Background to the Iranian oil crisis
The EU oil sanctions anticipated to be announced on 23rd January will prohibit all EU countries from importing Iranian oil. The reality is that this will only impact Greece, Italy and Spain, the only EU members who import Iranian oil but it is widely expected there will be a carve out for these countries to perform pre existing contracts in order to allow a lead-in time of between 3 to 12 months. I estimate 6 months will be agreed.
Traditionally, refiners buy two thirds of their oil under long term contracts and the balance on the spot market. It is these long term contracts which will likely be subject to the carve out, with spot purchases ceasing immediately. Greece, Italy and Spain have no doubt won significant carrots in return for their agreement to play ball with their EU partners.
The US oil sanctions work in a different way. These sanctions allow the US to sanction banks, refiners and traders worldwide who buy Iranian oil. It is not an offence for these non US entities to buy, supply, or be involved with the purchase ofIranian oil but the US can choose to cut these entities off from the US financial system.
Who currently buys Iranian oil?
Estimates are as follows:
China: 549,000 bpd
Greece, Italy and Spain: 450,000 bpd
Japan: 341,000 bpd
India: 330,000 bpd
South Korea: 244,000 bpd
Turkey 182,000 bpd
South Africa: 98,000 bpd
Taiwan: 33,000 bpd
Sri Lanka: 39,000 bpd
How will buyers of Iranian oil react?
China is the key to successful pressure on Iran. Will the US persuade China to reduce its dealings with Iran? Initial signs indicate that the Chinese are reducing exposure to Iranian oil but it could be that they are simply trying to push the price of Iranian oil as low as possible whilst paying temporary lip service to the US. In the meantime, Iran will build up its stocks - but when Iran is desperate, China may march back in. Financially, it makes complete sense for the Chinese to ultimately take as much Iranian oil as it can at a discount in order to fill up its strategic petroleum reserves. My assessment is that we will see a short term reduction in Chinese deals with Iran, but ultimately the Chinese will re-enter the market with gusto and take as much Iranian oil as it can, while it can, at rock bottom prices. The US is unlikely to exercise its right to punish China.
Beijing has cut its imports of Iranian crude by more than half for January, paying premiums for oil from Russia and Vietnam to replace it. China, which bought 11 % of its oil from Iran during the first 11 months of last year, has cut its January purchase by about 285,000 barrels per day, more than half of the 549,000 bpd that it bought through a 2011 contract.
Greece, Italy and Spain
Between them they buy circa 450,000 bpd. Spot purchases will likely stop and after a 6 month run-in period, exports to the EU under long term contracts will cease. This will be potentially devastating for the Greeks who have generous credit facilities with the Iranians which no one else will match. Indeed, there are few in the market willing to deal with Greece due to perceived credit exposures. The EU will no doubt informally help Greece and are likely negotiating this right now.
Japan, South Korea and Taiwan
They will come under significant US pressure to reduce dealings with Iran. They need not worry about EU sanctions but the US will be quietly urging them to decrease dependency. They will likely agree in order to placate the US - but also to mitigate the risk of being overly dependent on Iranian oil moving forward. If matters deteriorate, say the Straits of Hormuz are closed and the supply tap is turned off, then anyone exposed will have to re-enter the market for urgent replacement purchases whilst prices are at their highest.
India buys circa 330,000 bpd. India is already reducing its exposure to Iranian oil. It is seeking additional oil and natural gas from Persian Gulf nations including Saudi Arabia. Saudi Arabia will increase shipments to some Indian refiners this year as they add plants and seek alternative supplies after a payment dispute with Iran.
Sri Lanka buys 39,000 bpd. They will seek to continue with purchases given they have an interest free credit facility.
Turkey takes 182,000 bpd and will likely seek a waiver from the US to continue to deal with Iran. Iran announced on December 24 2011 that it had extended its crude export contract with Turkey for 2012. Tupras, Turkey's sole refiner and owned by Turkey's largest conglomerate Koc Holding, is said to have purchased over 7 million tonnes of crude oil from Iran in 2010, equivalent to almost 38 percent of the 19.6 million tonnes of crude it refined that year.
South Africa takes 98,000 bpd and will likely seek to continue with this relationship.
To whom will Iran sell its excess stock?
Iranian oil is of low quality, requiring sophisticated refineries so this limits the number of doors Iran can knock on. Pakistan is a possibility. Sri Lanka has no more capacity since it already buys all its oil requirements from Iran. Turkey and South Africa already buy one third of their requirements from Iran and are unlikely to want to increase purchases due to energy security risk management. But they will naturally seek a discount on what they purchase. Iran has few options and will be betting on the Chinese. Their challenge will be to avoid selling to the Chinese at a discount.
Impact on Iran and the future
EU and US sanctions are the first that could have a serious effect on Iran's oil trade, 60% of its economy. Although China, India and other significant non EU countries are unlikely to sign up to any full oil embargo, tighter Western sanctions mean such customers will be able to insist on deeper discounts for Iranian oil, reducing Tehran's revenues. There has already been an impact on the Iranian Rial, which reached a record low last week and has fallen by 40 percent against the dollar in the past month. Queues are said to have been forming at banks and some currency exchange offices have shut their doors.
We are already seeing an impact. Iranian oil stocks are increasing and the price is already being driven down. The USD/Rial rate has been ravaged. Most major banking system doors to Iran business have been closed.
The key potential impact, yet to manifest itself, is that if Iran cannot shift sufficient oil at its budgeted costs then the Iranian economy will go downhill very quickly. Iran has hitherto been resilient in the face of sanctions but that may well change and hit people on the street harder. With an election looming and internal pressure being placed on Ahmadinejad, there is an increased likelihood of a knee jerk reaction with Iran closing the Straits of Hormuz. The Iranian navy will have only limited success since if push comes to shove it will be no match for the US Fifth Fleet. But what this will do is ensure an oil price spike which the Iranians hope will result in an increase in the price of its own oil back to where it needs it. In the meantime the Chinese may well be the real victors.
Nigel Kushner is CEO of Whale Rock Legal, a law firm specialising in international trade.
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