Foreign Correspondence

[Amaunet]

Iran Nuclear Sanctions Would Affect Markets
Oxford Analytica 04.05.06, 6:00 AM ET


The United Nations Security Council called on Iran last week to suspend its uranium enrichment program within 30 days. The United States and the European Union, as the next step in their diplomatic offensive against Iran's nuclear program, are seeking to introduce a binding resolution under Chapter VII of the U.N. charter, paving the way for some sort of sanctions.

While Russian and Chinese objections will render progress extremely slow, any measures that do emerge are likely to have a significant effect on oil markets:

Gasoline imports. One form of sanctions being touted is a ban on Iranian gasoline imports. Iran is dependent upon such imports for 40% of domestic consumption. However, the government is desperately seeking to reduce gasoline consumption.

In the short term, there would be economic pain. However, Tehran could significantly increase gasoline prices and curb consumption. Furthermore, Iran's porous borders would ensure that a ban on gasoline imports would be of limited effectiveness.

Oil services. Limitations on Iranian access to oil-services companies and technology might eventually produce results. However, the United States owns most of the companies and technology, so such sanctions have already been in place for a long time thanks to the Iran-Libya Sanctions Act. If the Europeans were to support a ban, this could cause problems, because it is largely through this route that Iran has gained access to such technology. However, such services and technology are increasingly available from China, India and other countries that might pay less heed to sanctions.


Foreign Direct Investment. Sanctions could also inhibit foreign direct investment into the Iranian upstream. Sanctions or U.S. efforts to impose ILSA more forcefully could again be undermined by the fact that much of the new investment is likely to come from Asian oil importers.


Asia is hungry for oil, and Iran is ideally located to supply it. In the last few months, Tehran has very actively wooed Asian oil importers with promises of favorable deals and access to both oil and gas. The eventual effectiveness of any sort of sanctions regime will depend on whether Asian countries rate their trade relations with Iran above concerns about a nuclear Iran and their desire for good U.S. relations.

Tehran has several options if it decides to respond:

Oil pricing. It could switch oil pricing from dollars to euros. The rationale is that, if oil were not priced in dollars, this would weaken the dollar and reduce the inflow of funds to cover the U.S. twin deficits. However, such a move would only have an effect if a lot more oil than the volume of Iranian exports were involved.


Oil exports cut. Tehran could make some sort of reduction in exports, whether overtly or citing "technical problems." Nonetheless, a small reduction in exports would not result in a physical shortage. The precise effect on prices would depend upon the reaction of the paper markets, but they would certainly rise.


Exports ban. The most extreme exports cut would be a complete cessation of crude oil exports. The International Energy Agency has indicated that existing stocks could replace Iranian exports for 18 months, but such claims are quite misleading. Therefore, the resulting physical shortage would push oil prices higher. In any case, regardless of the actual number of wet barrels, the paper markets would instantly raise prices.

Blockade. Iran could retaliate or reinforce its own embargo by closing the Straits of Hormuz, through which a quarter of global oil exports flow. However, such an act would certainly result in military action. A far more serious and realistic threat would be to stop all oil exports from southern Iraq.


The effects on both sides of an oil embargo would be very damaging. However, for Iran, there are mitigating factors. Iran could survive with zero oil exports for far longer than the industrialized oil consumers, particularly those in Asia, could survive without Iranian imports.

An escalation of the crisis to a complete loss of Iranian oil exports is highly unlikely. Less dramatic, but more plausible, are sanctions and responses to them, which are unlikely to have much of an effect on physical supply in the oil market. However, they would probably push prices higher, depending upon the paper markets' reactions. These measures would have less of an effect on the Iranian economy than on oil consumers, leaving the balance of harm in Tehran's favor.

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