Cartoon by Ben Garrison

Petrostates usually benefit from war. Let’s make sure Iran and Russia don’t.

By Simon Johnson and Catherine Wolfram

The Washington Post: Simon Johnson, former chief economist at the International Monetary Fund, and Catherine Wolfram, a former deputy assistant secretary for climate and energy economics at the Treasury Department, are professors at MIT’s Sloan School of Management.

An unfortunate fact about oil markets is that all petrostates profit from violence — whether they perpetrate it themselves or benefit when other petrostates do. And that creates a conundrum for U.S. policymakers: How to punish Iran for its suspected assistance to Hamas without helping Russia during its war on Ukraine?

Our solution: Impose a price cap on Iran’s oil exports. Here’s our thinking.

Russia is one of the largest oil exporters in the world (about 8 million barrels per day; world consumption is about 100 million barrels per day). After its brutal invasion of Ukraine in February 2022, world oil prices rose sharply, from about $80 per barrel to more than $120 per barrel. The main driver was fear that Russian oil would come off the market because of sanctions imposed by countries such as the United States or because of physical disruptions related to the war. In the end, the fear was worse than the reality, and Russia was able to sell its usual oil volumes at a “war premium” created by a conflict that it started.

For the first nine months after the invasion, Russia earned almost 50 percent more from oil exports than it had in 2021. Then, in December 2022, the Group of Seven and the European Union instituted a price cap of $60 per barrel on Russian oil and significantly limited Russia’s revenue without cutting off its exports, keeping world oil prices flat.

Oil markets are now focused on Iran, also one of the world’s largest exporters, at about 2 million barrels per day recently. As is true in Russia, oil funds a significant share of the Iranian government, part of which has historically supported Hamas. Some members of Congress have called for stricter measures to limit Iran’s oil revenue, although statements from the Biden administration indicate that it is still gathering evidence linking Iran to Hamas’s horrific terrorist attacks against Israel.

On Oct. 17, 10 days after the attacks, oil prices were more than 5 percenthigher than the day before the attacks, suggesting that some market participants are concerned about steps against Iran or other disruptions to oil exports from the region.

So far, Iran is benefiting from these concerns. Simple math suggests that at current oil prices (close to $90 per barrel), Iran would earn about $1 billion every six days from its oil exports. Even if it must sell oil at some discount (due to increased stigma and potential repercussions), it would still be able to replace the $6 billion in Qatari accounts, recently frozen by Washington, in a matter of weeks. (These funds are previous earnings from Iranian oil exports that can be used only for humanitarian purposes.)

To punish oil exporters, policymakers have traditionally turned to sanctions that make it illegal to buy oil from the target country. In 2019 and 2020, Iranian exports were reduced by about 75 percent due to U.S.-led sanctions in response to Iran’s nuclear activities. Even if this is possible today, it’s not clear that Western policymakers would want to constrain Iranian exports to those depressed levels again. Taking 75 percent of Iran’s oil off the market could, by our estimate, drive oil prices up by between $10 and $20 per barrel. This harms the world economy and helps Russia.

In a well-timed development, the U.S. Treasury announced on Oct. 12 that it was stepping up enforcement of the price cap on Russian oil and had sanctioned several tanker companies for transporting oil above the price cap. The more barrels of Russian oil that transact at the price cap, the less Russia benefits from increases in world prices tied to the unrest in the Middle East.

This is helpful but squeezes just Russia. How can we protect the global economy from higher oil prices while punishing Iran?

One approach would be to apply a version of the price cap to Iran. The Russian price cap is designed to keep oil on the world market while reducing the revenue of an aggressive regime. Iran is already under secondary sanctions, meaning that not just Iran but also anyone doing business with it can be sanctioned (including being excluded from the U.S. financial system). A logical modification could be to allow oil transactions with Iran, but only if the price paid is less than a stipulated cap (which could be $60 per barrel but probably should be lower) and subject any parties involved in transactions above the cap to secondary sanctions. Any price cap above the cost of Iranian production (about $10 per barrel) would encourage continued supply, because Iran needs as much cash as possible to keep its regime functioning.

Organizations such as TankerTrackers.com do an excellent job of following the path of oil shipments out of Iran. It is hard to hide an oil tanker or disguise how much it carried to its destination. A cap could be enforced by requiring that the tanker owner (a matter of public record) pay a toll per barrel equal to the difference between current world prices and the price cap. The United States would publish a list of oil shipments that have paid this toll. Secondary sanctions would then apply to anyone dealing with any Iranian shipment who is not on that list. If the buyer paid no more than the price cap and could provide proper proof, the tanker owner could apply for a rebate of the toll.

This suggestion would be a novel extension of the Russian oil price cap, which was already a breakthrough in thinking about the global economy. The toll enforcing the Iranian oil price cap would not be easy to implement. But facing two wars involving major oil exporters, U.S. policymakers don’t have many good options. We need to break the cycle of petrostates benefiting from fomenting violence. And when we punish one petrostate, we need to be careful not to reward another.