April 04, 2012
Replacing Iran's oil production
If an embargo is successful in preventing Iran from selling a significant amount of oil on the world market, what would replace it?
On Friday the White House released the following statement:
there currently appears to be sufficient supply of non-Iranian oil to permit foreign countries to significantly reduce their import of Iranian oil, taking into account current estimates of demand, increased production by some countries, private inventories of crude oil and petroleum products, and available strategic petroleum reserves and in fact, many purchasers of Iranian crude oil have already reduced their purchases or announced they are in productive discussions with alternative suppliers.
That the President or anybody else is counting on the world demand for petroleum curve to shift left in 2012 seems doubtful. And which are the countries from which increased production is anticipated? Libyan production averaged only 500,000 barrels/day in 2011, and if things go well could soon be producing a million barrels more than that daily. In the mean time, disruptions in Sudan, Syria, and Yemen have taken out a separate 640,000 barrels/day. The best hope is perhaps Saudi Arabia, which presumably has been making private statements to U.S. officials similar to this public statement from Saudi Oil Minister Ali Naimi last Wednesday:
Saudi Arabia's current capacity is 12.5m barrels per day, way beyond current levels demanded, and a reliable buffer against any temporary loss of production. Saudi Arabia has invested a great deal to sustain its capacity, and it will use spare production capacity to supply the oil market with any additional required volumes.
Where have we heard something like that before? Maybe this statement from June 2004 rings some bells:
Oil Minister Ali al-Naimi, in Beirut ahead of the OPEC meeting, said Riyadh was "fully ready" to increase its oil production in an effort to trim soaring prices to the cartel's target range of $22-28 a barrel.
Or perhaps this one from August 2004:
Making good on a pledge made in May, Saudi Arabia announced Wednesday it is prepared to increase oil output by up to 1.3 million barrels per day -- 14 percent -- to cope with world demand. ....[Adel al-Jubair, foreign affairs advisor to Saudi Crown Prince Abdullah] said the Saudis had informed all of their customers within the last week of the kingdom's intention to make additional crude oil available to the international market.
Just for fun, here's a graph of actual Saudi production in the years following those statements, with the date of the second quote above noted by a vertical line.
And in case you've been hiding in a hole for the last few years, here is what actually happened to the price of oil after those words. To help your imagination, I've also drawn a horizontal line at $28, the upper end of the price range referred to.
Moving along through the President's list of alternatives in the first quote above, what about a release from strategic stockpiles? This may well happen, but it's obviously only a temporary stopgap. I'm therefore inferring that Plan A is the embargo successfully shuts down Iranian exports, the world gets by for a short while on releases of strategic reserves, the Iranians cry "uncle" within a few months, and President Obama enjoys a great diplomatic success.
I guess my only question is, what does Plan B look like?
Posted by James Hamilton at April 4, 2012 11:52 AMdigg this | reddit
Well, it absolutely will not do to import any oil from Canada. Nor should we even think about drilling for it in the United States, that would be unthinkable.
Posted by: Walter Sobchak at April 4, 2012 01:06 PM
JDH One positive development is that the US military consumes ~300K barrels of oil per day. With the unwinding of our wars and the parking of military vehicles, there's probably room to save at least 50K barrels per day if we had to. Maybe more.
I don't think the goal of Plan A is to make the Iranians say "uncle." No one seriously believes that's going to happen, and surely the Administration doesn't expect it to happen. And that's why there's no Plan B. But there is a Plan 4CO, and that one has a good chance of succeeding. Plan 4CO stands for Four Corners Offense. Basically the Administration is simultaneously dealing with three sets of crazies; the Iranians, the Likudniks in the Knesset, and the Tea Party Rapture types. The goal is to look like you're doing something while you wait for the crazies to fade away. After November the Tea Party Rapture nuts will be off stage and Obama will have more flexibility to deal with the missile defense against an Iranian attack (that's what Obama meant in his sidebar with Medvedev). That's a carrot he can give to the Iranians in exchange for a small concession on their part. And after this summer Israel's window of opportunity will close, so that will shut down the Knesset crazies. Finally, after next year the Iranians will have to deal with Afghanistan on its eastern border. The US might be the Great Satan, but as far as the Iranians are concerned the Taliban are at least Satan's first cousin. Remember, the Iranians actually helped us overthrow the Taliban in 2001. So there will probably be some opportunities for some grand bargains involving the US, Russia, China, India and Iran. The objective isn't to immediately solve a potential problem in the future, but rather to temporarily immobilize the nutjobs and prevent Armageddon.
Finally, the embargo really doesn't kick in until July and it's sure to be a very leaky embargo with lots of built-in off-ramps and easy excuses.
Posted by: 2slugbaits at April 4, 2012 02:58 PM
Professor, I believe a clearer articulation of Plan A may be that the embargo successfully shuts down the infrastructure and logistics of Iranian exports. Said exports are still being exported, they're just being bartered.
As suggested by:
Iran has production capacity of just over 4 million barrels/day, but is currently running at just under half that (as far as we know from official sources). Iran is also among the top 10 nations in gold holdings, with some 900 tonnes+ (goldbugs beware!). There's a great deal of value there to barter with.
India imports 12% of it's oil from Iran, and has so far not enthusiastically endorsed the embargo program currently underway. China, UAE and Iraq are Iran's largest goods importers respectively, and UAE, China and South Korea are the biggest three exporters. As for the smaller partners:
In that opaque economic environment, given what is at stake, the assumption that Iran would fail to find a way to keep on carrying on seems off target to me. The oil is still flowing, and on the assumption that it is going 'somewhere' it follows that it is going where it has been going to until now, only moreso. To emphasize the point further, note that trading partners are not reducing trade - they're just having a difficult time paying/getting paid for it, intermediaries included. That's a different problem than "there's no oil".
If Iran puts a barter system in place before the intensification of the embargo this summer, they may be able to hang on long enough for the embargo program to begin to appear like an expensive and futile endeavor in the eyes of those footing the bill.
One thing I can say with certainty is that as a resident of North America, it's incredibly difficult to obtain reliable data about all of this, hence the off-the-beaten-path links above. If my assessment above is more right than wrong the nonlinearity of outcomes makes a plan B moot.
If Iran does replace it's "official" income with a somewhat greyer one, how well would current models and tangential economic releases capture this?
Warmest regards to all form Toronto,
Posted by: DToronto at April 4, 2012 03:12 PM
What's interesting about this is the timing. With a fragile economy, it would seem to me that the easiest way to lose the election in November is to have oil prices at $130/brl.
The embargo is a long-term policy action with limited political upside (relative to the swing voters in PA., OH., MI.,etc. swayed by economic conditions). Romney has already started a populist attack on Obama based on gasoline prices.
If Obama is primarily concerned with getting re-elected (safe bet), is politically shrewd (safe bet),and is kept informed of the dynamics of the global oil markets (ummmm...), the only reasonable conclusion I can make is that he knows something we don't. My best guess is that back-door deals to get the Iranian oil out have already been made. Further, the embargo will give Obama cover for a coordinated release of strategic oil reserves.
I'm not normally a conspiracy theorist, but it's hard not to think this way in an election year.
Posted by: SMcCourt at April 4, 2012 08:10 PM
The IMF publishes a comprehensive analysis on sources of energy and substitution gas versus oil (Energy analysis,IMF working paper)
In substance,sources of diversification is the key discriminant in energy, a better geographical spread of supply origins (P 23,24 IMF working paper) and they are material.
'Over the past two decades, Saudi Arabia, Iran, the United Arab Emirates, Indonesia, and Mexico have seen a decline in their share of world net exports of oil, with a corresponding increase in the shares of Russia and Angola"
In essence,the anticipation would be the drivers of oil prices, an ample monetary policy would induce higher energy consumption,higher stocks of strategic reserves would deplete the oil market available resources.
Bloomberg Oil falls a second day.
"An American Petroleum Institute inventory report after the market closed showed an increase in crude supplies three times larger than analysts expect a separate report from the Energy Department to show later today. Federal Reserve minutes from a March policy meeting showed it plans to hold off from increasing monetary accommodation unless economic expansion falters."
The charts of the CME light and sweet May,seem to be in agreement
As an ode to the progresses made by the human intelligence and greater foresight, it is interesting to compare (Econbrowser Peak production for U.S. oil-producing regions and
charts on historical oil production picks with business booms and depression since 1775 (Fraser, Fed Saint Louis).
When the US dollar was providing the same quantity of heat and light from 1815 until 1920 oil peaks or not.
Posted by: ppcm at April 4, 2012 10:56 PM
It appears to me that Plan A~ is being implemented. Naive Plan A could have sent oil prices shooting much higher than $128/bbl Brent Crude. And more to the point, jeopardized the incumbent US president's chances at a second term.
Plan A~ looks like this: Prod allies to saliently cut a few orders of Iranian oil and then after they have played along to American satisfaction issue special 'permits' to resume buying Iranian oil. Iranians will carry higher reserves or sell elsewhere, perhaps at lower prices. It is a form of extra-territorial economic harassment designed to send a clear signal of annoyance. It appears preferable to exchanging missiles and running a higher risk of blocking the Strait of Hormuz.
If Israel were to unilaterally disarm her nuclear warheads, it might go a long ways to resolving this Iran situation. Israeli security would improve. More than a few dollars of 'fear premium' would ooze out of the price of oil. US security would improve.
A nuclear weapons free zone agreement for the Mid-East and Gulf including Iran would create an environment much more favourable to commerce, trade, and that old-fashioned business of growing wealthier.
Posted by: westslope at April 5, 2012 12:15 AM
Walter - oil production in the United States is at its highest level since 2001, with drilling rig counts at all-time highs.
Posted by: Mitch at April 5, 2012 05:04 AM
I seem to see your tongue planted firmly in your cheek!!
The oil embargo will have about as much effect as has any embargo. All our governmnet is doing is spitting in the wind. The only problem is that we seem to be down-wind...
Posted by: Ricardo at April 5, 2012 05:18 AM
SMcCourt: "it would seem to me that the easiest way to lose the election in November is to have oil prices at $130/brl."
Louisiana LIght Sweet is generally the median global crude oil price, and it is currently at about $124.
Based on the WTI crack spreads, US consumers are almost completely exposed to global crude oil prices. US Mid-continent refiners are paying WTI based prices for crude oil, but charting product prices that are indexed to global crude oil prices.
Posted by: Jeffrey J. Brown at April 5, 2012 05:59 AM
Iran is a short term problem. The longer term problem is the increasing ratio of domestic petroleum consumption to domestic petroleum production in oil exporting countries.
A Summary of my Recent Thoughts Regarding Consumption to Production Ratios in Oil Exporting Countries
Saudi Arabia, and the (2005) top 33 net oil exporters overall, are showing the same type of increase in their ratios of domestic consumption to domestic production of total petroleum liquids (C/P) that led to a number of net oil exporting countries becoming net oil importing countries, e.g., Indonesia, UK and Egypt. While there are some examples of increasing C/P ratios, followed by declines, they tend to correlate to falling oil prices, e.g., Saudi Arabia in the early Eighties, or they tend to correlate to political problems causing a temporary production decline, e.g., Colombia in recent years.
The initial increases in the C/P ratios for many oil exporting countries, e.g., Indonesia, when extrapolated provided reasonably accurate estimates for when the exporting country: (1) Approached zero net oil exports and (2) For the approximate volume of post-peak Cumulative Net Exports (CNE).
Given an ongoing production decline in an oil exporting country, unless they cut their consumption at the same rate as, or at a rate faster than the rate of decline in production, the C/P ratio will increase with time, and the net export decline rate will accelerate with time. Case histories of countries that have "successfully" cut their consumption, e.g., Denmark, are not encouraging, since the small decline in consumption has not come close to offsetting the decline in production. Furthermore, Indonesia's current attempt to reduce petroleum subsidies illustrates how difficult it is for countries to cut back on subsides, even, in Indonesia's case, after they have become a net importer of petroleum liquids.
An extrapolation of the 2005 to 2011 Saudi C/P data, using the most optimistic estimate for 2011 data, suggests that Saudi Arabia would approach zero net oil exports around 2030 and that remaining Saudi post-2005 CNE are on the order of about 23 Gb (billion barrels), which is about one-tenth of the most commonly used number for proven Saudi reserves. As noted above, a projection of the initial three year increase in the Indonesia C/P ratio, from 1991 to 1994, accurately predicted when Indonesia would approach zero net oil exports and it accurately predicted post-1991 CNE.
Furthermore, an extrapolation of the 2005 to 2008 Saudi C/P data, an increase from 18% in 2005 to 22% in 2008, if extrapolated to 2011, would indicate a 2011 C/P value of about 27%, which is my most optimistic estimate for the 2011 Saudi C/P ratio (BP data).
An extrapolation of the Global Net Export* (GNE) 2005 to 2010 data suggests that remaining (after 2010) post-2005 global CNE are on the order of about 300 Gb.
An extrapolation of the Available Net Export** (ANE) 2005 to 2010 data suggests that remaining post-2005 CANE (Cumulative Available Net Exports) are on the order of about 106 Gb. This would be the estimated remaining (after 2010) total volume of post-2005 Cumulative Net Exports available to importers other than China & India.
Therefore, an extrapolation of the 2005 to 2010 data suggests that China & India alone would consume about two-thirds of remaining global Cumulative Net Exports of oil, leaving one-third for about 155 net oil importing countries.
*Top 33 net oil exporters in 2005, BP + Minor EIA data
**GNE less China & India's net imports
Two Approaches to Petroleum Subsidy/Taxation in Oil Exporting Countries
An example of how tough it is to cut fuel subsidies, even after a former net oil exporter slips into net importer status:
Indonesia Delays Fuel Price Increase:
Denmark is a case history of a net oil exporter, showing a production decline, that taxes fuel consumption and that has "successfully" cut their consumption. Their 2004 to 2010 rate of change numbers (BP, Total Petroleum Liquids):
(P = Production, C = Consumption, NE = Net Exports.)
*C/P ratio increased from 48% in 2004 to 72% in 2010, which implies that Denmark will approach zero net oil exports in 2015, versus net exports of about 0.2 mbpd in 2004.
Denmark is one of 21 of the top 33 net oil exporters in 2005 that showed declining net oil exports from 2005 to 2010.
Posted by: Jeffrey J. Brown at April 5, 2012 06:09 AM
Jeffery Brown might be interested in this:
Of course, it's probably due to their lack of access to coal and nuclear.
It's amazing that they aren't building coal power plants and importing coal.
Posted by: aaron at April 5, 2012 07:47 AM
Posted by: aaron at April 5, 2012 08:02 AM
About two weeks ago Juan Cole reported on a translation of a column published in Farsi in Iran that claimed that the embargo had increases Iranian oil revenues by $3 billion as the price increases had more than offset what were being claimed as minimal declines in oil exports. The column claimed that this was a conclusion from a meeting held in Sweden of intel officials from US, UK, France, Germany, and Israel, and that on balance the West was hurting itself with its embargo policy (and, yes, Mossad is reportedly opposed to the hawkish line of Netanyahu and Barak on the Iranian nuclear issue).
OTOH, this may have been a planted article trying to sway western opinion as there certainly is evidence that the embargo has caused economic damage in Iran, most notably through major devaluation of the rial with subsequent inflationary pressures accelerating noticeably there.
Posted by: Barkley Rosser at April 5, 2012 10:02 AM
There was a report just a few days ago that Saudi Arabia is now seriously considering developing nuclear power plants, partly in response to this large scale domestic use of petroleum.
Posted by: Barkley Rosser at April 5, 2012 10:04 AM
Westslope - True but in terms of market signals the U.S. is also: has continued reduced production on Federal areas in the Gulf of Mexico; 87% of our offshore acreage off-limits; Federal permits lagging in offshore areas; Federal permits lagging in onshore areas; a million barrels a day from ANWR languishing for decades; U.S. blocking upwards of 800,000 barrels a day from Canada; a plan for increasing taxes on U.S. exploration and development; and three years worth of delays and obstructions of oil and natural gas development in the U.S.
Posted by: EnergyTomorrow at April 5, 2012 10:11 AM
I would like to remind the fact immune among us that, thanks to the Iraq war, we have proof that the embargo had actually worked.
Posted by: Frank in midtown at April 5, 2012 11:25 AM
The idea of SPR used to buffer an embargo shock is rediculous.
Iran knows it is sustainable for only a short period of time, and that demand and prices will go up significantly after the release.
Given the high inelasticity of demand, the prices increase may well make up for their lack of sales volume.
The only reason to talk about the SRP is to prepare for or threaten a short, intense military action. Quick and decisive (whether it's korea, syria, or Iran, who knows).
Posted by: aaron at April 5, 2012 11:36 AM
2sb, excellent insight on the Obama missle defense "gaff". He's saying, "We can back down on missle defense after the Iran threat is neutralized."
Posted by: aaron at April 5, 2012 11:43 AM
EnergyTomorrow: I'm not a big fan of what Menzie Chinn referred to as the 'Drain America First' energy policy. Fossil fuels are non-renewable.
I own shares in offshore oil exploration and production companies but sympathize with offshore drilling moratoria.
Moreover, I have personally felt the rush of a commodity boom--as a worker and as an investor--but regard policies that slow and temper commodity booms as overall positive. Like recreational narcotics, users focus insufficiently on the downside that inevitably lies ahead. Sometimes tougher environmental regulations are the incumbent firm's best friend as they raise barriers to entry, slow growth, reduce pressure on input markets and create level playing fields among competing companies.
The USA can do little to buffer the American economy from oil price shocks on the supply side. But it can discipline demand with higher green-Pigouvian-excise taxes on dirty fossil fuels, and ultimately buffer the economy from oil price shocks.
None of these supply side issues would affect how the Iranian embargo plays out and drives benchmark oil prices.
Posted by: westslope at April 5, 2012 12:01 PM
I do hope that there is no plan B. Plan B is to face voters angry that their gasoline prices are sky high and then to challenge the lock that farm states have on ethanol production.
Federal law requires that ethanol that goes into gasoline has to be made from plants. Celanese claims it has a process that turns natural gas into ethanol and that it can sell this for $1.50 to $1.75 per gallon. Even though ethanol has 70% of the BTUs of gasoline per volume this is still an attractive option. Celanese is restricted in this country to using the ethanol as feedstock for products.
There are currently 8 million E85 cars on the road. While there is no short-term fix for oil prices, if the law were changed we would suddenly have an ample and regionally well distributed alternative to oil as a motor fuel. The only barrier would be ramping up demand by providing fuel pumps and the time it would take to convert a large amount of the car fleet to E85 vehicles.
Posted by: colonelmoore at April 5, 2012 04:20 PM
I guess my only question is, what does Plan B
Sending american troops to the oil fields of Iran to enforce the embargo at the well.
Posted by: anonym at April 6, 2012 02:39 AM
What drives the higher domestic consumption in Saudi Arabia ME countries? Is it production of electricity?
Posted by: Ulenspiegel at April 6, 2012 03:40 AM
Re: Saudi Consumption
I suppose three primary factors: (1) Fuel subsidies; (2) Demographics (very large Saudi families) and (3) Efforts to industrialize the country.
Posted by: Jeffrey J. Brown at April 7, 2012 03:18 PM