Low-Energy Fridays: Is it possible to “take” Iran’s oil?
President Donald Trump has announced his desire to “take the oil” in Iran, presumably to signal to producers and investors that more oil could potentially come on the market following military ground operations. However, it should be appreciated that the complex nature of energy markets render military interventions antithetical to price stability.
The first thing policymakers should understand is that the price of oil is mainly determined in “futures markets” in which buyers promise to purchase oil at a specific price. Because it costs more to drill oil from some locations than from others, these markets enable producers to invest more efficiently in production. Additionally, while the total amount of product currently available on the market is a factor, longer-term risks also significantly impact the price of oil. Past threats to close the Strait of Hormuz (during which oil prices jumped even before any scarcity occurred) exemplify these risks. This dynamic, in which prices bake in perceptions of longer-term risks, is still present even when there is oversupply. In other words, while temporary gluts might cause short dips in prices, perceived future scarcity pushes those prices back up.
This leads to the second thing policymakers should appreciate: Energy production is generally capital intensive, which necessitates sustained investment. We hear stories about tech companies that “started in a garage” before taking off, but nobody hears similar stories about energy companies. Obviously, it’s not possible to run an oil refinery, a nuclear power plant, a coal mine, or a wind turbine factory out of one’s garage due to the physical needs of those industries.
Capital intensity is measured by the dollars of capital needed relative to one dollar of output sales. While this figure changes constantly (and is not always easy to compare to other industries), classic examples of the most capital-intensive industries are energy, transportation, and semiconductors. Policymakers should keep in mind that even though products like oil can be seized, continued extraction and production of oil from another country (e.g., Iran or Venezuela) requires sustained capital investment. Because the U.S. government isn’t in the business of owning energy companies, this investment must come from the private sector.
This leads to the last point, which is that military conflict detracts from the investor confidence needed to increase production. I covered this in a past Low-Energy Fridays; however, the unsurprising takeaway from considerable research on the relationship between conflict and capital investment is that people do not like to park their assets in war zones.
A good historical example of this challenge relates to the U.S. invasion of Iraq in 2003. Before the war, some believed that a quick start-up of Iraq’s oil industry would fund reconstruction efforts; unfortunately, this didn’t pan out. Iraq’s oil production finally reached pre-war levels around 2010 thanks to increased foreign investment spurred by high oil prices (over $100 per barrel).
An obvious caveat is that if the price of oil is high enough, producers might view the risk as acceptable. We’ve seen this with oil tankers risking passage through the Strait of Hormuz due to the promise of huge payments. If oil prices remain high, then the necessary capital investment could occur in the absence of lower-risk oil investment alternatives.
But policymakers must understand that Iran’s oil cannot be “taken”—it can only flow to the market via sustained private sector investment. Peace and stability aid in the achievement of this goal. Alternatively, ground operations in Iran could reduce oil prices not by seizing oil assets, but by mitigating Iran’s ability to close the Strait of Hormuz.
The most important overall lesson from conflicts in oil-rich regions is that they do not enhance market access to resources—even when we are the ones securing the assets.