Oil: Caught Unawares

Oil: Caught  Unawares
Oil: Caught  Unawares

The decision made by the Persian Gulf Arab states, namely Saudi Arabia, to stick to current outputs at the OPEC meeting last week (Nov. 27) caused Brent crude prices to nosedive below the $70/barrel benchmark the following day, the lowest level since May 2010.

Since then, Brent has climbed up again slightly to reach $71 on December 2. Prices are down by 36.2 percent from their mid-June 52-week high of $112. The Tehran Stock Exchange also lost about 5 percent in value since the OPEC meeting on fears that the decline in petrodollars would affect stock values.

Fall in oil prices since summer has been spearheaded by a resurgent United States’ economy, falling global demand, notably from China, and rapidly expanding US shale production. For the Iranian government, what matters most now is what economists call the ‘fiscal breakeven point.’ Financial services company Standard & Poor’s defines the fiscal breakeven price as “the average price at which the budget of an oil-exporting country is balanced in a given year.”

Iran’s breakeven point stands at $131/barrel for 2014 and is projected to remain stable next year, according to research conducted by Citigroup. In Citigroup’s calculation, Iran’s breakeven price is similar to that of Algeria (see graph). Bloomberg puts Iran’s 2014 fiscal breakeven price higher, at $143.

The reason why Iran needs relatively high oil prices for its budget to balance is largely due to the large costs of subsidies. Djavad Salehi Isfahani, an Iranian economist at Virginia Tech, has estimated subsidies to cost the government around $70 billion in 2011. Although this figure has probably decreased since the Rouhani administration pushed through reforms last year, such as decreasing subsidies on petrol consumption, subsidies are still costly. For example, bread subsidies alone are estimated at 7 trillion rials, according to ministry of industry, mine and trade. On the other hand, dependence on oil has been reduced as tax income has steadily grown over the past few years. However, oil still makes up 40 percent of government revenue, according to ISNA. The government has found itself unprepared to deal with such shocks. Not only are actual oil prices hovering far below the $100 benchmark on which the current budget is based, the government also resumed daily oil exports of 1.3mbpd. In contrast, the International Energy Agency estimated that Iran exported an average of 1.1 million barrels a day this year.


Iran is facing a dilemma. So long as the country faces international sanctions, oil exports will remain low, and can possibly be reduced below government benchmarks, leading to volatility in national revenues and the budget. On the other hand, if sanctions are lifted and a deal with western governments is reached, global oil prices would plummet further, requiring Tehran to export even more of the black gold to reach its budget commitments.

The most appropriate way for Iran out of this dilemma would be to reduce dependency on oil. The country has a history of reducing this dependence, primarily in response to the international isolation it has suffered since the 1979 revolution. However, when conditions improved, the temptation often proved too strong to export more. One example is the second term of Mahmoud Ahmadinejad’s presidency, when tough sanctions were not yet implemented but the world suffered from an economic crisis which sent oil prices skyrocketing. While Iran had the highest oil revenues in its entire history during the fiscal year ending in March 2009, it did not lead to economic growth, but rather to corruption, social inequality, inflation and unemployment. The share of oil in government revenues in that year also jumped to 56 percent.     

Since the coming of power of President Hassan Rouhani in August 2013, an up-to now highly successful inflation-reduction program has been implemented, taking annual inflation down from over 40 percent on his coming to power, to about 20 percent now. Despite a looming budget deficit, the incumbent administration has room for maneuver. Iran’s foreign exchange reserves are estimated to be as high as $100 billion.

The government has been trying to diminish dependency on oil. Gholamreza Kateb, spokesman of the parliamentary Planning and Budget Committee, recently stated that the drop in oil prices is a result of “excessive supply.”

However, some critics argue that the government should forcefully push up oil exports. Abbas Ali Noura, an ex-parliamentarian stated that "we should not pin our hopes on high oil prices, but seek to compensate for falling revenues with bigger volumes of exports," according to Qods Online. Indeed, it only costs the National Iranian Oil Company between $10 and $15 to produce a barrel of oil, so the oil industry remains highly profitable with current prices.

  Government Efforts and Challenges

The government is aware of the dangers of highly volatile oil prices on its revenues. For the 2015-2016 fiscal budget, the government will take into account an oil price of $70, which is lower than the earlier proposals putting it at $75 or $80. Although not yet discussed in detail, the government should also reduce its estimate of daily oil exports to bring it more in line with reality.

Despite the budget deficit, Iran’s national sovereign wealth fund (SWF) has continued to grow, which indicates that the government tries its best to split oil revenues from other sources. Iran established its own SWF in 2004, called the National Development Fund of Iran (NDFI), a renewed effort to make Iran less dependent on global markets and its economy more self-reliant. Under the Rouhani administration, NDFI resources are estimated to have reached $70 billion. However, the size of the NDFI compared to the SWFs of other oil producing countries remains disappointing. Kazakhstan's national SFW has funds double that of Iran, reaching $156b, while Qatar’s is worth $300b and Russia’s $187b. Saudi Arabia and Norway have funds amounting to $742b and $893b respectively.

The aim of the NDFI is that it would annually receive 30 percent of the country’s oil revenue. However, one unnamed senior official, quoted by the Persian daily Donya-ye-Eghesad, a few months ago stated that “last year [2013-March 2014] 86 percent of government revenues went directly to current spending and only 14 percent was allocated to the NDFI.”

The official was quoted as saying, “these statistics indicate that growth is low and the state has become too big, which of course will not lead to development, welfare and the fulfillment of people’s needs.”