Tuesday, April 24, 2012

Ejecting oil- and gas-rich Iran from SWIFT may be a strategic error on a historic scale....

Ejecting oil- and gas-rich Iran from SWIFT may be a strategic error on a historic scale....

Thinking the unthinkable;
By Chris Cook

How often is it said that when you have eliminated the impossible, whatever remains, however improbable, must be the truth? Recent events in Iran bring this axiom of Arthur Conan Doyle's famous fictional detective, Sherlock Holmes, very much to mind.

Much has been written in respect of the sanctions being applied to Iran, in two areas: oil and finance. The oil sanctions are, as similar sanctions have almost always been, counterproductive, and to date have probably served to increase Iran's net oil receipts.

This is because an "Iran risk premium" of some US$20 to $30 per barrel has been a factor in the oil market for some time, caused by refiners and governments bidding up the price in order to secure physical supplies. The bets placed on the future oil price on derivatives markets - despite the popular misconception as to the role of speculators shared even by US President Barack Obama - have had no direct effect on the physical market price.

But looking forward, we may expect China, India and a few other buyers to pick up Iran's crude oil at a steep discount, and to sell or export their refined products very profitably.

Financial sanctions, on the other hand, have been instrumental in bringing Iran to the negotiating tables in Istanbul and Baghdad over its nuclear program, which some say - and Tehran denies - is aimed at nuclear weapons capability.

Dollar payments have been made it impossible for Iranian banks generally and Iran's Central Bank Markazi in particular - by having them ejected from the SWIFT financial messaging system.

In doing so, the US and the EU may well have made a strategic error with unintended consequences on a historic scale.

Retail prices of staple goods and commodities in Iran have risen fairly drastically as conventional trade has been throttled, because payment channels have dried up or have become extremely expensive. Some barter transactions have taken place, and some settlements have been made in gold for high value transactions, while pallets of dollar bills have been stacking up in Iranian bank vaults.

While current rates of inflation are bad enough, the domestic policy response by President Mahmud Ahmadinejad last week was to schedule a TV appearance in which he was to announce a second round of payments in rials to Iran's population. The rationale for these payments was that they were further compensation for fuel price increases aimed at reducing Iran's massive energy subsidies and cutting profligate consumption.

The Supreme Leader's office, a Majlis (parliament) now firmly aligned against the president; the financial services sector, and other factions, all united in condemnation of this initiative as being likely to lead to hyperinflation. As a result, the planned payments appear to have been suspended.

With all conventional options being systematically made impossible, Iran is as a result seriously examining the improbable.
Energy swaps
For several years, Iran has been routinely conducting "oil swaps" whereby oil supplied by Turkmenistan to Iran's northern refineries was exchanged for oil supplied by Iran from terminals in the Persian Gulf at an agreed price differential. Other swaps such as natural gas and electricity have also been agreed sporadically by Iran with other neighboring countries.

The author of the Caspian oil swap - a senior official who formerly headed Iran's Caspian oil and gas production - has been widely interviewed by the media in Tehran in respect of an interesting proposal. This is for an "energy dividend" of vouchers that are redeemable in payment for gasoline, diesel, and even natural gas or electricity.

The attraction of this concept is that it changes incentives in a very interesting way. If energy prices are increased to global market levels, then rather than continuing profligate use of energy - which the recent modest energy price increases have failed to deter - consumers can be expected to drastically reduce demand.
The reason is that if they do so, then they will possess vouchers, which tend to hold their value and are generally acceptable in exchange within Iran. Moreover, if the Iranian oil and gas complex were to accept the vouchers in payment for natural gas, electricity, crude oil and oil products they export, then these vouchers could even come to be acceptable in exchange internationally.

In other words, such vouchers would essentially become energy currency, both domestically and regionally.

An energy standard
Taken to its logical conclusion, where this policy leads is for Iran's Central Bank simply to fix a new rial - with several zeroes removed - to a suitable unit of energy, and for energy prices to be set against this unit. This could be implemented in a similar way that a deficit-based abstract currency unit was fixed to participating European currencies at the launch of the euro.

The transition process would need to be properly and transparently managed by a monetary authority - probably the Central Bank - in close liaison with the oil and gas complex. The outcome of adopting an "energy standard" and an energy dividend in this way would be to rapidly reduce profligate use of energy at the same time as addressing the problem of inflation.

The value of energy - while very significant in Iran - is only one of several sources of value. So while such an energy currency could become widely acceptable as a national and regional means of exchange, the fiscal basis of Iran's economy would necessarily shift to its other immense physical and human resources.

So as sanctions make conventional monetary solutions impossible, Iran is seriously considering the improbable.

Chris Cook is a former director of the International Petroleum Exchange.

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