Iran's Oil Woes Threaten the Mullahs

Much to the dismay of Ahmadinejad’s government, oil prices seem to be falling. From a record $147 in July, oil is now trading at around $100 per barrel. And despite Hurricanes Gustav and Ike, which usually push the price of oil up, there is talk that prices may go down to $80 or even to the $70 per barrel mark.

“Oil prices are dropping because they are inflated,” says Fadel Gheit, senior energy analyst for Oppenheimer, in an interview with Business Week. “You cannot sustain an artificial price forever. At the end of the day supply-demand fundamentals will take over.” According to an increasing number of analysts, not even the mighty Chinese economy and its insatiable appetite for oil can keep prices at current levels, because a lot of “hype” is involved in estimating future levels of demand.

The Iranians see no hype in the danger which the falling price of oil entails for them. This concern was openly expressed by Iran’s oil minister, who said that as far as his government is concerned, “$100 a barrel was the lowest appropriate price.” Meanwhile, at the recent OPEC meeting, Iran failed to convince other members to cut production, in order  to push oil prices up. Therefore, unless there is a serious event, the government of President Ahmadinejad may find itself facing the nightmare scenario of falling oil prices.

With presidential elections 10 months away and sanctions hurting, this is the last thing Ahmadinejad needs. High oil prices have been like a morphine injection which has kept the sick Iranian economy alive. Despite oil and gas income for this year jumping to $81 billion, representing a whopping 31% increase from last year, Iranian people have seen no improvement in their economic welfare. If anything, the situation is getting worse. Inflation has reached the post-revolution record level of 27%. To make matters worse, the government of Ahmadinejad is coming up with new ways to reduce subsidies which Iran’s citizens receive. First it introduced its controversial petrol-rationing scheme in June 2007. This scheme failed miserably in its plans to reduce traffic and pollution.

Now the Ahmadinejad government wants to reduce government subsidies paid to Iranian families for their gas and electricity bill as well. The first part of this plan, which many Iranians find very annoying, involves each family filling out forms from the government, in which they have to declare their income and assets. Many rich people are openly saying that they are cheating, because declaring a high income could translate into a serious fall in the subsidies received. Others are withdrawing money from the banks in order to hide it from the government inspector’s prying eyes, thus leading to a fall in savings levels.

Should this plan go through, it could cause much pain to Iran’s population. The subsidy replacement plan, which involves paying the subsidy money directly into families’ bank accounts — instead of government paying the subsidy amount directly to the electricity company — is not expected to maintain its value in accordance with high inflation levels. This will mean that if inflation levels stay the same until next year, the value of the subsidy received in cash will be 27% less than last year. With falling oil prices, it is very likely that the government will have to go through with this plan. This will lead to serious damage to Ahmadinejad’s popularity. It will also antagonize Iran’s population. The revolution has not brought them edalat (justice). Now high oil prices, their only hope for better economic welfare, are failing them too.

Despite the rising unpopularity at home, what worries Iran’s leadership even more is that, as history has shown them, lowering oil prices could mean having to be flexible with the West. This was first shown in the mid 1980s, when Iran was fighting Iraq. Midway through the war, many countries were calling for a ceasefire, but Khomeini didn’t listen. He was confident that his forces could go on fighting and topple Saddam. In order to finance this ambition, Tehran attacked oil tankers in the Persian Gulf, with the hope of pushing oil prices up. This didn’t work. By 1988, the falling oil price finally forced Ayatollah Khomeini to take the painful decision of accepting a ceasefire with Saddam Hussein, something which he likened to “drinking a chalice of poison.”

The same happened in 1997. The Asian crisis of that year, which led to a crash in oil prices to less than $10 per barrel, was one of the major motivators behind Iran’s rapprochement with the West, headed by the reformist administration of Ayatollah Khatami. Low oil prices were again a factor behind Iran’s Western-friendly policy of temporarily suspending uranium enrichment in 2005. In fact one of the reasons Iran felt confident enough to stop the suspension was that oil prices started increasing sharply in August that year.

What this all could mean is that if oil prices fall to $70 per barrel or below, Ahmadinejad may find it difficult to maintain the same level of belligerence against the West. Things could get much worse for him if Obama is elected. His pledge to invest $150 billion in renewable energy could very well burst more bubbles around oil prices, thus pulling them to more unbearable lows for right-wingers in Iran — so low that the words “suspension of uranium enrichment” may turn from blasphemy into a realistic option.