is not expecting any military action any time soon. Like merchants in the Iranian bazaar, Iranian diplomacy can stretch the negotiation about its "nuclear technology" to a great length until it concludes that there is no more wiggle space. Then and only then will it make a deal.

*Dr. Nimrod Raphaeli is Senior Analyst of MEMRI's Middle East Economic Studies Program.

Appendix

MEMRI TV Clip #1246 - Iranian Generals Reveal New Weapons Systems and Methods and Discuss the Possibility of Confrontation with American Forces in the Persian Gulf

http://memritv.org/clip/en/1246.htm

MEMRI TV Clip #1102 - Iranians Test "Highly-Advanced Flying Boat" and Two Missiles

http://memritv.org/clip/en/1102.htm

MEMRI TV Clip #1097 - Iranians Present New High Velocity Underwater Missile

http://memritv.org/clip/en/1097.htm

MEMRI TV Clip #1095 - Iranian TV Shows Divers Train in Mine Planting

http://memritv.org/clip/en/1095.htm

MEMRI TV Clip #1065 - Footage of New Iranian Nahang 1 Submarine

http://memritv.org/clip/en/1065.htm

MEMRI TV Clip #780 - Iranian Defense Minister Ali Shamkhani on Iran's Space Activities

http://memritv.org/clip/en/780.htm

MEMRI TV Clip #779 - Mesbah - A New Iranian Satellite

http://memritv.org/clip/en/779.htm

MEMRI TV Clip #676 - Iranian TV Shows a Scale Model of "New Iranian Submarine" - The Ghadir

http://memritv.org/clip/en/676.htm

MEMRI TV Clip #575 - Iranian Generals: Recent Wars in the Region Allowed Us to Prepare for the Americans

http://memritv.org/clip/en/575.htm

MEMRI TV Clip #272 - Footage from Tehran Military Parade

http://memritv.org/clip/en/272.htm

MEMRI TV Clip #252 - Iranian Revolutionary Guard Official in Tehran University Lecture (Part II): We Plan To Target US Nuclear Warheads on US Soil; Should Take Over England

http://memritv.org/clip/en/252.htm

MEMRI TV Clip #212 - Iranian Minister of Defense on Possible Iranian Preemptive Strike

http://memritv.org/clip/en/212.htm