January 17, 2012

Impact of an embargo on Iranian oil

    Tuesday, January 17, 2012   No comments

Strait of Hormuz

International news has been dominated by the Iranian issue these days. Not only the nuclear dispute is present front and center, but military confrontation was moved from the threat level to active planning level. In return, Iran put its cards on the table. Any attack on its nuclear facility will force it to attack all parties involved and all military bases in the region. Then, Iran announced that even in the absence of war, and if an oil embargo is imposed, it will close the Strait of Hormuz because it sees such sanctions as a declaration of war. A recent study, published by Chatham House, an influential think tank based in London, discussed the possible outcomes of an EU embargo on oil exports from Iran. The author made five key conclusions:
  • The initial impact is that the EU countries will have to find alternative supplies to replace their imports of heavy, sour crude from Iran.
  • The hunt for alternative supplies will create transitional friction for oil prices. Thus prices for heavy source crude in the Atlantic basin markets would increase and in Asia-Pacific they would decrease as Iran tried to find alternative outlets for the crude originally destined for European markets. 
  • So far the analysis has assumed that Iran simply accepts the EU embargo without retaliation. This is extremely unlikely.
  • There has been much speculation that Iran's response would be to inhibit the flow of oil through the Strait of Hormuz. This is unlikely. First, any closure would equally damage Iran's ability to export the oil on which its economy is so dependent. Second, serious and credible attempts to close the Strait are in effect Iran's 'big guns' on the issue of whether or not the United States (or Israel) would launch a military attack on      Iran. 
  • A more effective means of putting pressure on Iran would be for the United States to persuade the EU to extend sanctions to financial transactions. An oil embargo alone cannot succeed.

The study remains speculative and overlooks many other critical variables. Importantly, while the author gave ample space to western adaptation to the fallout of an oil embargo, it did not factor in Iran’s ability to adapt as well. The threat of closing the Strait alone increased the prices of oil. An actual instance of violence will devastate the world economy.

The author also estimated that Iran would not close the Strait because doing so would affect its own oil export. That may be true, but that neglects the fact that the closure of the Strait would impact other Gulf States more than Iran. Without the Strait being sealed, Iran’s export would be already impacted by the sanctions.  With the Strait sealed, other Gulf States will be effectively under an embargo as well. Specifically. Kuwait, Bahrain, and Qatar will not be able to export any oil for the duration of any violence in the Persian Gulf. In other words, 40% of world supply will be impacted; but 100% of the oil export of those three countries will be shut down.

Lastly, Iran’s revenues from oil export are about 60%, relatively high. But the Gulf States dependency on oil export is even higher.

In conclusion, western powers ought to revisit their math and assess the likelihood of imposing more sanctions on Iran would bring about change that would outweigh further damage to the global economy and bring about the desired outcome in terms of Iran's behavior.



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Islamic Societies Review Editors

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