The Coalition Against Iranian Oil: Winners and Losers

On January 23, the E.U. enacted new sanctions targeting Iran, including an oil embargo, with the aim of pressuring Iran's economy in order to spur changes in the government's stance over its nuclear program. The current E.U. ban on Iranian oil is actually the third attempt by outside powers to use oil as a tool of economic pressure on Iran in the last 50 years.

The first instance occurred in 1951, following the nationalization of Iranian, when the Anglo-Iranian Oil Company (known today as British Petroleum) imposed sanctions against Iranian oil and sought to prevent other countries from purchasing. However, this attempt failed to dissuade other foreign purchasers.

The second attempt took place, after the Islamic Revolution in Iran, when the U.S. implemented an oil embargo against Iran and stopped importing Iranian oil. Prior to this action, the U.S had been a major consumer of Iranian oil, importing about 500 thousand barrels of oil per day. However, the U.S. embargo had a negligible effect on Iranian output, as Iran succeeded in redirecting its oil to other markets after a few months.

Now in early 2012, the effectiveness of using an oil embargo as a tool of economic pressure is being questioned once again: will the current E.U. ban on Iranian oil force Iran to change its attitude regarding its nuclear program? If the oil ban leads to a dangerous oil price rise in the midst of fragile global economy, how many countries are actually willing to stop buying oil from Iran? And how long can such an embargo be maintained?

Alternatives to Iranian oil

Considering the E.U.'s ban on 150 thousand barrels a day of oil coming from Syria, combined with unrecovered production drops in Libya, the E.U. will feel pressure from not buying Iranian oil.

Currently, Saudi Arabia is theoretically the only producer that could substitute Iranian oil, given a spare capacity of approximately more than 2 million bpd. However, since Saudi Arabia is the sole producer with substantial spare capacity and the ability to control the market in case of a supply cut, the Saudis might consider keeping hold of at least half of their excess capacity for any other future supply cut. If the Saudis produce extra oil before Iranian supply has left the market, oil prices will fall due to over-supply, also Saudi oil has to compete with Iranian discounted oil. Saudi Arabia and other major producers clearly are not going to benefit from lower oil prices, which would undercut any rationale for Saudi Arabia to step in to alleviate market imbalances.

Who is the winner?

The implementation of the E.U. ban on Iranian oil does not immediately take effect, as it is a gradual, phased-in embargo. It is due to be implemented on July 1st this year, in order to give the market and some E.U. countries, chiefly Italy, Greece and Spain (major consumers of Iranian oil in this region), time to find substitute supplies and hence prevent any market shocks. However, this gives Iran equal time to find new customers for its oil. Iranian officials also announced that they are considering a decision to stop selling their oil to E.U. members even before July 1st, as a sort of pre-emptive measure. Although this decision would have clear consequences for a vulnerable Iranian economy, officials know they are in a race against time to find alternative customers. On the other hand, immediately pulling the plug on Iranian oil to the E.U. could precipitate a spike in oil prices.

Countries such as India and Turkey are less likely to take a direct position against Iran, as their officials constantly announce that they are only following U.N. sanctions and will not abide by unilateral measures. On the other hand, Japan and South Korea both depend on the United States for a security umbrella and the U.S. expects them to reduce their oil imports from Iran, at least symbolically. However, there is a belief among energy analysts that such a reduction could not last, as these countries are highly dependent upon Iranian oil. At the most, Japan and South Korea will be able to negotiate a reduced price, rather than wean themselves off completely.

However, there is more beneath the surface that is unrevealed by these statements. Both Tokyo and Seoul are already finding new solutions to continue their oil purchases within the framework of U.S. sanctions on Iran's Central Bank. Here is where it gets tricky. Iran's customers can all use barter to trade for oil. The Indian government on different occasions tried to negotiate with Russian and Turkish officials to find a new ways to send money to Iran. They have also floated the idea that they could buy Iranian oil in Indian Rupees or barter gold for oil. Some countries already have a vigorous bilateral trade which would make barter somewhat easier. Turkey and Iran, for example, have increased their annual bilateral trade with Iran from $15 billion in 2011 to $20 billion in 2012 and will reach an estimated $30 billion in 2015.

China and Iran, for their part, also carry on a significant level of bilateral trade. This makes it easy for them to use a barter system, lest such valuable trade be lost. In 2010, for example, Sino-Iranian bilateral trade was $29 billion, which increased to $41 billion in the first 11 months of 2011. This vigorous bilateral energy and non-energy trade demonstrates that the two countries can exchange goods and services and, in a way, circumvent sanctions against the Iranian Central Bank.

But of course, the real question is: who is the winner in this game? There is no doubt that even if Iran is able to substitute its customers by offering steep discounts and using a barter system, its economy is still going to be hurt. Yet the question is, how much? There is also no guarantee that Iran could sell all of its sanctioned oil. Its foreign currency reserves will drop sharply and the double effect of inflation could pose difficulties for procuring imports and purchasing domestic goods. However, Iran could still sustain under these circumstances, without revising its current attitude and direction regarding its nuclear program.

Russia stands to theoretically gain from oil sanctions on Iran. As the world's biggest oil producer, Russia is well positioned to increase its market share in Europe. Despite price disputes and challenges, Russian oil does not pass through the Strait of Hormuz; this could be a challenge for Saudi oil. If Europe relies on Russian oil to offset Iran's share in this region, Saudi will be forced to redirect and sell some its extra output to Asia, where Iran's reduced price oil is available. Thus, the availability of Russian supplies is more reliable in the event of any conflict in Persian Gulf. Russia and other major oil producers are also going to benefit from higher oil prices.

China is another potential winner. The world's second largest consumer of oil will be able to negotiate substantial discounts from Iran. China has also nearly finished the first phase of building its Strategic Petroleum Reserves (SPR), with a capacity of over 100 million barrels of oil, according to the International Energy Agency. Therefore, if China increases its imports from Iran in order to fill its SPR, Iran could sell an extra 450 to 500 thousand barrels of oil for about 160 to 200 days to China. This is nearly the same amount of oil that travels daily from Iran to E.U. member states.

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