The nuclear deal will stimulate global economic growthby Anatole Kaletsky / August 20, 2015 / Leave a comment
The deal to end sanctions against Iran is an event of great importance. What is less widely recognised is that its effect on the world economy may turn out to be even more powerful than its geopolitical impact. While it is possible to speculate about Iran’s re-emergence as the dominant power in the Middle East and how this could affect the conflict between Sunni and Shia Islam, the prospects for nuclear proliferation or the security of Israel, the economic impact of the end of sanctions is already clear. World oil prices, which halved from $100 a barrel to $50 last autumn, fell sharply again after the Iran deal. The country’s re-admission into the global economy—if and when the sanctions are actually lifted—will all but eliminate the risk of oil prices returning to $100, or even bouncing back to the $65-70 level that most industry experts and ministers from the Organisation of the Petroleum Exporting Countries (Opec) still predict.
The economic effects of halving the oil price, if it persists, will be enormous. Since global oil consumption is 93m barrels daily, a $50 reduction in prices will redistribute $1.7 trillion from oil producers to consumers every year. And because oil consumers spend more of their incomes than oil producers, the net effect of this income redistribution is certain to stimulate global growth, as it did during the previous occasions when oil prices fell by comparable amounts: 1982-83, 1985-86, 1992-93, 1997-98 and 2001-02.
Why, then, does the world economy seem weaker today than a year ago, when oil was at $100? Part of the explanation is the time-lag between financial events and their economic impact. But the main reason is probably the belief that prices will soon rebound, making consumers and businesses nervous about spending their windfalls from cheap oil. Quelling this scepticism should be an immediate benefit as the Iran deal solidifies.
Once sanctions are lifted, Iran plans to double its oil exports almost immediately to two million barrels daily and then to double this again by the end of the decade, which would require total output (including domestic consumption) of around six million barrels per day, roughly equal to the country’s peak production in the 1970s. Many experts question the feasibility of these targets, asking who will provide the necessary financing and technology. The answer is obvious: western oil companies and drilling contractors are desperate for access to Iran’s oil fields, which are much easier and cheaper to develop than remote regions such as the Arctic. Raising hundreds of billions of dollars will be no problem against the promise of future sales from Iran’s enormous reserves.
Iran’s proven oil reserves are the world’s fourth largest, after Venezuela, Saudi Arabia and Canada. Taking account of the 40 years of technological progress in geology and oil extraction since the 1970s, restoring and exceeding Iran’s peak production levels seems a modest long-term objective. As this target moves into sight in the second half of this decade, Iran will add about as much or more to global oil output as the US shale revolution did in the first half.
To find buyers for all this extra oil, Iranian exports will have to compete fiercely with Saudi Arabia, Iraq, Kurdistan and other Opec producers, who are already pumping at record rates and are determined not to cut back production. As a result, the price war in oil seems certain to intensify.
Why, then, do so many experts still believe that oil prices will rebound? There are three reasons, and all will be called into question by the rapprochement with Iran.
First is a naive belief in Saudi monopoly power. The Saudis kept oil at $100 from 2011 to 2014, but that was a period when Iran, Iraq, Libya, Nigeria, Venezuela and Russia all suffered internal collapse and geopolitical isolation. If Iran is re-admitted to global markets, Saudi Arabia could support prices only by drastically reducing its own production—and that would create opportunities for Iran and other resurgent producers to increase market share at Saudi expense.
This connects with the second assumption Iran is about to contradict: that geopolitical events can only push oil prices upwards. Iran proves the opposite. The world’s most productive oil regions are already suffering unprecedented chaos. It is hard to imagine the anarchy in Libya and Iraq, or the isolation of Russia, deteriorating to the point where oil production would fall any further. Even when the Islamic State takes over a region, it needs to fund its violence by selling oil. On the other hand, any improvement or stabilisation in political conditions can substantially boost global oil production. This happened in Iraq last year, and Iran promises to take this process to a new level.
Which leads to the final fallacy: that the world is running out of oil. If this were the case, it might make sense for Saudi Arabia or Opec as a whole to restrict output now, in the hope of selling their oil at higher prices in future. But this is no longer plausible. Environmental regulations, rapid declines in clean energy costs and advances in fuel economy mean that global oil demand is slowing and will soon start to decline. Meanwhile, potential oil supplies are continually expanding as a result of technical progress in shale production and the re-opening of exploration in the world’s most productive oil region: the Middle East. This convergence of ecology, technology and geopolitics suggests that many of the world’s oil reserves will be left in the ground, worthless, like the vast Australian and US coal deposits that are now redundant. A former Saudi oil minister used to warn his country against reliance on ever-rising oil prices with a sagacious insight: “The Stone Age did not end because the cavemen ran out of stone.” Now the flood of new oil released by Iran’s re-integration in the world economy will confirm the end of the Oil Age.