I

ran’s rapidly advancing nuclear program is one of the most acute national security challenges facing the United States, for reasons that are not entirely well appreciated. Whatever else it would portend, an Iranian nuclear breakout would pose first-order challenges to the stability of the entire global economic order via its impact on energy prices, a concern with obvious broad strategic implications. 

As policymakers formulate strategies to curb Iran’s nuclear ambitions, the oil market has loomed large, and with good reason. Iran is the third-largest producer in the Organization of the Petroleum Exporting Countries (OPEC), and its location and military capabilities enable it to disrupt up to 17 million barrels of oil per day (mb/d) produced in and exported from the Persian Gulf—roughly 30 percent of the global oil trade. Iran holds a knife across the jugular of the world economy.¹

The Obama Administration’s dual track pressure-and-negotiate strategy has been crafted with the risk of oil price spikes in mind. But its calculations pull up short by considering only the relatively short term. Administration analysts know that a complete embargo on Iranian oil would take 4.6 percent of traded oil off the market at a time when OPEC’s spare capacity is tight, contributing to a bias toward rising oil prices. Washington thus designed oil sanctions so as to keep Iran’s oil flowing into the tight global market while at the same time reducing Iran’s revenues. The plan called on some importers of Iranian oil to reduce or stop Iranian imports and others to demand large discounts as the list of Iran’s customers diminished. Unfortunately, the plan has not worked as intended. Instead of dropping prices, Iran dropped production. The unexpected production drop is due partly to unforeseen constraints on exports arising from problems with tanker insurance, a reduction in foreign investment in Iran’s oil fields, and a policy decision by Tehran to choose lower output over big discounts as the lesser of evils. The U.S. Energy Information Administration has noted that unexpected loss of Iranian supply, among other factors, has contributed to the recent upward pressure on global crude prices. Some of the lost Iranian supply may take many years to return to production, if ever, due to the nature of Iran’s fields. This unexpected loss of supply has made Washington skittish about taking additional steps that could cut Iranian exports still further.

Nevertheless, Iran’s nuclear program remains an important foreign policy challenge, and if diplomacy and sanctions fail to convince Iran to limit its nuclear...