In following news of the latest taking of Royal Marines by Iran, I keep running into stories such as this one from the BBC. The headline is “Oil prices leap on Gulf incident”.

Iran is in something of a financial pinch. While they export a large amount of oil, they also lack refining capacity and must import refined products such as gasoline and diesel fuel. These are sold on the domestic market at below cost with the difference subsidized by the government. Iran has been behind on her payments to Russia for the construction of a nuclear power plant. Recent delays in payments have resulted in further delays in construction. The Iranian president’s budget is also increasingly dependent on oil revenue and he has been criticized by others in the government for not sticking to a plan to reduce that dependence bu 10% per year as had been agreed.

Estimates dated 2004 place Iran’s oil exports at 2.5 million barrels of oil per day. For every dollar oil rises on world markets, Iran receives another $2.5 million per day or roughly $75 million per month and taken out farther, nearly a billion dollars a year for every dollar oil increases on the market. Iran has a direct financial incentive to create uncertainty and instability in order to create a rise in oil markets that are often driven more by emotions of the traders than market fundamentals of actual supply and demand.

There really isn’t much Iran can do on the supply side. If they withhold production from the market, world prices go up but their revenue goes down. They have been trying to get OPEC production quotas lowered but the other countries aside from Venezuela have not gone along. Iran is shipping oil as fast as they can produce it and their infrastructure is suffering from age, mismanagement, and neglect. They can not increase production to increase revenue. Their only remaining card is to somehow get the oil prices up in the market and I believe that is their purpose in this event. Oil prices spiked today to their highest level since last December.

This isn’t the first time they have done this and I have commented on other blogs that a lot of Iran’s games seemed to be designed to create instability in order to jack up oil prices. Iran profits directly from events of this sort. I believe the last time they did this, they miscalculated. I believe that the kidnapping of the Israeli soldier on the Lebanese border was done to increase tensions and raise the price of oil. I think Iran expected there to be heated rhetoric, brinkmanship, and a rise in world oil markets. I don’t believe they anticipated Israel’s response but in any case they managed to get oil to $75 per barrel at the time.

The question then becomes one of what we can do to remove this incentive to destabilize the region. If we threaten a massive response, that in and of itself will further inflate the markets and reward Iran even more. One way would be to reduce Iran’s domestic oil refining capacity causing them to buy more imported refined products. While world markets would still rise, Iran’s profit from this rise would diminish. As time went on, we could systematically reduce her refining capacity and when that is finished, begin on her domestic natural gas network. While Iran does export gas, gas prices are more regional in nature than global. It is more difficult and more expensive to ship gas around the world than it is to ship oil. This would put direct pressure on Iran’s revenue while leaving her oil export ability intact. Prices would rise, but Iran would not profit.

So basically, I see this as being mainly about money. Iran is using those Royal Marines to create a show, anger the UK, escalate the rhetoric, and drive world oil prices up to increase their revenues so they can pay the Russians and the Iraqis from Sadr’s militia newly on their payroll and who knows how many in Lebanon and in other places around the globe.

A way out of this must be found that prevents Iran from profiting and prevents them from doing this again. I am personally in favor of a reduction in their domestic refining capacity as a start. Sanctions on world companies working on her petroleum infrastructure would be a second, longer lasting step.