Every once in a while I find an article or a book that totally changes my perspective on an issue. It happened this week after I read a small piece in the New Yorker by James Surowiecki. Surowiecki outlines the “risk premium” affecting the price of oil. Essentially, the “risk premium” is the extra price traders are willing to pay for a barrel of oil today to account for the chance of disruption in supplies sometime in the future. By some accounts the “risk premium” could add an extra $10 - $15 to the price of oil, depending on current events.
What makes his article so interesting is that he goes on to analyze the rhetoric of President Ahmadinejad of Iran with the “risk premium” in mind. Ahmadinejad is by no means universally liked or supported domestically in Iran. He was elected on a populist platform by promising to tackle high unemployment and a stagnant economy. His programs have not been successful. The official unemployment rate is still something in the range of 10 - 15%, but most economists believe it is actually somewhere above 20%. Inflation continues to be a problem. The oil infrastructure is in desperate need of upgrades and repairs. So what does Ahmadinejad do? Well, think about it…
Because Iran pumps millions of barrels of oil every single day, a small change in the price can mean windfall profits for the government. The potential conflict between Iran and the United States began to heat up this past winter with both sides making inflammatory statements. Iran began talking up its nuclear program and expressed an unwillingness to submit to UN inspections; the United States began talking up Iranian actions inside Iraq and sent an extra carrier group to the Persian Gulf. The result? A 20% jump in the price of oil within the span of two weeks. The consequence? An extra 20 million dollars a day for the Iranian government to spend.
Interesting, huh. As Surowiecki says, Ahmadinejad actually has economic and political incentives to increase tensions with the West. The risk premium allows him to spend lavishly at home on subsidies for things like gas, food and health care. The extra money also allows him to postpone the negative effects of Iran’s crumbling infrastructure.
Likewise, every time the United States responds to Ahmadinejad they are in effect taking the bait. A confrontational policy actually strengthens Ahmadinejad at home by filling the coiffures of the Iranian government with extra oil revenues. The Bush administration can weaken Ahmadinejad politically and increase the power of the reformers by engaging in diplomatic negotiations, publicly ignoring Iranian provocations and driving down the price of oil.
For an administration supposedly familiar with energy markets and the politics of oil…they just don’t seem to get it.
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