"All of Iran’s misery, wretchedness, lawlessness and corruption during the last 50 years has been caused by oil and the extortions of the oil company." Radio Tehran broadcast these words of warning shortly after Mohammed Mossadegh became prime minister in 1951 on a promise to nationalise the oil industry.

Many Iranians would argue the sentiment has held true in the half-century since, with the 1953 overthrow of Mossadegh by UK and US spies, the inequitable distribution of oil wealth under the Shah, the foreign fortunes made by Iranian oil and, more recently, a widening wealth gap that has prompted fresh accusations of corruption. Mahmoud Ahmadinejad’s June electoral victory was won in part because he promised to distribute Iran’s oil wealth more fairly.

But economists understand the curse of oil differently. Apart from the dangers of over-dependence on a single export, they say the country’s continuing petrol price subsidy has wrought havoc with the public purse, balance of payments and national economy. "This must be one of the worst policies of any sector in any country in the whole world," says a local economist. "Unfortunately, the political and economic costs of reversing it are enormous."

Figures in Iran have wide margins of error. But the subsidy will likely cost between $6,500 million-7,000 million in direct government expenditure in 2005, depending on the oil price. That represents up to 14 per cent of total government spending for the previous year. Behind this extravagant cost further millions, even billions of dollars, are lost to smuggling, inefficient or unnecessary petrol use and straightforward leakage.

The subsidies are supposed to help the poor. But the 11 million or so Iranians living below the poverty line income of $270 a month can barely afford the several thousand dollars needed to buy even a second-hand car in this closed market. "More than 50 per cent of the subsidies paid for petrol is going to the top

10 per cent of the population because of the cost of cars," says economic analyst Saeed Laylaz. "Poor people mainly use public transport. But this is not understood and people think the poor are most at risk from cutting the subsidy."

 The direct cost figures are pretty straightforward (see table): petrol is sold at IR 800 a litre, but is produced domestically at a cost of IR 2,500 a litre. So far, so expensive. But about one-third of Iran’s petrol is imported because the country with the world’s second largest oil and gas reserves does not have enough refining capacity to satisfy local consumption.

This amount – 25 million-30 million litres – is equivalent to about 155,000 barrels a day of crude oil. Because the excess is bought at international prices, it will this year cost about IR 4,500 a litre, according to Oil Ministry officials, pushing foreign petrol purchases far above $4,000 million. In short, Iranians at the petrol pumps pay less than a quarter of what the government has to pay for their fuel.

The price does little to encourage thrift. At pumps alone the waste is terrible. About 250,000 litres a day (l/d), according to Laylaz, falls to the floor of petrol stations between the outmoded pump nozzles and car tanks. That is $93,000 evaporating every day in forecourts, incidentally damaging the health of pump attendants, who complain of headaches and nausea. The total amount of petrol used unnecessarily because it is so cheap cannot be calculated, but is certainly excessive.

This is, in part, also due to the Paykan effect. Iran’s old warhorse of a car has finally been put out to grass this year after decades of devoted service. But it is still easily the most common car used in the Islamic republic and if its poor-mileage engines were replaced today by more efficient models, consumption could fall by up to 10 per cent, according to local economists. That process is under way but will take many years to complete. Lower levels of pollution from newer engines will also bring incremental savings in healthcare provision.

Of course, when a commodity is much cheaper across the border, unscrupulous neighbours recognise a major business opportunity. Laylaz believes between 500,000-1 million l/d are smuggled out of the country – representing an Iranian subsidy of up to $140 million a year to smugglers and motorists in Turkey, Pakistan, Afghanistan and probably the UAE as well.

Solutions

So what is the solution? Rapidly increasing refinery capacity is essential to reduce the huge payments to foreign refiners. Other technological solutions – such as newer car engines and more use of natural gas as a transport fuel – will reduce consumption and improve efficiency. Raising prices to at least the cost of local production is also seen as necessary by most Iranian economists to reduce waste and smuggling and put government finances on a more even keel. And better ways of spending on the poor must be developed if the money is to go where it is needed.

It all sounds very easy and some of it is. Refinery capacity is in the process of a long overhaul expected to cost about $10,000 million. But this process will take at least five years if it goes to schedule, which so far looks unlikely. New nozzles are being ordered for petrol stations but will again take years to be installed across the country. A new fleet of buses is being introduced to use compressed natural gas (CNG) instead of petrol. And the Paykan will slowly be phased out as newer, more efficient cars are produced. Somewhere in Iran’s future lies a land of blissful energy efficiency.

But increasing prices and reforming subsidies are very different matters. "There are huge logistical issues associated with targeted subsidies," says Ali Ghezelbash, an associate director at Atieh Bahar Consulting. "We can’t means test because there isn’t enough transparency and we don’t have accurate income statistics. Many people do not have bank accounts so we can’t just put money in. And the coupon option or charging different prices for different wealth brackets could lead to a black market."

Besides these problems, the new government would have to tackle Iran’s most politically sensitive subject and risk a short-term hike in inflation. Iranians have long seen the provision of cheap petrol as the surest proof the government was returning their country’s natural resources to the people. Raising prices is immensely unpopular and leads to accusations that the oil is being siphoned off by the rich.

Given that Ahmadinejad ran a campaign that explicitly promised to give the oil back to the people, it will be very difficult for him to bring prices up. His close political allies in the Majlis (parliament) last year froze prices – worsening a problem that the old administration had tried to solve with the apparently inadequate measure of raising prices by 10 per cent a year, still below the rate of inflation. Recent riots over petrol prices in Yemen left more than 30 dead and provided the new president with a clear indication that the public temper can be as inflammable as the oil.

Political nettle

Even if he were to grasp this oversized political nettle, the new president would still face the problem of immediate inflation. Laylaz believes the effect would be less painful than politicians fear. "This is a false justification for not doing something unpopular," he says. "Our main problem is that rising liquidity and keeping one price stable only boosts prices elsewhere."

Other analysts believe there would be more telling consequences as the increase in transportation costs led to an immediate bump up of general prices – possibly by as much as 50 per cent – in what is already a long-term inflationary environment of more than 15 per cent.

Does this new government have the political will to face down one of Iran’s most severe economic problems? "The government might have to sit down and decide to just take it face on with a big inflationary burst," says Ghezelbash. "But this government came to power promising social justice and giving back to the people. If things are more expensive in a year they could be in trouble. This is, in a sense, a trap of their own making, and I am not sure if they can get out of it easily."