Middle East: Preparing for Iranian sanctions? (page 1 of 2)

The past few months have seen a significant deterioration in relations between the international community and Iran. The International Atomic Energy Agency's (IAEA's) decision to refer Iran to the United Nations Security Council, after Iran removed UN seals on its uranium enrichment equipment, led to the downward spiral in relations.

Iran had already passed a law that any such referral would lead to a suspension of IAEA spot checks on its nuclear facilities - which Iran still stresses are merely for peaceful power generation purposes - and a restarting of moves towards uranium enrichment. The IAEA has since released a report indicating that efforts towards small scale enrichment have already begun.

Of course, one could easily argue that in a world and a region with nuclear weapons, Iran also has a right to possess nuclear weapons, let alone peaceful nuclear power generators. However, one could just as easily argue that President Ahmadinejad's comments about Israel illustrate the risks involved with such a stance. The focus of this article is the economic implications for the region rather than the rights or wrongs of the arguments being presented.

The first implication is clear. With oil markets so tight, any risk to Iran's 3.9 mbpd production (4.6% of global supplies) is unnerving. The rationale for such fears ranges from a total embargo on all Iranian exports, including oil, to the view that Iran could retaliate to any sanctions by reducing or halting oil exports. The former would likely be suicidal for the global economy and therefore is highly unlikely. The latter is more plausible and Iran is keen to highlight this leverage at any available opportunity.

Indeed, high oil prices may be one of the reasons for Iran's recent confidence when dealing with the international confrontation, both from a domestic financial standpoint and from an international leverage perspective. High oil prices mean that the country is benefiting from huge export revenues.

Meanwhile, markets get nervous when a mere 0.3mbpd is taken off the market in Nigeria due to militant attacks. Just think what the impact of losing a multiple of that amount would be. Therefore, it is conceivable that an Iran that is being threatened by the West, in the form of economic sanctions - or even worse military action - could feel inclined to threaten economic sanctions of their own in the form of reduced oil exports.

In the short term, this would be positive for the region as higher oil prices would boost further the export earnings of all the oil-producing nations. Of course, should this push the world economy into recession - a supply-side shock has much greater potential to do this than a demand-side phenomenon, which should be self-correcting in nature - then this would be damaging to the region's long-term prospects as it would undermine the current assumption implicit in commodity markets that oil prices will remain high in the indefinite future.

Our assumption that oil prices will average USD 40pb over the long run is very positive for growth in the region as it not only supports the oil sector, but it also allows for continued strong government spending aimed, presumably, at increasing efforts towards diversification. Once oil prices fall below USD 25-30 per barrel, then countries move back into budget and current account deficits.

What is less clear is the impact on the region of increased sanctions against Iran via trade and financial channels. Iran is the second largest economy in terms of GDP and also the second largest in terms of population size - behind Saudi Arabia and Egypt respectively.