COLUMN - Saudi/Iran oil swap more difficult than it seems: Kemp

LONDON Wed Dec 7, 2011 7:32pm IST

A worker holds a fuel nozzle at a petrol pump in Mumbai June 11, 2010. REUTERS/Danish Siddiqui/Files

A worker holds a fuel nozzle at a petrol pump in Mumbai June 11, 2010.

Credit: Reuters/Danish Siddiqui/Files

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LONDON (Reuters) - The EU's push to impose sanctions on Iranian oil is dividing western officials in charge of foreign policy and those charged with energy security and economics.

Energy policymakers worry that their diplomatic colleagues underestimate the problems involved replacing EU imports from Iran with oil from other sources such as Russia and Saudi Arabia.

Swapping Iranian oil for more Saudi production in Europe, and the reverse in Asia, will be fiendishly difficult unless Saudi Arabia's King Abdullah takes a political decision to accept lower prices on sales to the EU as part of a deliberate plan to undermine the kingdom's regional arch-rival.

While the kingdom shares European and U.S. concerns about Iran's uranium enrichment programme, it has not yet signalled publicly that it is willing to forego oil revenues to support the EU's effort to up the pressure on Tehran.

REFINERS CHALLENGED

The EU imported 670,000 barrels per day from Iran in Q2, and rather more in Q3, according to the International Energy Agency. Almost all the Iranian crude went to refineries in the Mediterranean including Italy (249,000 barrels per day), Spain (149,000) and Greece (111,000) as well as non-EU Turkey (217,000).

Of the total, roughly 25 percent was the Iranian Light crude grade, with an API gravity of 33.3 degrees and sulphur content of 1.6 percent. The remainder was Iranian Heavy and other crude streams that are even harder to process, with a weighted average sulphur content of 2.1 percent and API of 29.4 degrees.

The nearest equivalents sold by Saudi Arabia are Arab Light (32.9 degrees API and 1.9 percent sulphur) and Arab Medium (29.8 degrees and 2.5 percent sulphur).

For European refiners, the Saudi grades are not a perfect replacement for Iranian oil because they have a substantially higher sulphur content. Following decades of under-investment, European refineries are notoriously unable to cope with high sulphur crudes, which is what made the disruption of Libyan exports and North Sea output earlier this year so problematic for them.

The only way to offset the higher sulphur content in Saudi crude streams and make them match the Iranian grades that have been lost would be to blend them up with more expensive low sulphur crudes.

EU refiners would have to blend Arab Medium with Arab Light (or similar grade) to match the quality specifications of Iranian Heavy. To replicate Iranian Light, refiners would need to blend Arab Light with Arab Extra Light (or equivalent), which would prove very costly.

Saudi crudes are already more expensive. Arab Light and Arab Extra Light sold into Europe are currently trading at $109 and $111 per barrel (loading at Saudi Arabia's Ras Tanura) compared with $107 for Iranian Light sold into the Mediterranean (loading at Iran's Kharg Island).

Arab Medium and Arab Light to Europe are selling at $107 and $109 per barrel compared with $106 for Iranian Heavy, based on official selling prices on Wednesday.

Sanctions would add at least $1-3 to crude acquisition costs for affected refineries. It may not seem very much. But affected refiners may struggle to pass the increase through to consumers since they compete with other processors in northern Europe, the United States, Turkey and Asia that are not affected by the sanctions.

As a result, sanctions could compress or wipe out the wafer thin margins for some refineries. It is not clear whether or how the EU would compensate affected refineries for the losses caused by sanctions policy.

SAUDI REVENUES CUT

Sanctions would also pose a major headache for Saudi Arabia. Aramco is currently charging customers in Asia almost $3 per barrel more for Arab Extra Light, $4 more for Arab Light, and nearly $4.50 for Arab Medium than customers in Europe.

Saudi crude in Asia is already trading at some of the highest prices relative to Europe and North America in the last eight years. Past practice suggests Saudi Aramco will try to close the gap by adjusting its regional differentials.

But sales are booming, especially into Asia. The kingdom upped production to more than 10 million barrels per day in November, a senior Saudi official told Reuters on Wednesday. It is much more likely the kingdom will raise its official selling prices in Europe and North America than risk stimulating even more demand and stockpiling by cutting them in Asia [ID:nL5E7N71H6] [ID:nL5E7LE0P2].

Senior Saudi officials have repeatedly made clear that increasing sales into the fast-growing Asian market is a top priority.

But if the EU embargo is not to affect total global oil supply and prices, as its advocates claim, Saudi Arabia will have to switch an equivalent amount of oil sales from Asia to Europe, to offset the Iranian oil that can no longer be sold in Europe and is pushed into Asian markets instead.

If Saudi Arabia raised its official selling prices to Europe to compensate for the loss of higher-price Asian sales, crude acquisition costs would need to increase $1-2 per barrel for all buyers or $3-4 just for the southern European refineries directly affected.

Saudi Arabia could make a political decision to keep European prices unchanged and forego revenues. But that would require a deliberate decision to prioritise foreign policy interests over short-term oil revenues and long-term relationships with customers across Asia, and could only be taken by the king and senior princes.

COSTS AND BENEFITS

For EU foreign policymakers, the benefits of introducing an embargo on Iranian oil imports are obvious. It would send a tough public signal of the EU's displeasure with the enrichment programme and represents a significant but carefully controlled escalation of pressure [ID:nL5E7N63LP].

The costs are less obvious and more complicated. For officials working on energy issues, the worry is that foreign policy specialists driving sanctions policy do not understand how the oil market works, and underestimate how difficult it would be divert Iranian crude to Asia and Saudi crude to Europe without disrupting the refining system and potentially causing shortages that would drive oil prices higher.

Speaking in Qatar on Wednesday, OPEC Secretary-General Abdullah al-Badri warned against an EU embargo. "I really hope there would not be a ban on Iranian crude by EU, it would be very difficult to replace," he said.

Badri must represent the interests of all cartel members, including Iran, so his warning could be dismissed as self-interested. But he is not the only one keen to emphasise the perils of sanctioning Iranian crude at a time when oil markets are not oversupplied.

Refiners and many officials privately warn sanctions will be hard to implement without disrupting the market.

Even these estimates may understate the true cost to refiners (and ultimately consumers) of an EU embargo. In cutting the overall flexibility in the global refining system, an embargo will increase the risk of a mismatch between the crude oils on offer and the streams refiners are legally allowed to buy and technically able process.

Lower flexibility will create increased opportunities for traders of spot cargoes. Sanctions are usually good business since they create captive buyers and sellers, and there are creative ways to arbitrage around them. But lower flexibility will also boost the risk of prices spiking if mismatches become acute.

By admitting the kingdom is already pumping more than 10 million barrels per day, much more than many analysts previously thought, Saudi Arabia has acknowledged its spare capacity is down to 2.5 million barrels per day, and perhaps less. There is not much room for error.

(Editing by William Hardy)

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