Iranian Gas Pains—for American Policy

Via the estimable Laura Rozen, a report on another effort to put paid to the Axis of Evil by cutting off Iran’s imports of gasoline, this time via a nonbinding bipartisan Congressional resolution proposed by Democrat Gary Ackerman of New York and Republican Mike Pence of Indiana.

It’s being floated at the AIPAC conference.

As we sweat through a summer of $4 gas, it certainly is infuriating to see Iran sucking up seven million gallons per day of the precious juice from the international market—and selling it for less than a buck a gallon at the pump in downtown Tehran.

But it appears likely that futility and frustration will continue to stalk the United States in our gas war with Iran.

There was a spasm of hope in the US foreign policy community last year when Iran tried a free market solution to dealing with its citizenry’s overconsumption of subsidized gas—it raised prices. Some gas stations were burned down, raising the specter of a righteous petrocarbon revolution.

However, the government backed down—guaranteeing a monthly ration of gas at the ridiculously low price—and the mollified protesters returned to their gas guzzlers.

The issue returns whenever the United States casts around for another way to pressure Tehran.

Previous efforts to cut off the flow through something I would characterize as “moral suasion plus”—the threat of US Treasury sanctions against banks that handle gasoline letters of credit—led to one of those irritating free market reactions: the Iranians shifted their purchases to cash at slightly higher prices on the Singapore market early this year.

The Ackerman-Pence resolution specifically excludes military action. That means the only additional measure open to the Bush administration would be to explicitly threaten financial reprisals against—well, that’s the problem right there.

It’s a good bet that the second-tier banks that Iran has turned to for cash transactions have minimal U.S. presence and therefore are relatively impervious to the big stick in Treasury’s arsenal—the threat that an offending bank will be cut off from the U.S. financial system.

If the bank isn’t intimidated enough to self-enforce the ban on Iranian transactions, then the U.S. has to detect and trace murky cash transactions in violation of national bank secrecy laws, threaten multiple jurisdictions and institutions with punitive sanctions, and basically risk the danger of appearing like Elmer Fudd shooting a the global financial house to pieces while he’s chasing Ahmadinejad’s Bugs Bunny.

The classic story of sanctions is Action: Meet Reaction.

Even as the U.S. government labors to exploit Iran’s gasoline import vulnerability, Iran is preparing its riposte.

And that means we have to prepare a riposte to their riposte.

An outfit called the Institute for the Analysis of Global Security provides an interesting insight into where a single-minded commitment to escalation can take one.

In a December 2006 report entitled Ahmadinejad’s Gas Revolution: A Plan to Defeat Economic Sanctions, IAGS authors Anne Korin and Gal Luft take aim at Tehran’s diabolical plan to reduce its dependence on imported gasoline, decrease its energy costs, and improve the environment... by converting automobiles to liquefied natural gas.

In its conclusions, the report warns darkly:

If Ahmadinejad’s plan for energy independence is implemented, within five years Iran could be virtually immune to international sanctions.

The solution, in Korin and Luft’s view: more sanctions, sabotage, economic warfare, and punitive US actions to strangle the Iranian LNG demon in its cradle.

If the Iranians switch to bicycles, I suppose the next step will be a war on gravity.

But for the time being, I suppose we can take solace in the fact that the Iranians are so stupid they don’t build sufficient domestic refining capacity to turn their own crude into mogas.

Well, maybe not.

Iran is aware of the problem.

Maintenance and expansion of their Shah-era refineries have been crippled by US sanctions--sanctions whose likely purpose in part is to prolong Iran's vulnerability to the "gasoline weapon". As a result, the product mix includes only 17% gasoline, about half of what a reasonably well-run refinery can achieve. If Iran could get those existing refineries up to capacity, they might not have to import any gasoline at all.

The government has bitten the bullet and decided to drop Euros 2.2 billion on a contract with China’s Sinopec to expand triple the gasoline output of two of its key refineries.

But there’s a good reason why the Iranian government has been reluctant to pull the trigger on these large, vulnerable, delicate, and ridiculously expensive facilities.

According to my back-of-the-envelope calculation, not building refineries makes perfect sense for Iran—at least in the context of socialist fiscal policy.

Currently, Iran pumps crude at a cost of let’s say $20/barrel and sells it for north—way north, today-- of $120 a barrel. Let’s assume a profit of about $100/barrel. Gasoline costs about $140/barrel wholesale. To make things simple, let’s say that Iran has to export 1.4 barrels of crude to net enough money to import one barrel of gasoline. Cost to Iran of that barrel of gasoline: $28 dollars in crude production costs. 42 gallons per barrel. Divide $28 by 42 and ta-da~! you get a cost of 67 cents a gallon, about the price it’s selling for at the pump in Tehran.

In other words, by the mathematics of a crude-based planned economy, Iranian motorists are getting gasoline roughly at cost.

How ’bout that.

Of course, from the a centrally-planned economy point of view, there should be better ways to spend Iran’s oil wealth than creating a thick brown haze over Tehran—and generating that ineffable sense of car-fueled freedom that is supposed to be the exclusive birthright of secular, capitalist free market economies.

As to the supposed no-brainer of building a refinery inside Iran to meet its gasoline needs, refineries are supposed to be built in major consumption centers, not production centers.

With a population of 50 million, Iran can stake a claim to be the Middle East’s major consumption center.

However, there is a 25 million ton surplus of gasoline production capacity in the Middle East already.

And here’s what’s happening in Saudi Arabia:

They already have 8 refineries with a throughput of 2.1 million barrels per day.

They are expanding local capacity by 25% to 2.5 million barrels per day at a cost of $12 billion.

Looking at the local glut, the Saudis have recognized that further refinery growth has to be near consumption centers, and they are putting another 800,000 barrels worth of capacity in China.

Long story short, there’s extra gasoline in the Middle East, and the Saudis are leading a charge to put in even more capacity.

Extra Iranian refining capacity is not really needed.

In refined products, they’ve lost the regional race to Saudi Arabia, and if Iran puts a refinery anywhere, it should be in Asia.

From a comparative advantage point of view, the Iranian government should be concentrating on pumping crude and using the proceeds to import gasoline and buy other nice things...like infrastructure and technology that will be useful to Iran after the crude is gone.

The only reason for Iran to expand its refining capacity is the political factor, not the economic factor.

In other words, U.S. sanctions are distorting the free market in trade and investment in the Iranian petroleum industry.

On the whole, we’re the ones fighting the invisible hand of market economics, not Iran.

And maybe that’s why it seems we’re losing the sanctions fight.