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Sanctions on Iran have failed to spike the oil market

Soaring Saudi output has given the West an advantage in its battle with Tehran

When Libya’s uprising shut in the country’s oil production last year, Brent crude prices spiked, rising about 25% from the start of the revolution in February to highs above $125 a barrel in May, 2011.

The reason for the price surge was obvious. Fighting had knocked out 1.4 million barrels a day (b/d) of Libyan oil almost overnight. The quality end of the crude complex, particularly relevant for Europe’s high-spec refineries, was caught short. Libya’s light, sweet, paraffin-rich oil was hard to replace.

Now Iran’s oil is on its way down, even though global demand for crude is higher this year than when Libya’s output was shut in. The EU embargo is biting and the US Congress has added another slew of sanctions to ones it has already imposed. A lot of oil — as much as was lost last year from Libya, believes Goldman Sachs, a bank — could be removed from the market. Far greater volumes would be lost, too, if Iran did what some of its politicians say it will, and shut down the Strait of Hormuz, through which about a fifth of the world’s oil passes.

Yet for all this, oil prices have slumped from a peak in April above $125/b to around $100/b in mid-July. Even a recent rally in the price, which has seen Brent recoup more than $10/b in the past four weeks, was largely for macroeconomic reasons: a Eurozone deal in June and, amid weakness in the Chinese and US economies, expectations for more stimulus cash. In short, the Iran factor has scarcely moved the price, let alone spiked it. Why?

Part of the reason is that the market has already priced in some of the loss. The story has been around since last December, when intense lobbying by Israel persuaded the EU that it had to impose tough sanctions — or watch the Israeli Defense Forces launch an attack to stop Iran’s alleged nuclear programme. The six-month lead-in time for the EU embargo also gave buyers of Iranian oil half a year to find alternative suppliers.

The second reason is that no one knows, yet, how much Iranian oil is reaching the market. In June, Iran told Opec that its production in May had risen to 3.76m b/d. Secondary sources guessed that the figure was closer to 3.2m b/d. In July, Opec said those secondary sources reckoned production had fallen again, to 2.963m b/d. Iran didn’t offer its own number. Tracking Iranian tankers, which would give a better picture, is now difficult: their transponders have been shut off.

Yet despite the fears of Goldman Sachs and others, the International Energy Agency (IEA) says the data that is available don’t support rumours of a plunge in the country’s sales in June. Thanks to renewed buying by China — one of 20 countries that the US government has exempted from its sanctions rules — total imports of Iranian oil around the world, it said, may have risen by more than 500,000 b/d, to 1.95m b/d. At the same time, Iran’s floating storage now amounts to 42m barrels, the IEA added: another difficult number to verify, but suggesting production may not be flagging as badly as some believe.

Another reason is that while global demand has risen, fresh supplies of oil are more than offsetting any lost Iranian barrels — and there is much more oil to come. The IEA expects non-Opec production to increase by 400,000 b/d this year. Production in the fourth quarter of 53.7m b/d will be 900,000 b/d higher than it averaged in 2011. Next year, it will rise by another 600,000 b/d. (Opec forecasts even stronger non-Opec growth in 2013, of almost 1m b/d.) Think Bakken, Kashagan, Fort McMurray and Brazil.

Et tu, Abdullah?

Those far-flung supplies-to-come give the market some comfort. But in the meantime, the main reason Iran’s woes aren’t spiking the price is found closer to home, within Opec. The 30 million b/d production ceiling the group set last year has become irrelevant. Output is around 31.6m b/d. Libyan production has reached pre-war levels and according to the group’s most recent data Iraq has overtaken Iran as Opec’s second-largest producer. It has added almost 300,000 b/d to supply since the start of the year, leaving its output just shy of 3m b/d.

Those additions, though, pale against the efforts of Saudi Arabia, which has set off on a deliberate campaign to replenish and build global inventories and prevent any price rises beyond a rough band a few dollars either side of $100/b. Production has been steady just beneath 10m b/d for most of this year. But in the past month, say sources in its oil ministry, supply has risen to more than 10.3m b/d: a huge jump.

Not all that extra oil — about 400,000 b/d more than the previous month, and almost 500,000 b/d more than secondary sources reported for June — is going to exports: some will be used for domestic power generation. Some of it has also been withdrawn from stocks, probably within the kingdom itself. But the impact is the same: a loosening of Saudi Arabia’s — and the world’s — supplies.

This is not really an effort to capitalise on Iran’s misfortunes, say Saudi sources. It stems from King Abdullah’s wish to see the market balanced, and prices within a range that will not damage the world economy, or the kingdom’s customer base.

But there, too, the impact is the same. Thanks to Saudi pumping, the rise in global inventories means that the world can cope with the loss of Iranian oil. The Energy Information Administration, the statistical arm of the US Department of Energy, reckons stocks rose by 1m b/d in May and June. That compares with a 1.2m b/d draw on stocks in same period last year, during Libya’s war. For Western diplomats, who said from the start of the latest sanctions campaign that Saudi Arabia would be key to their efficacy, things are going to plan.

It leaves Iran isolated and in a tough spot. Plunging oil exports will drain its economy — but, it seems, without further damaging the economies of the import-dependent countries that are imposing the sanctions. That’s a surprise even for diplomats in the West, who said the inevitable spike in prices would help show Iran their governments were serious.

How will Iran respond? The country’s parliament, the Majlis, is alive with plans to shut down the Strait of Hormuz, a threat that is usually guaranteed a jump in oil prices, but has had a muted impact this year. The UAE and Saudi Arabia have already opened new overland oil-export pipelines, which now offer 6.5m b/d of capacity, or about 40% of the volume that sails through the strait. That weakens the Hormuz threat. In any event, shutting down the strait beneath the watchful gaze of the US military would take some doing — and be short-lived.

Another response may include proxy retaliation elsewhere in the Middle East. Iran’s influence in Iraq, say some analysts, could be used to destabilise its fragile politics and stymie its oil-production growth.

Saudi Arabia’s strategy to keep the market balanced, though, isn’t about to change. As the months pass, Iran’s oil output could fall steeply, damaging its fields, even as its fellow Opec members gobble up its market share. Within a year, new production outside the group may loosen supplies still further.

In short, Iran’s options are shrinking along with its economy. To be sure, the country has grown accustomed to international sanctions. And a weakened Iran may be dangerous. But a negotiated settlement to the nuclear issue looks increasingly attractive. 

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