KB
07-05-2007, 08:24 AM
IRAN RATIONS GASOLINE
By Bill O’Grady
Chief Global Investment Strategist
A.G Edwards
Last week, the Iranian government implemented a gasoline rationing program. In this report, we will examine the announcement and details of the rationing plan, the economics behind the program, why Iran decided to unveil this unpopular program now, the potential political outcomes from the decision, and the ramifications for the financial markets.
The announcement
On Tuesday, June 26, at 9 p.m., Iranian government officials announced that a rationing program would be implemented at midnight. Thus, consumers had but three hours before the plan would go into effect. Reports indicate that the decision was made at the highest levels of government. Local officials, including police, had no advance warning. The announcement led to a mass scramble to fill gasoline tanks before the measure went into effect. Long lines quickly formed at gasoline stations, and as stations ran out of gasoline or it became apparent that many waiting in line would not reach a pump before midnight, civil unrest broke out. Although definite numbers cannot be ascertained, it appears that up to 50 gasoline stations were torched.
Iranian citizens tolerate persistent intrusions into their personal freedoms. The religious police force women to wear traditional clothing, and men can be beaten for a “Western” haircut. The economy is very inefficient, and inflation is running at 17%. But one of the “perks” of Iranian life is cheap gasoline prices. Up until May 25 of this year, Iranians paid only nine cents per liter (34 cents per gallon) for gasoline; after this date, the price was increased to 11 cents per liter (42 cents per gallon). Thus, to have this “birthright” suddenly infringed upon is a politically dangerous move and explains the civil unrest that followed the announcement.
The details
For most of the past year, Iranian officials have been trying to decide the best way to contain rising gasoline consumption. Although the most economically efficient way to curtail consumption would be to simply raise prices, it would have the most adverse impact on the poorest Iranians. Because this is President Ahmadinejad’s primary constituency, he opposed large price increases. Instead, he has been supporting rationing. However, during the past year, rationing plans were delayed several times, likely leading Iranians to believe that a program would never be implemented. That’s why Tuesday’s announcement came as such a surprise.
In addition, the program is more draconian than expected. Individual drivers will be allowed 100 liters per month (26.4 gallons). This is less than half of what was anticipated. Registered taxis will get 800 liters per month, and vehicles that use compressed natural gas will have a smaller gasoline allocation. Iran has issued “smart cards” that keep track of the rationed gasoline purchased, but despite widespread distribution of these cards, hundreds of thousands of drivers report that they still don’t have the cards. Thus, they may not be able to purchase gasoline at all. Iranian officials indicate they intend to halt gasoline imports by Sept. 23.
The program is expected to last six months. It isn’t clear whether Iranians can buy rationed gasoline at the current price of 11 cents per liter and pay a higher price for consumption above the rationed amount or whether gasoline simply won’t be available over the rationed amount. The suddenness of the rationing plan’s implementation, the lack of card distribution, the lack of clarity about the sale of nonrationed gasoline all point to a program decided in haste.
Iranian gasoline economics
Iran consumes 470 thousand barrels per day of gasoline, and demand has been growing 10% per year for the past four years. By comparison, gasoline consumption in the United States usually rises 1.5% to 2.0% per year. Because of the lack of investment, Iran’s refining industry is inefficient and insufficient. It imports 40% of its gasoline needs, making Iran the world’s second-largest importer of gasoline after the United States. Last year, Iran budgeted $2.5 billion for gasoline subsidies; it actually paid $5.5 billion. Iran’s total cost of gasoline, including imported and domestically produced, is $1.51 per gallon; imported gasoline costs $1.97. Thus, if refining capacity isn’t increased and demand continues to rise, gasoline imports will continue to rise, leading to a disproportionate increase in subsidy costs.
The heart of the problem is pricing. Because of the low price of gasoline, there is little incentive to purchase fuel-efficient cars and little demand for public transportation. Nearly 40% of Iran’s car fleet is the Paykan, based on the British Hillman Hunter, an old design. It gets approximately 15 miles to the gallon. Assuming 26.4 gallons per month, a rationed driver using a Paykan will be able to drive 13.2 miles per day in a 30-day month. Clearly, gasoline rationing will lead to massive changes in behavior. (Imagine what such a program would do for the United States!) Over time, if this program remains in place, Iranians will buy more fuel-efficient cars and the government will increase public transportation.
However, these changes take time, and there is no indication rationing won’t change in the future. It is worth noting that there are also plans to double refining capacity to 1.8 million barrels per day, but these plans have been on hold as U.S. financial restrictions have made financing from abroad difficult.
Rampant smuggling is another issue. Iran-Daily reports that on a daily basis light trucks carry 400 liters (106 gallons) across the Iranian-Afghan frontier, where these “entrepreneurs” can sell gasoline for three times the Iranian price. In addition, Turkish trucks and buses that traverse into Iran commonly have two gasoline tanks and often sell the excess gasoline in Turkey at a large profit. Usually, such behavior is illegal, so for smuggling to be this common, one would expect that local officials permit it, likely for a “fee.” Rationing will probably curtail this activity.
Although there has been a lack of reports suggesting black market activity, rationing programs are notorious for fostering ways to get around the rationing restrictions. Creating counterfeit smart cards, electronically manipulating them to allow the driver to buy more gasoline, selling nonrationed gasoline at market prices — which usually leads to shortages of rationed gasoline — are just some of the ways that drivers could evade the rationing program. It would be reasonable to expect this behavior to become more prominent as time passes.
Despite high oil prices, the pigate fiscal spending and an inefficient economy have led to a sharp increase in inflation. Inflation currently running 17% and fears that additional increases in gasoline prices would exacerbate the inflation problem are two reasons why President Ahmadinejad opposed lifting gasoline prices to reduce consumption. However, it will cost more to deliver goods because of the gasoline rationing program; and given the inefficiency of the Iranian economy, distributors will likely pass the increased costs of delivery on to consumers. Thus, it would be reasonable to expect that rationing will still bring an uptick in inflation.
Why now?
Although gasoline subsidies are expensive, with oil prices and government revenues high, there appears to be little reason to move so suddenly to implement rationing. Gasoline rationing is unpopular, so for Iranian officials to take such action makes sense only if they are afraid of something.
That “something” appears to be an embargo. The June 28 Financial Times reports that a U.K. proposal to the United Nations Security Council would target Iranian sea lanes for unspecified restrictions. In addition, two years, ago, Mark Kirk (R-Ill.) and Rob Andrews (D-N.J.) proposed a bill that would enforce an embargo on Iran, interdicting gasoline shipments specifically. Both were targeted to halt Iran’s nuclear program. The bill died a quick death in the House of Representatives, and in September 2006, Secretary of State Rice suggested the Bush administration would oppose legislators’ efforts to bring an embargo.
Though there is a threat that the United Nations would consider an embargo, it seems highly unlikely that one would be implemented, given that China and Russia have a permanent veto at the Security Council. The United States and its allies could implement an embargo, and given that Iran is surrounded by America’s allies, it is likely that an embargo would be effective. However, it would surely end discussions currently under way between the United States and Iran. In other words, it would be a hostile act that would likely bring Iranian countermeasures.
The most likely short-term response would be to activate Hezbollah and Hamas to attack U.S. interests in the Middle East, namely Israel. The second potential response would be to halt oil sales. Given the lack of OPEC excess productive capacity, such action would likely lead to a spike in oil prices to the triple-digit level. Thus, Iran isn’t without effective responses.
Although a gasoline embargo and a halt to oil sales would put the Iranian economy in difficult straits, the Iranian government could rightly claim that Western actions were hostile and could use this to rally support for measures to counter the threat. That is what makes Iran’s decision so odd. Instead of being able to use the foreign threat as an excuse, Iranians seem to be viewing gasoline rationing as further evidence of the government’s incompetence. Waiting for the West to implement an embargo, given the long odds that it would happen anyway, seems to be a better plan.
Thus, it would appear that the only rational argument for Iran’s decision is the belief an embargo is a clear and present danger. We note that the speaker of the Iranian parliament cited the failed House bill as a reason for implementing measures to reduce consumption. Although not stated, another reason for rationing could be to put the nation on a war footing; if faced with a ground invasion, it may not have the fuel to counter an enemy. The decision to ration, then, appears to be based on the perception that an embargo is imminent, despite little evidence to support that idea. Either Iranian officials know something not clearly evident in the Western media or they have likely made a costly mistake.
The political issues
Rioters have reportedly been chanting “death to Ahmadinejad.” As mentioned above, Iranians tend to view cheap gasoline as a birthright. Without an imminent threat from the West, implementing a draconian gasoline rationing plan now seems risky.
Pragmatic conservatives who oppose the Iranian president have been pressing to reduce fiscal spending, especially the gasoline subsidies. And although there doesn’t appear to be any imminent action to implement an embargo, it is a long-term threat. The pragmatists have been pushing for a gradual increase in gasoline prices, which would be a more economically orthodox policy. However, President Ahmadinejad, the champion of the poor, opposed further price increases. Thus, he has allowed the rationing program to go forward.
This could be a ploy by the pragmatists to undermine Ahmadinejad and ensure his removal from office. However, on Saturday, June 30, the Supreme Ayatollah Ali Khamenei came out in support of the rationing program. Thus, it is possible that the radicals will be able to absorb this threat. If so, their position would be solidified.
Ramifications
The Iranian government’s decision to suddenly implement rationing is rather unsettling. It appears that the West is far from agreeing on a radical measure such as an embargo; either Iran is grossly misreading the current situation in the West or Iranian officials know something not obvious in our reading of the situation. If it’s a gross misread, rationing could undermine Ahmadinejad, which would likely support Iran’s pragmatists. Such an outcome would be bullish for financial assets. On the other hand, if Iran has correctly assessed that an embargo is imminent, such an escalation would be very bullish for oil prices and bearish for financial assets.
It has been our position that current negotiations between Iran and the United States over Iraq would lead to a deal that would de-escalate tensions in the Middle East, allowing for a reduction of U.S. troop levels in Iraq. Such an outcome would be supportive of the equities, neutral to bearish for debt, and bullish for the dollar. This is still, in our estimation, the most likely outcome.
However, the Iranian decision to implement what appears to be a divisive and politically dangerous policy raises concerns that our expected outcome is wrong. For now, we will still assume that negotiations will lead to a reduction of tensions and U.S. troop strength; however, we will monitor the situation with Iranian gasoline closely, and if it is signaling an unexpected embargo and a reduction in oil supplies, we will need to reconsider our position.
By Bill O’Grady
Chief Global Investment Strategist
A.G Edwards
Last week, the Iranian government implemented a gasoline rationing program. In this report, we will examine the announcement and details of the rationing plan, the economics behind the program, why Iran decided to unveil this unpopular program now, the potential political outcomes from the decision, and the ramifications for the financial markets.
The announcement
On Tuesday, June 26, at 9 p.m., Iranian government officials announced that a rationing program would be implemented at midnight. Thus, consumers had but three hours before the plan would go into effect. Reports indicate that the decision was made at the highest levels of government. Local officials, including police, had no advance warning. The announcement led to a mass scramble to fill gasoline tanks before the measure went into effect. Long lines quickly formed at gasoline stations, and as stations ran out of gasoline or it became apparent that many waiting in line would not reach a pump before midnight, civil unrest broke out. Although definite numbers cannot be ascertained, it appears that up to 50 gasoline stations were torched.
Iranian citizens tolerate persistent intrusions into their personal freedoms. The religious police force women to wear traditional clothing, and men can be beaten for a “Western” haircut. The economy is very inefficient, and inflation is running at 17%. But one of the “perks” of Iranian life is cheap gasoline prices. Up until May 25 of this year, Iranians paid only nine cents per liter (34 cents per gallon) for gasoline; after this date, the price was increased to 11 cents per liter (42 cents per gallon). Thus, to have this “birthright” suddenly infringed upon is a politically dangerous move and explains the civil unrest that followed the announcement.
The details
For most of the past year, Iranian officials have been trying to decide the best way to contain rising gasoline consumption. Although the most economically efficient way to curtail consumption would be to simply raise prices, it would have the most adverse impact on the poorest Iranians. Because this is President Ahmadinejad’s primary constituency, he opposed large price increases. Instead, he has been supporting rationing. However, during the past year, rationing plans were delayed several times, likely leading Iranians to believe that a program would never be implemented. That’s why Tuesday’s announcement came as such a surprise.
In addition, the program is more draconian than expected. Individual drivers will be allowed 100 liters per month (26.4 gallons). This is less than half of what was anticipated. Registered taxis will get 800 liters per month, and vehicles that use compressed natural gas will have a smaller gasoline allocation. Iran has issued “smart cards” that keep track of the rationed gasoline purchased, but despite widespread distribution of these cards, hundreds of thousands of drivers report that they still don’t have the cards. Thus, they may not be able to purchase gasoline at all. Iranian officials indicate they intend to halt gasoline imports by Sept. 23.
The program is expected to last six months. It isn’t clear whether Iranians can buy rationed gasoline at the current price of 11 cents per liter and pay a higher price for consumption above the rationed amount or whether gasoline simply won’t be available over the rationed amount. The suddenness of the rationing plan’s implementation, the lack of card distribution, the lack of clarity about the sale of nonrationed gasoline all point to a program decided in haste.
Iranian gasoline economics
Iran consumes 470 thousand barrels per day of gasoline, and demand has been growing 10% per year for the past four years. By comparison, gasoline consumption in the United States usually rises 1.5% to 2.0% per year. Because of the lack of investment, Iran’s refining industry is inefficient and insufficient. It imports 40% of its gasoline needs, making Iran the world’s second-largest importer of gasoline after the United States. Last year, Iran budgeted $2.5 billion for gasoline subsidies; it actually paid $5.5 billion. Iran’s total cost of gasoline, including imported and domestically produced, is $1.51 per gallon; imported gasoline costs $1.97. Thus, if refining capacity isn’t increased and demand continues to rise, gasoline imports will continue to rise, leading to a disproportionate increase in subsidy costs.
The heart of the problem is pricing. Because of the low price of gasoline, there is little incentive to purchase fuel-efficient cars and little demand for public transportation. Nearly 40% of Iran’s car fleet is the Paykan, based on the British Hillman Hunter, an old design. It gets approximately 15 miles to the gallon. Assuming 26.4 gallons per month, a rationed driver using a Paykan will be able to drive 13.2 miles per day in a 30-day month. Clearly, gasoline rationing will lead to massive changes in behavior. (Imagine what such a program would do for the United States!) Over time, if this program remains in place, Iranians will buy more fuel-efficient cars and the government will increase public transportation.
However, these changes take time, and there is no indication rationing won’t change in the future. It is worth noting that there are also plans to double refining capacity to 1.8 million barrels per day, but these plans have been on hold as U.S. financial restrictions have made financing from abroad difficult.
Rampant smuggling is another issue. Iran-Daily reports that on a daily basis light trucks carry 400 liters (106 gallons) across the Iranian-Afghan frontier, where these “entrepreneurs” can sell gasoline for three times the Iranian price. In addition, Turkish trucks and buses that traverse into Iran commonly have two gasoline tanks and often sell the excess gasoline in Turkey at a large profit. Usually, such behavior is illegal, so for smuggling to be this common, one would expect that local officials permit it, likely for a “fee.” Rationing will probably curtail this activity.
Although there has been a lack of reports suggesting black market activity, rationing programs are notorious for fostering ways to get around the rationing restrictions. Creating counterfeit smart cards, electronically manipulating them to allow the driver to buy more gasoline, selling nonrationed gasoline at market prices — which usually leads to shortages of rationed gasoline — are just some of the ways that drivers could evade the rationing program. It would be reasonable to expect this behavior to become more prominent as time passes.
Despite high oil prices, the pigate fiscal spending and an inefficient economy have led to a sharp increase in inflation. Inflation currently running 17% and fears that additional increases in gasoline prices would exacerbate the inflation problem are two reasons why President Ahmadinejad opposed lifting gasoline prices to reduce consumption. However, it will cost more to deliver goods because of the gasoline rationing program; and given the inefficiency of the Iranian economy, distributors will likely pass the increased costs of delivery on to consumers. Thus, it would be reasonable to expect that rationing will still bring an uptick in inflation.
Why now?
Although gasoline subsidies are expensive, with oil prices and government revenues high, there appears to be little reason to move so suddenly to implement rationing. Gasoline rationing is unpopular, so for Iranian officials to take such action makes sense only if they are afraid of something.
That “something” appears to be an embargo. The June 28 Financial Times reports that a U.K. proposal to the United Nations Security Council would target Iranian sea lanes for unspecified restrictions. In addition, two years, ago, Mark Kirk (R-Ill.) and Rob Andrews (D-N.J.) proposed a bill that would enforce an embargo on Iran, interdicting gasoline shipments specifically. Both were targeted to halt Iran’s nuclear program. The bill died a quick death in the House of Representatives, and in September 2006, Secretary of State Rice suggested the Bush administration would oppose legislators’ efforts to bring an embargo.
Though there is a threat that the United Nations would consider an embargo, it seems highly unlikely that one would be implemented, given that China and Russia have a permanent veto at the Security Council. The United States and its allies could implement an embargo, and given that Iran is surrounded by America’s allies, it is likely that an embargo would be effective. However, it would surely end discussions currently under way between the United States and Iran. In other words, it would be a hostile act that would likely bring Iranian countermeasures.
The most likely short-term response would be to activate Hezbollah and Hamas to attack U.S. interests in the Middle East, namely Israel. The second potential response would be to halt oil sales. Given the lack of OPEC excess productive capacity, such action would likely lead to a spike in oil prices to the triple-digit level. Thus, Iran isn’t without effective responses.
Although a gasoline embargo and a halt to oil sales would put the Iranian economy in difficult straits, the Iranian government could rightly claim that Western actions were hostile and could use this to rally support for measures to counter the threat. That is what makes Iran’s decision so odd. Instead of being able to use the foreign threat as an excuse, Iranians seem to be viewing gasoline rationing as further evidence of the government’s incompetence. Waiting for the West to implement an embargo, given the long odds that it would happen anyway, seems to be a better plan.
Thus, it would appear that the only rational argument for Iran’s decision is the belief an embargo is a clear and present danger. We note that the speaker of the Iranian parliament cited the failed House bill as a reason for implementing measures to reduce consumption. Although not stated, another reason for rationing could be to put the nation on a war footing; if faced with a ground invasion, it may not have the fuel to counter an enemy. The decision to ration, then, appears to be based on the perception that an embargo is imminent, despite little evidence to support that idea. Either Iranian officials know something not clearly evident in the Western media or they have likely made a costly mistake.
The political issues
Rioters have reportedly been chanting “death to Ahmadinejad.” As mentioned above, Iranians tend to view cheap gasoline as a birthright. Without an imminent threat from the West, implementing a draconian gasoline rationing plan now seems risky.
Pragmatic conservatives who oppose the Iranian president have been pressing to reduce fiscal spending, especially the gasoline subsidies. And although there doesn’t appear to be any imminent action to implement an embargo, it is a long-term threat. The pragmatists have been pushing for a gradual increase in gasoline prices, which would be a more economically orthodox policy. However, President Ahmadinejad, the champion of the poor, opposed further price increases. Thus, he has allowed the rationing program to go forward.
This could be a ploy by the pragmatists to undermine Ahmadinejad and ensure his removal from office. However, on Saturday, June 30, the Supreme Ayatollah Ali Khamenei came out in support of the rationing program. Thus, it is possible that the radicals will be able to absorb this threat. If so, their position would be solidified.
Ramifications
The Iranian government’s decision to suddenly implement rationing is rather unsettling. It appears that the West is far from agreeing on a radical measure such as an embargo; either Iran is grossly misreading the current situation in the West or Iranian officials know something not obvious in our reading of the situation. If it’s a gross misread, rationing could undermine Ahmadinejad, which would likely support Iran’s pragmatists. Such an outcome would be bullish for financial assets. On the other hand, if Iran has correctly assessed that an embargo is imminent, such an escalation would be very bullish for oil prices and bearish for financial assets.
It has been our position that current negotiations between Iran and the United States over Iraq would lead to a deal that would de-escalate tensions in the Middle East, allowing for a reduction of U.S. troop levels in Iraq. Such an outcome would be supportive of the equities, neutral to bearish for debt, and bullish for the dollar. This is still, in our estimation, the most likely outcome.
However, the Iranian decision to implement what appears to be a divisive and politically dangerous policy raises concerns that our expected outcome is wrong. For now, we will still assume that negotiations will lead to a reduction of tensions and U.S. troop strength; however, we will monitor the situation with Iranian gasoline closely, and if it is signaling an unexpected embargo and a reduction in oil supplies, we will need to reconsider our position.