Juan Cole
Oil Price

January 26, 2012

The European Union threatened Iran on Monday with cutting off petroleum imports into the 27 EU member states, and announced sanctions on Iranian banks and some port and other companies.

Iran sells 18 percent of its petroleum to Europe, and Greece, Italy and Spain are particularly dependent on it. Europe also sells Iran nearly $12 billion a year in goods, which likely will cease, since there will be no way for Iran to pay for these goods. Some in Europe worry that the muscular anti-Iran policy of the UK, France and Germany in northern Europe will worsen the economic crisis of southern Mediterranean countries such as Greece.

Others think that Iran’s nuclear enrichment program is still primitive and that allegations that Iran is seeking a nuclear warhead are hype.

About 60% of Iran’s petroleum now goes to Asian countries, especially China, India, South Korea and Japan. China and India have no announced plans to reduce purchases of Iranian crude, and South Korea says it will seek an exemption from the US so as to continue to import. Japan says it plans only very slowly to reduce imports from Iran. Iran and India have just reached an agreement whereby some trade with Iran will be in rupees, to sidestep US sanctions. Indian firms are considering whether to fill the $8 billion gap in exports to Iran left by the Western sanctions (many do not want to be cut off from also exporting to the US, as they would be if third party sanctions were applied to them).

Europe’s squeeze on Iran will not take place until June, and there will be a meeting in May to assess the situation (i.e. to make sure Greece won’t be sunk, along with the European economy, by these steps). There is some indication that much of Europe hopes Iran will be more forthcoming on the nuclear issue with Europe by then, so as to forestall these drastic steps.

Although a European boycott of Iranian oil will increase the cost of doing business for Iran, will hurt the Iranian public, and is already harming the value of the Iranian currency, it is highly unlikely to cut Iran off from exporting to the world market or to put so much pressure on the government that it will change its policies.

In order for Iran to find it impossible to sell its petroleum, world supply would have to exceed world demand by roughly 2.5 million barrels a day. That outcome could be produced either by a fall in world demand (typically as a result of a further economic turn-down) or by an increase in world supply (which would require that all current producers continue to export at at least the same rate, and that some of them export much more than they are currently doing).

The Organization of Petroleum Exporting Countries expects world demand for petroleum actually to increase in 2012 by about 1 million barrels a day, up to 89 million b/d over-all. There is probably slightly more demand than supply in the world market, with China and other Asian countries still growing strongly, and the number of cars and trucks driven in Asia increasing rapidly. If Iran’s 2.5 million barrels a day really could be taken off the world market, that would be a total shortfall of 3.5 million barrels a day (if one counts the expected increase in demand), which would cause petroleum prices to skyrocket.

Europe seems to hope that Saudi Arabia will pump an extra 2.5 million barrels a day to keep prices stable if everyone stops buying Iran’s petroleum. But since demand will likely increase this year, Saudi Arabia would have to pump 3.5 million barrels a day to meet the total shortfall. That kind of increased production on a sustained basis is probably beyond Saudi technical capacities, and much of that extra production will likely be “sour” (full of sulfur and other impurities and expensive to refine). Saudi Arabia already is pumping nearly 10 million barrels a day, which is unusually high. That it could do 13.5 million barrels a day is frankly fantastic.

Moreover, there is a lot of evidence that Saudi Arabia does not want to cause prices to fall below $100 a barrel for a while. The kingdom forestalled Arab Spring style protests by much increasing its welfare spending, essentially bribing its population to remain quiet. But to pay for all that extra kindness to its population, it needs its petroleum to sell at historically high prices. If Riyadh increases its production, and Iran continues to find customers around the world for its own petroleum, then the price would fall, creating massive budget shortfalls in Saudi Arabia and making it impossible for the kingdom to follow through on its promises to its people. That course would be, to say the least, dangerous.

Moreover, some current world supplies cannot be counted on. South Sudan is threatening to turn off its spigots to protest high tolls (35%) imposed on its pipeline exports via Sudan proper. There is some danger that the pipes will be ruined if they are not used for a while, so getting that petroleum on line again may be difficult.

Indeed, a lot of oil producers are unstable or face labor actions. Oil workers in Nigeria are threatening to take its 2 million barrels a day of exports off the world market.

Other major producers and exporters face problems of increased domestic consumption, as populations drive more, and of poor management or lack of investment in the sector. Mexico has seen its oil exports fall by 25% since 2004, and may export no petroleum at all in a decade unless there is a lot of new investment in its petroleum industry.

A temporary fall in petroleum prices from time to time is possible, but the US Energy Information Agency expects there to be upward pressure on petroleum prices in the next few years, predicting a price of $120 per barrel by 2016. (This is despite an expected rise in US oil production, which will probably be eaten up by increased US demand as the economy improves).

A secular trend toward higher petroleum prices indicates demand outpacing supply for the foreseeable future, which is exactly the circumstance under which an attempted boycott of Iranian petroleum would fail.

All Europe would be doing is importing petroleum from, say, the United Arab Emirates, which now mainly supplies Japan, and forcing Japan to import instead more Iranian oil– whether Washington likes it or not. It is a shell game, unless world supply exceeds demand by 2.5 million barrels a day for several years, allowing the world to leave Iran’s petroleum in the ground.

Eventually a combination of renewable energy and better automobile batteries may allow the world to fuel automobiles in a less destructive way than via petroleum. But that day is too far off to be relevant to Iran’s progress in closing the nuclear fuel cycle.

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