- The Washington Times - Wednesday, May 10, 2006

The standoff over Iran’s nuclear program has been a chief irritant driving oil prices to record highs this year. The tensions are likely to continue pressuring prices well into next year and could flare up at any time, analysts say.

But a diplomatic breakthrough also could help ease prices, as was seen Monday when Iranian President Mahmoud Ahmadinejad sent a letter to President Bush suggesting the two countries find “new ways” to improve relations.

Iran’s gesture sent the price of premium oil to less than $70 a barrel for the first time in a month, but it quickly rebounded after Secretary of State Condoleezza Rice dismissed the overture. Analysts say a long-lasting diplomatic solution could cause prices to fall back into the $50 to $60 range, and shave about 30 cents off gasoline prices.

A worst-case scenario, on the other hand, is one that likely would extinguish economic growth and spark inflation in the United States by sending oil prices to more than $100 a barrel, and drive pump prices to $4 a gallon.

That could happen, oil analysts and traders say, if Iran keeps ignoring U.S. and European demands that it abandon nuclear-weapons research, triggering a U.S. or Israeli air strike at Iranian nuclear facilities or a U.S.-led military blockade of Iran.

Iran might retaliate with missile strikes on Persian Gulf oil facilities, by cutting some or all of its 2.6 million barrels a day of oil exports, or by blocking passage of ships passing through the Strait of Hormuz, which carry a third of the world’s oil supplies, as it did in 1979 during the Iranian hostage crisis.

The 1979 Iranian oil crisis caused a doubling of oil prices, sparked double-digit inflation and sank the U.S. economy into a deep recession from which it did not fully emerge until 1983.

“Iran has a couple of very big oil trump cards, and it knows how to brazenly flash them around,” said Peter Tertzakian, author of a book on oil, “A Thousand Barrels a Second.”

Any military confrontation with Iran could turn into a minefield for the global economy, he said, because other oil producers cannot indefinitely replace Iran’s daily oil exports, which are 2 times the surplus cushion of 1 million barrels a day in world oil supplies. Also, Iran’s strategic position near the world’s largest oil fields and the most important “choke point” of world oil supplies give it formidable leverage to damage the world economy.

“Countries on the other side of the Persian Gulf from Iran — Qatar, the United Arab Emirates and Kuwait — are generally considered by Iran to be complicit with the West,” he said, making their oil fields “potential targets for Iranian missiles.”

Richard Berner, chief economist with Morgan Stanley, said he does not expect a “doomsday” scenario like the one in 1979 that torpedoed the world economy, but all it would take is a cutoff of Iran’s oil exports to deliver a withering “shock” to the global economy.

“How high crude price quotes could go is anyone’s guess,” he said, suggesting a figure such as $110 a barrel as a starting point. The world would face several years of severe economic restructuring as consumers and businesses struggled to become more fuel-efficient, he said.

Mr. Tertzakian said it’s possible Iran could turn out to be a paper tiger like Iraq and put up minimal resistance in the face of military action, with few repercussions for oil supplies — in which case, the effect on oil prices would be fleeting.

“But Iran is not Iraq,” he said. “Iran’s bombastic leadership appears far more determined to pick a fight and play the trump cards it knows it has in its hand.”

In negotiations before the United Nations, Iran also has several aces in the hole. The biggest one is China, whose demand for oil is growing rapidly, analysts say. China has cultivated Iran as a critical oil supplier and is helping to develop Iran’s oil fields.

Russia, which has joined China in refusing to go along with multinational economic sanctions advocated by the United States, also has important trade relations with Iran — most notably, its contract to help Iran build nuclear-power plants.

“Iran knows sanctions against its oil and gas industry are unlikely because China and Russia, both veto-wielding members of the U.N. Security Council with strong trade and energy ties to Tehran, would block such a move,” said Lionel Beehner, an analyst with the Council on Foreign Relations.

The most likely scenario is that tensions would continue at a low level well into next year, played out in maneuvering at the United Nations, but would stop short of military confrontation because the U.S. and its European allies know the consequences could be severe for the world economy, analysts say.

In that case, oil prices would stay elevated, but probably not spike to eye-popping levels, Morgan Stanley’s Mr. Berner said.

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