(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Jan 10 If war is merely the
continuation of policy by other means, aimed at compelling our
enemy to do our will, as military strategist Carl von Clausewitz
maintained, then sanctions are a form of warfare without overt
For the last few years, Iran has been locked in an
intensifying, undeclared war with Israel, the United States and
their allies in Europe and the Middle East.
Sanctions on Iran's oil exports are simply the most recent
and visible element of a complex conflict that also includes
covert operations, sabotage, the arrest of agents and the
abduction of scientists, engineers, agents and policymakers on
Sanctions are often portrayed as a diplomatic alternative to
war, but a more realistic assessment sees them as simply as one
tool in an intensifying political, military and economic
For both Iran and its enemies, the conflict is existential.
Israel fears a nuclear-armed Iran would fatally undermine its
ability to guarantee the safety and security of its own
citizens. Iran fears encirclement by hostile powers attempting
to overthrow the government and affect regime change.
The conflict's total nature makes it difficult for either
side to back down. It also makes the escalation sequence
extremely unpredictable since neither side may be willing to
compromise short of achieving its maximum aims.
The confrontation seems more likely to end with Iran
acquiring nuclear capability and/or the government in Tehran
being overthrown than a diplomatic compromise and a return to
negotiations or the suspension of the enrichment programme.
For the oil market, the important question is not whether
sanctions will be imposed (the initiative appears to have
acquired unstoppable momentum in the strategic studies
community) but how the conflict will develop once the EU and
other states announce their restrictions on imports from Iran.
Global oil production and consumption stood at around 89
million barrels per day (b/d) in November, according to the
International Energy Agency's latest "Oil Market Report".
Iran produces just over 3.5 million barrels of crude a day,
and exports around 2.5 million.
The only country with significant unused production capacity
is Saudi Arabia, which produced 9.75 million b/d in November,
according to the IEA, and slightly more according to Saudi
sources, but has capacity to pump as much as 12 million b/d.
Iran's output is therefore roughly equivalent to total spare
capacity in the global market. The market cannot afford to lose
all or a significant part of that output as it would cut spare
capacity to zero and make the market exceptionally vulnerable to
any unexpected growth in demand or output losses elsewhere.
If sanctions cut Iran's exports, losses would have to made
up by higher Saudi production or from emergency stocks held by
IEA member countries and other importing countries such as
Any increase in Saudi output will cut the market's margin of
spare capacity. Release of emergency inventories cannot be
sustained indefinitely (IEA government-controlled stocks were
just 1,500 million barrels at the end of November).
So assuming the oil market is currently "balanced" at
present levels of supply, demand, capacity and inventories with
prices at $112 per barrel, any bid to cut Iran's exports would
force prices substantially higher to reduce consumption until
the margin of spare capacity and inventories has been restored.
If sanctions cut Iran's exports significantly, the most
likely consequence will therefore be higher prices and a
slowdown in both global growth and oil consumption.
To avoid this costly outcome, early sanctions proposals
suggested the EU would embargo imports from Iran and force the
country to boost its exports to Asian markets at a discount. The
total volume of exports would not change, ensuring world prices
did not rise, but the composition of Iran's markets and its
earnings would be adversely affected.
But sanctions legislation approved by the U.S. Congress
seeks to cut off, or reduce, Iran's access to markets in Asia as
well. The combination of the restrictions contained in the
National Defense Authorization Act (PL 112-81) and the proposed
EU import ban implies Iran's exports could fall significantly in
the coming months by anywhere from 200,000-300,000 b/d to as
much as 1 million b/d or more.
Saudi Arabia could certainly offset these losses by
increasing its own exports, and the IEA would almost certainly
cut several hundred million barrels from government inventories.
Whether it would succeed in averting a rise in prices
depends on whether the market perceives the loss of exports as
temporary or permanent, and whether any confrontation worsens
and leads to the loss of even more, perhaps cutting exports to
zero, or results in a swift compromise.
It is far from clear Iran would back down quickly. Sensing
an existential threat, the government in Tehran might remain
defiant or choose to escalate. If so, exports could be lost for
an extended period, gradually running down emergency stocks and
eroding Saudi spare capacity.
One unintended consequence is that Iran will take over Saudi
Arabia's traditional role as the swing producer, holding much of
the idle capacity needed to meet an unexpected surge in demand
or outages elsewhere.
The global oil market could probably just about absorb the
loss of up to 1 million b/d of Iranian exports on an ongoing
basis, albeit at higher prices. But it is not clear what would
happen if more output was lost because of the deteriorating
political situation in Iraq and protests in Nigeria, production
losses in the North Sea or a natural disaster such as hurricane
in the Gulf of Mexico.
Would the EU and the United States relax sanctions
(temporarily or permanently) to offset the intense upward
pressure on oil prices?
The impact on Iran's revenues remains unclear. Most
strategic studies analysts assume sanctions would cut volumes
and/or force the country to discount its crude, reducing its
export earnings. But Iran might see little or no impact, even
gain, if sanctions push traded oil prices higher.
For a small reduction in volumes (200-300,000 b/d) and small
discounts ($5 per barrel), the impact on Iran's earnings might
be offset by a $10-20 per barrel increase in international oil
prices. For a really big cut in volumes (1 million b/d or more)
and hefty discounts ($20 plus), the impact on earnings would
probably be negative, but oil prices might surge $50 or more,
risking serious harm to the world economy.
None of the leading sanctions advocates has published
meaningful estimates of how much volume would be lost, how much
Iran might be forced to discount its oil, or how far traded
prices might rise in response to the combination of an EU
embargo and lower crude purchases by Asian customers such as
Japan and South Korea.
For all the detailed planning behind the scenes, sanctions
policy, like battle plans, is unlikely to survive first contact
with the enemy.
Once sanctions are imposed the results in terms of oil
supply and prices are likely to be quite unpredictable. No one
knows for certain how Iran would respond, how much export volume
would be lost, or for how long, and how the market would evolve
in the light of other shocks to supply and demand.
To improve their political acceptability, advocates have
portrayed sanctions as a carefully calibrated and low-cost way
to ratchet up pressure on Iran and force the country's
government to suspend its enrichment programme without sparking
an uncontrolled escalation of violence.
In reality, sanctions are a gamble: a bet Iran will not
choose to escalate further; a bet the oil market can absorb the
loss of exports without serious difficulty; and a bet nothing
else will go wrong in other producing countries.
Once sanctions go into effect, no one is quite sure how Iran
and oil prices will respond.
(Editing by Keiron Henderson)