Declining Oil Prices Fuel Paranoia in Tehran

For citizens of an oil producing country, the price of oil is not just another commodity indicator. It is the thermometer of social welfare and the government’s ability to provide crucial services. For nations like Iran, who depend heavily on oil income and have poorly developed private sectors, a drop in crude oil prices means serious trouble looming.

Today the price of a barrel of crude oil has reached an average of $81 per barrel and continues to fall.  Only three months ago prices were hovering above the benchmark of $100 per barrel. A drop of 20 per cent in just three months is alarming for any country, but is catastrophic for Iran.

Iranian officials did not expect to see such a sharp dip in oil prices and now they are blaming it on almost anything but economic factors. One Iranian official, Mohsen Qamsari, speculated: “Oil prices are falling because the world powers are permitting it.” But he is still hopeful and predicted that prices would not fall below $80 per barrel, a bold expectation given the market trend.

A distressed Iran is asking members of the Organization of the Petroleum Exporting Countries (OPEC) to reduce production and allocate new quotas, something they have not done for six years.  OPEC members are divided. Countries like Saudi Arabia are not inclined to cut their oil production further, prompting many in Iran to accuse Saudi Arabia of sabotaging Iran’s economic interests. 

But unlike what some Iranian officials want people to believe, falling oil prices are not Saudi Arabia’s handy work. The hidden hand of the market is at work, and as always the interactions between supply and demand explain much of the change. Oil prices are dropping because there is more oil supplied than demanded, with new countries producing oil using fracking or offshore deep water drilling. To expect anything other than a declining oil price is folly. 

US oil production is surging due to the success of fracking and shale oil and its oil imports are shrinking. Russia, the official bad boy of oil and natural gas, is in a hurry to produce more and more again. Recently its production reached a historical record: 10.6 million barrel per day. No one is cutting production, but some countries are cutting demand. China’s economy, whose rapid growth fueled the increase in oil prices back in the 2000s, is slowing down and the economic growth rate for EU countries leaves much to be desired. There is no country whose demand for oil would increase rapidly in the foreseeable future. The most likely outcome right now is to see a surplus forming in oil markets.  

Last time when oil prices were falling, OPEC countries adopted a new regime, working carefully to avoid a potential for a surplus. They managed production levels so well that the oil prices began to rise. However OPEC countries do not have the same influence as in the past. Rising oil prices encouraged many countries to seek alternative techniques and resources. OPEC’s market share and dominance is receding, ironically because the high price of oil encouraged non-OPEC countries to seek alternatives. Countries like Saudi Arabia have to make a choice between price or market share. Saudi Arabia can choose market share, but Iran cannot. 

The Iranian government has always been concerned more by oil revenues than its market share. It has to feed a larger population than Saudi Arabia and is more vulnerable to changes in the price of oil. Saudi Arabia and other OPEC members have diversified their portfolios and used their oil revenues in investment markets. Besieged by sanctions Iran’s economy has become even more dependent on oil revenues. Oil revenues footed the bill for Ahmadinejad’s populist policies and his patronage of special interest groups. With oil revenues declining, the current Iranian administration is facing dissatisfaction among the populace and among its support base. If President Hassan Rouhani’s administration wants to keep the same level of spending it will face an even larger budget deficit, which will increase already high inflation. 

However reducing oil revenues is not necessarily bad news. When oil prices fall Iranian governments remember that there are such phenomena in the economy such as the private sector, entrepreneurs, taxation and market dynamism. Rising oil revenues did not bring Iranian people prosperity or welfare, those dollars paved populist Mahmoud Ahmadinejad’s path to power. He brought Iranians international isolation, sanctions and a tainted international image as a Holocaust denier. Now more than ever the Iranian regime and economy need access to the global market. Industries like tourism are already receiving some attention these days as the government finally notices their revenue earning potential.

But this does not mean Iran has avoided the unfolding economic crisis. It simply means President Rouhani’s cabinet has some hard choices to make. Will the political establishment continue to favor and support the presence of military institutions in the economy or will the government finally start to lessen its controls of the private sector and allow some fair competition?

Promoting the private sector requires political will and courage, both of which are lacking at the present moment. Until that changes, falling oil prices will create great unease in Tehran.