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FOR IMMEDIATE
RELEASE Contact: Testimony of William F. Martin Chairman, Washington Policy & Analysis BeforeThe
Senate Committee on Banking, Housing, and Urban Affairs Thursday,
June 28, 2001 Good morning. My name is William
Martin. I am delighted to be here today to testify on the reauthorization
of the Iran and Libya Sanctions Act of 1996. I
am an energy economist by training. I am the chairman of the Council
on Foreign Relations Energy Security Group and the chairman of Washington
Policy & Analysis, Inc., an international energy consulting firm.
I served as Deputy Secretary of Energy and Executive Secretary of
the National Security Council under President Reagan. The purpose of my testimony today is to share
with you the results of a recent study conducted by my firm. It investigated
the impact of sanctions on current and future energy markets and the
ensuing effects on the American and world economies.
This study is consistent with the Administration’s National
Energy Policy recommendation that President Bush “direct the Secretaries
of State, Treasury and Commerce to launch a comprehensive review of
U.S. sanctions policy.” While
a comprehensive review requires inquiries into national security,
economic, energy and foreign policy issues, WPA focused on how sanctions
affect energy supply, demand and pricing. Its inquiry addressed four
key areas:
Findings and Recommendations In our study, WPA used its
global energy model to develop a base case scenario for the future
world oil market. It then created a second case to model how changes
in sanctions policies towards Iran, Iraq and Libya could affect the
market. This comparative analysis led to the following
findings. What is the state of the global oil market? How well can the world respond to rising demand or to supply disruptions? The global oil supply is a
cause for concern. After decades of whittling away at surplus production
capacity to the point where it has almost vanished, energy markets
are so tightly balanced that they threaten global economic growth. If there were even a short-lived disruption
of energy supplies, the oil market would have less flexibility to
respond than in earlier decades for several reasons:
Given these
conditions, the world now faces the tightest balance between readily
accessible supply and global oil demand that it has experienced in
many decades. As seen below,
WPA expects global demand to grow by 1-2 mbd per day over the next
several years, despite assumptions of a near-term economic slowdown
and modest 2.5% global average growth over the 2001-2008 study period.
On the supply side, WPA assumes aggressive growth in OPEC and
non-OPEC production growth when compared to growth rates over the
last decade - a 20% increase in OPEC’s production growth rate and a 55%
increase in non-OPEC supply growth by 2004. (Refer to Annex A.)
Nevertheless,
WPA forecasts shortfalls, even with steady increases in global oil
production under stable conditions and in the absence of any major
disruptive events. WPA recognizes that no actual shortfall exists;
in reality, the market always balances. However, the growing notional
gap suggests a greater likelihood of price increases because oil
prices are set at the margin of supply and demand; even a small surplus
or deficit can cause wide price swings. Thus, the already fragile
world and American economies remain vulnerable to oil prices rising
from today’s high levels. The diminished OPEC supply cushion also has troubling implications for
the ability of oil-consuming countries to weather major oil supply
disruptions, which have occurred roughly every five to seven years
since the 1970s. For the reasons discussed earlier, commercial stock
release, surge capacity and the International Energy Agency system
- the three key instruments the world
relies on to respond to crises - could be less effective than they
have been previously. What effects do maintaining sanctions against Iran, Iraq and Libya have
on energy prices? What effect do rising prices have on the world and
U.S. economies? U.S. sanctions
against Iran and Libya are intended to hinder investment in their
energy sectors, but the sanctions do not affect oil exports. Multilateral
United Nations sanctions against Iraq do limit exports and oil sector
development. Recently proposed “smart sanctions” against Iraq aim
to limit the acquisition of dual-use technologies. If implemented,
they would permit increased Iraqi oil exports. However, this additional
amount is not sufficient to dramatically alter the outlook for oil
prices. An environment in which sanctions
are maintained could see steady upward pressure on oil prices because
they would rise as the notional gap mentioned earlier expands. Historical evidence demonstrates that oil prices
are set at the margin of supply and demand; even a small surplus or
deficit can cause wide oil price swings. According to the WPA Global
Energy Model, oil prices could rise to as much as $33 a barrel by
2003 and to nearly $40 per barrel by 2008 (prices in 2000 dollars).
WPA also evaluated a variety of alternative energy scenarios involving conditions in the world
oil market in 2003 and the effects of plausible potential oil shocks.
WPA concludes that supply shocks could drive per barrel prices from
$33 to nearly $40, or even higher in the more severe scenarios. (Refer to Annex C.) These
price spikes would occur even if present response mechanisms were
fully utilized. In general,
the more severe the shock scenario, the greater the degree of oil
market instability and the larger the magnitude of the price spike. The International Monetary
Fund (IMF) quantified the link between oil price increases and economic
growth in a December, 2000 research paper. It estimated that every
$5 increase in the price of crude oil skims an average of 0.27% per
year from the real global economic growth rate for three consecutive
years after the initial price spike occurs. The effects are more pronounced
for the United States, which would experience a 0.37% average annual
GDP decline during the same period, according to the IMF. Therefore,
WPA expects that U.S. GDP will be at least l%, or roughly $100 billion,
lower in 2004 than it would be without a notional supply gap.
The economic effect would be even more pronounced if there
were unanticipated disruptions in oil markets. Sustained high petroleum prices
take their toll on every sector of the U.S. economy. Any significant
change in the crude oil price drives large retail price movements
within the gasoline and home heating oil markets, although refining
and distribution issues also affect product prices.
If crude oil prices rise $10 a barrel to $35 in 2004, the typical
American household will spend an extra $400 annually
to fuel their cars; heating oil consumers will pay $50 a month
more throughout the winter to keep their homes warm; distribution
of goods and services will cost railroads and trucking companies an
additional $10 billion each year; and collectively, American farmers
will spend $1 billion more to fuel their tractors during the
planting and harvesting seasons. How do unilateral
U.S. sanctions against Iran and Libya affect their energy sectors?
How
effective U.S. sanctions against Iran and Libya have been in achieving
their national security objectives is the subject of much debate.
Some analysts argue that foreign oil firms are ready to disregard
American sanctions and aggressively move forward with plans to exploit
some of the largest fields in Iran and Libya. Many of these companies
have the technological ability to quickly expand production capacity
without U.S. participation. In fact, Iran has signed contracts worth
more than $10 billion with foreign oil firms over the past five years.
The
situation is not that simple, however. U.S. sanctions and Executive
Orders prohibit American investment and hinder non-U.S. companies’
activities by creating political uncertainty surrounding Washington’s
response to violations. Furthermore, the SEC recently declared that
it considers investments in sanctioned countries to represent significant
material risk for investors. The SEC requires foreign businesses raising
funds in U.S. capital markets to publicly disclose their dealings
with the sanctioned countries and file the information electronically,
making these companies more vulnerable to scrutiny. However,
for the purposes of this study, WPA does not purport to take a position
on the merits or effectiveness of U.S. sanctions policy. The only
intent is to evaluate how future enforcement of sanctions could
impact the ability to bring adequate oil supplies to market and alleviate
higher energy prices over the short to long term. Based
on these considerations, WPA assumes only modest increases in oil
production from Iran and Iraq -
400,000 barrels per day by 2004 -
aided by investment from international oil companies, even if sanctions
are maintained. WPA expects Libyan production to remain at current
levels. By factoring these expectations into the Global Energy model,
WPA projects that much greater production levels are needed to relieve
the tight oil market situation and thus lower prices. Over the past 18 months, high
oil prices have bolstered international oil firms’ balance sheets,
enabling the expansion of exploration and production activities worldwide.
Although capital investment is occurring, the most promising and lowest-cost
properties remain in countries under U.S. sanctions. Libya and Iran
were the two nations considered most attractive for new venture activity
in a survey of 85 international oil firms by UK-based Robertson Research;
Iraq came in eighth. Not surprisingly, Iraq, Iran and Libya have
the second, third and sixth largest remaining reserves, according
to U.S. Geological Survey figures. Yet rather than immediately
reinvesting portions of their profits in exploration plays that carry
more geologic risk, or in acreage that will result in high production
costs, major U.S. oil firms are buying back their stock. They have
announced some $10 billion in stock repurchases in the past year,
clearly signaling that share buybacks are currently one of the best
uses for available cash. If sanctions are lifted, however, Iran and
Libya could offer American petroleum companies the opportunity to
invest in some of the world’s most prolific, and easily accessible,
reserves. Such investment opportunities would perhaps present lucrative
alternatives to stock buybacks and bring more supply to the market.
How would lifting unilateral sanctions against Iran and Libya and modifying
multilateral sanctions against Iraq affect the global energy balance
and prices? Do sanctions unintentionally provide Iran, Iraq and Libya
with higher revenues than what they would earn in the absence of sanctions? U.S. sanctions were imposed against Iran and Libya
in 1996 when oil markets were in surplus and featured relatively low
oil prices. In addition, preparations were being made
to reintroduce significant volumes of Iraqi oil into an amply supplied
market under the United Nations’ Oil-for-Aid Program. Iraq’s production quickly ramped up by more than 2 mbd from late
1996 to mid-1998. The oil
market has tightened substantially since then as global demand growth
has outpaced new supplies and driven oil prices higher. If U.S. unilateral
sanctions are removed and U.N. multilateral sanctions are modified,
WPA projects that oil output from Iran, Iraq and Libya combined could
increase 3 mbd by 2004; as much as 5 mbd of new supply could
be forthcoming from these three countries by 2008.
Over the longer term, such supply expansions are large enough
to potentially reduce oil prices by some $12 a barrel in 2004 and
by roughly $16 a barrel in 2008, as illustrated below.
Furthermore, the supply expansion
that is likely to result from both lifting sanctions against Iran
and Libya and modifying sanctions against Iraq goes a long way toward
closing the notional gap between supply and demand. The additional
supply would also provide
a cushion to help ease the effects of potential future oil shocks
later in this decade, as shown in the table below. (Refer to Annex
B.)
Ironically,
WPA’s analysis reveals that U.S. sanctions may unintentionally provide
the targeted nations with greater oil revenues than what they would
earn in the absence of sanctions. In fact, lifting sanctions could
reduce the collective revenues accrued by Iran, Iraq and Libya
– even as their production rises – because prices will drop
precipitously in a well-supplied market.
The subsequent price declines would actually cut their oil
revenues by billions of dollars annually. For example,
in the table below, WPA predicts a $35 a barrel oil price in 2004
if sanctions are maintained and a $23 a barrel oil price if sanctions
are removed. With sanctions, WPA estimates Iran would produce 3.8
mbd of oil and generate $133 million a day in revenues (3.8 mbd x
$35 =$133 million). Without sanctions, WPA projects that Iranian production
could reach 5.0 mbd by 2004 and revenues would fall to $115 million
a day due to the lower oil price (5 mbd x $23 = $115 million).
The figures work similarly
for Iraq; WPA predicts slightly higher revenues for Libya due to the
increased production. Yet collective daily revenues in 2004 would
decline slightly over $27 million from $287 million with sanctions
to about $260 million without sanctions; annual 2004 revenues would
be nearly 10 billion lower ($27.1 million x 365 days =$9.89 billion).
If sanctions were lifted, Iran, Iraq and Libya’s collective oil
revenues for the 2002-2008 period would be almost $63 billion lower. Lifting sanctions
would have both short and long-term effects. The announcement of sanctions removal could
lead to a small, near-term reduction in oil prices. It would positively
signal the oil futures market to erase any premium it holds due to
concerns over a lack of future oil supplies, which WPA believes could
be approximately $0.50-$1 a barrel. If sanctions
are lifted, it is reasonable to expect changes in the dynamics of
OPEC production restraint and quota allocations within a year or two.
As more oil firms ink deals with the formerly sanctioned countries,
Saudi Arabia and Kuwait may seek production quota increases to preemptively
position themselves to boost their market shares before more Iranian,
Iraqi and Libyan oil comes on stream. Such intra-OPEC competition
would likely push crude oil prices down by several dollars per barrel. Most energy economists
agree that a competitive environment among OPEC members strongly diminishes
the cartel’s ability to exercise supply restraint and therefore dilutes
their influence on oil prices. Over the
medium to long term, crude prices will gradually trend downward as
global oil supplies expand with the lifting of sanctions. As lower
crude costs for refiners move through the distribution system to retail
outlets, prices for consumer products, including gasoline and home
heating oil, will experience comparable declines. Lower oil prices
should translate into average retail prices at the gasoline pump in
the area of $1.00-$1.50 a gallon compared to a $2.00-$2.50 a gallon
range that could occur if sanctions are maintained. In conclusion,
the National Energy Policy recommendation that President Bush have
the Secretaries of State, Treasury and Commerce initiate a comprehensive
review of U.S. sanctions policy is extremely timely and well advised.
The tightness and inflexibility of the world oil market make it both
unprepared for the looming supply shortfalls that WPA forecasts and
especially vulnerable to major supply shocks. To combat
these distressing conditions, WPA suggests that the unilateral sanctions
on Iran and Libya, which were imposed when the world oil market was
in surplus, be reviewed with greater sensitivity to global energy
needs. Replacing the unilateral sanctions and modifying the United
Nations sanctions on Iraq would provide 3 mbd of additional supply
by 2004 and as much as 5 mbd of additional supply by 2008.
These amounts would relieve increasing upward pressure on oil
prices and create a modest supply cushion to help alleviate price
spikes during any unforeseen oil supply disruptions. It is also
likely that Iran, Iraq and Libya would earn less from oil sales in
the absence of sanctions than what they would receive in the presence
of ongoing sanctions. For example, WPA’s analysis indicates that their
collective revenues would be almost $10 billion lower in 2004 without
sanctions than what they would realize with sanctions. This surprising,
counterintuitive finding, combined with the upward pressure on oil
prices to which sanctions contribute, argues strongly for a reappraisal
of sanctions and the consideration of alternative approaches to achieve
the nation’s energy and national security goals. Thank you for inviting
me to speak here today. I look forward to answering any questions
that you may have. ANNEX A
ANNEX B
ANNEX C
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