How will sanctions on Iran impact oil markets….

A nice research piece from Philip Verleger of PIIE.

Both US and Eu have imposed steep sanctions on Iran. US has even said that either you trade with us or trade with Iran. This has led to concerns over world economy as Iran happens to be a major oil supplier. Sanction on Iran could disrupt oil supplies from Iran and higher oil prices. This could threaten recovery of world economy for the umpteenth time since the crisis broke out.

Verleger says much of this seems to be hyped.

First impact on oil prices will be minimal as Iran contributes very little to world oil trade. Second, whatever is the shortfall Saudi Arabia can easily manage the reduction by increasing its own oil supplies. Third, even US can dampen the oil price rise by selling its huge oil reserves (called US Strategic Petroleum Reserve or SPR). SPR  is an emergency fuel storage of oil maintained by the United States Department of Energy. It is the largest emergency supply in the world with the capacity to hold up to 727 million barrels.

Hence, even if Iran is off the oil markets, one should not see much impact on oil prices. On the contrary one could actually see lower oil prices if US and Saudi augment their supplies..

Many fear that world oil prices will climb if Iran is pushed from the global crude market. Such concerns are justified even
though Saudi Arabia has indicated it would replace oil previously purchased from Iran. Saudi sales may dampen but will
not totally stop price escalation, though, if the Kingdom’s incremental output is inferior to the crude it supplants. Here again, the United States can help. The United States originally purchased large volumes of high-quality crude for the SPR. That crude was needed by refineries 25 years ago because they could not process heavier sour crudes. Much of this higher quality crude is now surplus because US facilities have been rebuilt or closed. Sales of some SPR volumes to support tighter sanctions on Iran would likely aid the Saudi sales in moderating any price increase.

As noted, China and other Asian countries have already expressed concern that prices pushed upward by stricter sanctions on Iran could harm the world economically. They are more likely to cooperate with US sanctions if the United States commits to a strategic stock release to forestall or dampen any impact on world oil prices. Prices might even be lower than presanction levels if the release is really successful. 

Europe, too, can offset the effect of EU sanctions by using strategic stocks, although at this point such action does not seem necessary. Unrelated closures of European refineries and increases in Libyan production, shut during the revolution there, should offset the loss of Iranian imports.

The paper begins with a short discourse on recent sanctions imposed by US and Europe.

It then discusses oil market  dynamics. There are some interesting data and facts:

  • The sanctions on Iran could remove roughly 1.5 million barrels per day from the world market if data published by the International Energy Agency (IEA) are correct. This number differs from the 3.5 million barrels per day cited in many reports.
  • There is a nice table which shows the type of oil Iran produces. It compares with Saudi and shows Saudi has nearly the similar kind of oil produced by Iran. So replacing not much of a problem

What about India? Lately, India has been greatly concerned over paying for oil imports  to Iran. India gets about 0.3 mn barrels  per day of oil from Iran which is about 11% of India’s oil import needs. Other more dependent countries on Iran oil are Sri Lanka (100% of oil imports from Iran, Turkey (51% of oil imports from Iran) etc.

Both lndia and Turkey are looking at different ways to settle oil payments with Iran outside the international banking system.

India, another one of Iran’s principal customers, has begun to take steps to address the US sanctions program. In the process, the country seems to be using its leverage over Iran to drive down crude prices. The Indian approach appears to acknowledge the threat of US sanctions against its central bank since India is terminating relationships with Iran’s central bank. As an alternative, however, Iran is being offered the “opportunity” to open an account with a private bank in India. Indian firms would then deposit payments in rupees, the Indian currency, in those accounts for oil purchased from Iran.

The author also says India could get Iran oil at cheaper price as there will be limited takers for Iran oil. So India could get Iran oil at a discount…

I don’t think it is as easy as the author makes it out to be. Oil crisis has become like a financial crisis where it is not limited to an entity but becomes a contagion of sorts. People are not sure whether reduced oil supply from Iran will be replenished by others and prices rise and remain there…Seeing higher prices OPEC countries might get into all kinds of games and wanting prices to rise further….

But then an interesting analysis and different perspective…

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