Cheap Energy Makes Iranian Manufacturing More Competitive
Global energy markets have been thrown into disarray following the Russian invasion of Ukraine. While the international community has yet to embargo Russian energy exports, Western policymakers have vowed to reduce dependence on Russian production and global energy firms have suspended their Russian operations. Export controls and other sanctions will probably make it difficult for Russian oil and gas fields to maintain the same level of production.
Oil and gas prices have been volatile as the markets react to daily events related to the conflict in Ukraine. But Western policymakers are clearly concerned about the prospect of sustained high energy prices. U.S. officials have asked for major energy producers to boost production and have even engaged in discussions to explore whether more oil could be supplied by Venezuela, which remains under U.S. sanctions. Some commentators have suggested that the chaos in the oil markets give the Biden administration a stronger incentive to conclude the Iran nuclear deal and to enable Iranian oil and gas to flow more freely into global markets.
In the end, it is unlikely that the Ukraine crisis will make the difference in getting Iranian energy unsanctioned, but the rising energy prices do create a short-term economic incentive. Looking longer-term, however, the crisis does change the outlook for the Iranian economy and GDP growth in one important way. In a widely read research note, Credit Suisse banker Zoltan Pozsar argues that the “unfolding crisis of commodities” will favor those countries that produce commodities, especially energy. Such countries will have an easier time mitigating inflation and its impact on growth. In his words, “you can print money, but not oil to heat or wheat to eat.”
Iran is one such country. Hydrocarbons are the main source of Iran’s energy. With abundant oil and gas reserves (as well as strong potential for renewable energy production), Iran will continue to benefit from low energy costs for decades to come. Presently, the Iranian government provides generous energy subsidies that boost consumption by consumers and businesses. These are among the most general subsidies in the world.
Increasingly, Iranian policymakers appear keen to rollback these subsidies. Though politically unpopular—a minor fuel subsidy reduction in 2017 led to nationwide protests—raising the cost of energy is necessary to create new fiscal space and to reduce wastage that prevents more oil, gas, and electricity from being exported. But even if the subsidies are removed, in comparative terms, Iran would still benefit from a far lower cost of energy than most countries around the world.
This should prove a major advantage for the Iranian manufacturing sector, which will be able to leverage significantly lower energy costs, especially as factories move to greater automation. Whether for fast moving consumer goods or more energy-intensive industries—such as the steel or automotive sectors—low energy prices make intermediate and final goods produced in Iran more affordable for domestic consumption and more competitive in global markets. This also makes manufacturing a more attractive sector for investment.
Chronic high energy prices are expected to contribute to demand destruction in advanced economies as households cut back spending in the face of higher prices. To the extent that Iran may be able to avoid that same outcome due to its domestic energy resources, international investors ought to take a closer look at one of the few countries that combines a large domestic market, a large manufacturing base, and cheap energy.
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