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Crude Oil vs. Iran: Who Blinks First?

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By EconMatters

Oil futures spiked more than 2% in one day to their highest level in nine months on Tuesday Feb. 21.  WTI front month contract closed at $105.84, while Brent ended at $121.66 on ICE, primarily on investors fear of potential conflict over the escalating tensions between the US, Europe, Israel, and Iran.  A second Greek bailout deal of €130bn (£110bn; $170bn) also helped to inject some optimism into the market (which would seem totally mis-placed as we may need to relive this Greek drama in two years).  Nevertheless, the fact remains crude oil market supply and demand has not changed a bit to warrant a 2%+ price jump in one day. 

 

The U.S. and its allies believe Iran is building nuclear weapons, which Tehran has vehemently denied. Last week, the European Union (EU) imposed a ban on Iran oil imports effective July 1, and froze the assets of its central bank. In December, the U.S. said it would "blacklist" companies in the U.S. market if they do business with Iran’s central bank.

 

In retaliation, over the weekend, Iran announced that it halted oil exports to France and the United Kingdom and warned European companies that it would stop their supplies unless they sign long-term contracts.  However, France and UK do not import a significant portion of crude oil from Iran, and Europe could most likely still get alternative crude supplies from other sources like Saudi, or Russia.

 

Despite Iran oil ministry spokesman Alireza Nikzad's statement that "we will sell our oil to new customers," according to Financial Times, Tehran is “struggling” to find a new buyer for the estimated 500,000 barrels of oil per day left as surplus from its decision to halt sales to France and the UK.  And another Reuters report quoted commodities traders that

"Iran is turning to barter - offering gold bullion in overseas vaults or tankerloads of oil - in return for food as new financial sanctions have hurt its ability to import basic staples for its 74 million people....Difficulty paying for urgent import needs has contributed to sharp rises in the prices of basic foodstuffs, causing hardship for Iranians."

 

Chart Source: CNN

 

Earlier report from AP suggested that Iran still had support from its major Asian buyers as India has joined China in saying it will not cut back on oil imports from Iran.  But the latest development, according to Reuters, is that China, India and Japan are now planning cuts of at least 10% in Iranian crude imports as tightening U.S. sanctions make it difficult to keep doing business with Iran. China, India and Japan together buy about 45% of Iran's crude exports.  So the cut-back on Iranian oil imports from these three big clients will be yet another serious blow to Iran.

 

Iran is OPEC's second-largest producer after Saudi Arabia, and exports 2.5 million barrels of oil per day, about 3% of world supplies. About 500,000 barrels go to Europe and most of the rest goes to China, India, Japan and South Korea.

 

Earlier this month, the International Energy Agency cut its 2012 oil-demand growth forecast for the second time in just a few weeks and said the decrease in demand would leave the oil market with enough flexibility to adjust to any loss of Iranian crude exports when sanctions take effect in July.  So similar to the "Libyan sweet crude supply crisis" of last year, even if oil exports from Iran goes completely off line, the shortfall would not be such a crisis as priced in right now by investor's fear.

 

However, the reality remains that crude oil prices get disproportionately distorted and detached from supply and demand fundamentals whenever there's a whiff of geopolitical tension and conflict.

 

Right now, it seems Iran could be the one blinks first (war or peace) with multiple sanctions putting mounting pressure on the country's basic necessity imports, while hurting its oil revenue.  But with Iran still a volatile unknown, analysts say oil could continue to rise and expect to see gasoline at $4 a gallon, and some even see $5, heading into the summer driving season.

 

If the analysts were right, $4 or $5 gasoline by summer time would certainly be detrimental to the nascent U.S. recovery, and debt-troubled Europe, which could bring demand destruction pushing oil prices back down.

 

Crude oil prices or Iran, no matter who blinks first, one thing for certain is that consumers most likely will end up footing the bill of higher fuel costs, and world economy would suffer as a whole in the process as well.

 

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Wed, 02/22/2012 - 15:23 | 2185825 steve from virginia
steve from virginia's picture

 

Governments all say lots of things without 'following up'. China needs oil, it has no scruples (but its government will say what it thinks Washington wants to hear).

The saber rattling comes from Iran which needs + $100 oil to pay its increasing expenses. Ditto Russia and even KSA. Here is the problem: high prices kill demand resulting in deflation as that demand whithers. In other words, there is price inflation but it doesn't last very long. The effect of inflation in the crude oil market is deflation everywhere else.

Short-term high prices also distort the credit regime. This ends badly as fuel-users discover they cannot borrow more (and consequently cannot retire or service existing debts: see Greece/PIIGF).

Worst-case scenario is out and out conflict where Iran closes the Straits of Hormuz. This would be 'low cost' to the Iranians. If the regime believes its existence is threatened it can keep oil exports from the Persian Gulf near zero for a long period, using oil access as a survivalist bargaining chip. Meanwhile, fuel demand within the exporting countries will not go away.

There is no 'happy outcome' to what is underway in the Gulf right now. The only solution is conservation, otherwise the outcome is ... conservation.

 

 

Wed, 02/22/2012 - 15:05 | 2185762 Augustus
Augustus's picture

Iran will not be buying in the food markets.  Rice prices are going to go down as the starving Iranians are removed from the consumption equation.

Wed, 02/22/2012 - 13:54 | 2185444 shutdown
shutdown's picture

 

 

The nice diagram says China, Japan and S. Korea are all actively pursuing other sources. Lol. Good luck with that! 

Wed, 02/22/2012 - 12:59 | 2185195 sodazed
sodazed's picture

Vampyroteuthis: As I repeat over and over, the world is awash in crude oil

 

Phew! Thanks for putting my mind at rest. And there was me thinking instigating yet another - far more dangerous - war in the ME had the potential to destroy the very (flimsy) threads of industrial civilisation itself. Apparently, once they stall they're a bugger to restart these industrial civilisation thingys.

[Right, I better put some towels up against the bottom of those doors as that oil slushing in is bound to ruin the carpets...]

 

Wed, 02/22/2012 - 12:01 | 2184987 Vampyroteuthis ...
Vampyroteuthis infernalis's picture

As I repeat over and over, the world is awash in crude oil. With the artificially inflated oil market, the majors are pumping as quickly as the drill bits hit the soil. Investors are hoarding oil in hopes of driving up the price even further. Now that the world-wide depression is accelerating due to "austerity", oil demand is dropping. Those who are in trouble are the Iranians and oil traders caught on the wrong side of the trade.

Wed, 02/22/2012 - 12:01 | 2184983 battle axe
battle axe's picture

Who loses? We all lose...

Wed, 02/22/2012 - 12:00 | 2184979 zot23
zot23's picture

The only thing better than sanctions for Iran would be open war.  The regime has long been propped up by HIGH oil prices, the crisis would occur if prices dropped below $80/brl and stayed there for 6 months.  Yes, Iran requires high oil prices to flourish (and oddly enough, to afford the luxury of a nuclear enrichment program.)  Without all that "mad money", it drains the swamp and puts the hard liners on life support.

Sure, sanctions punish the country but not equally.  The republican guard and religious elite will eat just fine, the lack of food just gets passed on to the commoners.  Again, oddly, the presence of an foreign "boogeyman" makes the commoners suffer for the greater good, giving the regime greater latitude to do as it pleases.  It shouldn't work that way, people should be smarter, but they are not.  Look at the USA and the support GWB garnered by starting an epicly bad set of wars.  Re-election based on hardship solidarity.

To be clear, Iran likes higher oil prices.  Sanctions make oil prices rise, bombing would make them skyrocket, land war would be like mana from heaven for oil prices.  So why does the USA keep giving them these elevated prices?  Are we lying about our motives or are we just plain stupid?

Wed, 02/22/2012 - 14:20 | 2185559 Grey-Ghost
Grey-Ghost's picture

Let me see if I've got this straight; if Iran likes higher oil prices and the bombing Iran would make them (oil prices) rise, than Iran would love to be bombed and ravaged?

So, the U.S. is in fact not a monstrous fascist crook that feeds on numerous carcasses it murders but a generous soul helping local economies by destroying them?

Wed, 02/22/2012 - 16:31 | 2186182 AnAnonymous
AnAnonymous's picture

That is indeed the song sung by US citizens.

The extorter sacrifices himself for the good of the extorted.

Wed, 02/22/2012 - 12:00 | 2184967 LawsofPhysics
LawsofPhysics's picture

Hogwash. the spice must flow and the world's economies still run very much on oil.  I seriously doubt that Iran will "have a hard time" finding any buyers.  Common sense tells you that the BRICs will suck it all up, especially if they get even the slightest discount.  The exponential growth of population (currently 7 billion) dictates that demand is not going down.  Stop being so Euro and Amercian centric.  The west is becoming less relevant every day, along with most fiat currencies.  gold is money, silver is money, and Oil is money as well.

Wed, 02/22/2012 - 11:04 | 2184739 falak pema
falak pema's picture

Demand will not dwindle all over the world, the price may. But the demand will increase in BRIC, especially chindia, as in SE Asia. Local consumption in ME/Turkey will also climb fast. We are now in costly energy for long time; and first world with hi-salary/cost structure will suffer most.

Wed, 02/22/2012 - 10:18 | 2184477 Ungaro
Ungaro's picture

Neither Iran nor crude futures blink. I am trying to figure out who wins here. Consumers and most corps in oil-consuming countries, as well as the people of Iran all loose. OPECers win on the short term but give it all back and more on the medium to long term (as demand dwindles all over the world).

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