Lessons From a Failed Iranian Oil Embargo
European Union leaders in Brussels failed to fix their mess during the do-or-die summit, but at least they agreed to postpone dragging the world into another recession, not by saving the euro, but by stepping back -at least for now- on imposing an embargo on Iranian oil imports.
Common sense, or rather self-preservation, appears to have delayed any imminent European recklessness.
The U.S., which doesn’t import any oil from Iran since 1991 and is thus more immune, has long sought more support in strangling the Ayatollah’s oil bloodline. The problem is some of America’s best friends are also Iran’s best customers, topped by Japan, South Korea, Italy, Turkey, and Spain, and understandably not so keen on a costly embargo for their economies.
Europe depends on oil for around 85 percent of its oil, and Iran is responsible for around 5 percent of it, but disproportionally so in southern Europe. While rhetorically attractive, an embargo would be economically na”ive and disastrous in this juncture, and with potentially damaging side effects amid the economic slump.
Still, the scathing report about Iran’s nuclear program released early in November by the UN’s International Atomic Energy Agency resurfaced calls for an EU embargo. France first, seconded by the U.K. and Germany, lobbied other EU members in an effort to get unanimous support by the end of the summit Friday.
Cost concerns though frustrated their attempt. Oil prices rose around $4 a barrel during the last couple of weeks largely on expectations that the EU would agree on the embargo. Leaders agreed only to further ratchet pressure, although France and others still hope to convince the rest an embargo is the only option.
Greece -one of the closest Israeli allies in the region- was blamed for wrenching the diplomatic effort. Iran supplies the troubled nation with 14 percent of its supply, according to the Energy Information Administration. Aside from the costly dislocation to its energy market in case of having to replace Iranian crude, other producers concerned about Greek credit will not offer equally good financial terms.
But it wasn’t just a Greek veto. It just so happens that Spain and Italy imported around 320,000 barrels per day from Iran in the first half of 2011, 70 percent of the total 450,000 bpd total Iranian crude imports into the EU. For each country, that’s 13 percent of their supply. The two countries that can easily bust the entire euro zone are not in a position to assume the cost of an embargo, and its neighbors are in no position to further undermine their economies.
But even more damaging would be higher oil prices amid an economy bordering on recession. EU officials were initially quick to dismiss the economic risk of an embargo. The EU Commissioner said the supply would be offset by OPEC, namely Saudi Arabia.
That is na”ive. Riyadh, as much as it wants to corner Iran, cannot just turn its oil valve on or off, especially against a fellow OPEC member and for western political purposes. OPEC’s spare capacity is simply too small, which means any embargo would come at great costs.
And that’s where the embargo makes even less sense. Iran would not stop selling its oil, it would just have to find new customers for about 20 percent of its 2.4 million bpd exports. The world simply can’t live without Iran’s crude. It would be a futile effort of relocating supplies.
Tehran has been doing just that since Europe started ratcheting pressure a year ago. Oil exports to Europe dropped around 25 percent from 2010, while Asia’s soared, in the case of Japan by 35 percent.
With an embargo, Iran would likely have to offer a discount while the market stabilized. China and India, which have both increased Iranian imports, would be happy to buy, especially in this bullish market.
In order for an embargo to work, Iran would have to lose more money by selling 20 percent of its oil at discounted prices than what it will earn for selling 80 percent of its oil at higher prices. That’s a multiplier of four. For every $1 increase per barrel, Iran can offer up to a $4 discount just to break even.
So let’s say an EU embargo raises prices by $10 a barrel, a conservative scenario considering they increased $4 a barrel just with talk of a failed embargo. Iran gets an additional $100 million per day from exporting 2 million bpd, allowing it to offer up to a $40 discount per barrel on what Europe doesn’t want to buy, and still not loose.
But since any discount in this tight market would be short lived and certainly not reach double digits, Iran would make a profit on just about any scenario.
Now consider what would happen to the US and European economies in case of a sustained $10 a barrel increase. Needless to say Spain and Italy would likely not make it without a bailout, which in turn would collapse the euro zone and the European Union along with it. The risks for the US are not smaller. Factoring in the consequences of a euro zone implosion would put America on the brink of a double dip recession, and more than likely a new administration.
In the meantime, higher oil prices would benefit countries like Russia and Venezuela, while hurting most market-oriented countries allied with the US and Europe in their concerns about Iran.
Furthermore, do the US and Europe really want to open this can of worms again, the one opened by OPEC in the 1970s when they used oil for political purposes? OPEC leaders have in unison warned consuming countries from imposing an embargo on Iranian oil imports, both over concern about their ability to offset supplies and over the diplomatic implication of using oil as a weapon.
Of course, EU leaders will meet again in January and calls for an oil embargo will intensify. The most exposed countries will have time to gradually substitute some crude, at least to reduce damages.
But even if Europe one day cuts all Iranian oil imports, what makes an embargo a non-starter is that anti-American regimes will benefit economically, while offsetting their diplomatic losses, as long oil markets remain tight (and they will throughout the decade).
The embargo threat is hollow. Iran and others will be better able to exploit oil as a shield than consumers do as a weapon. National security of Europe and the US will be increasingly undermined by the heavy weight of oil prices amid stagnant economies.
And the best lesson to be learned here is that America, Europe and its allies need strong economies to put some teeth into their diplomacy.
And that demands more oil, not embargoes.