Low oil prices rather than an embargo will hurt Iran most

Yacov Sheinin

Iran's already shaky economy will not be able to function if its oil revenues plummet.

The EU, which represents 500 million people and has a GDP of $15 trillion, has decided to impose an oil embargo against Iran beginning on July 1. The EU imports nine million barrels of oil a day, almost a tenth of global production, and the EU is joining the embargo on Iran by US, which imports 13% of global production. Despite the importance of the EU's message, more than 70% of global oil importers are not participating in the embargo.

The EU's decision did not cause an oil price shock, causing the price of Brent Crude to rise by 0.9%, at a time with the daily volatility in the price of oil can reach 10%. Meanwhile, the euro continues to strengthen against the dollar, the opposite of what might be expected.

At the end of the day, the world's stock exchanges, which have fluctuated wildly in recent years on every meaningless announcement, were utterly calm, and even rose slightly.

Everyone has his own interests

Iran's economy is totally dependent on oil revenues. The country's economy is failing, it has to feed 75 million people, and without oil revenues, its economy is presumably headed for collapse. The greatest threat to Iran is that the price of oil will fall sharply in the coming years, and its already shaky economy will not be able to function if its oil revenues plummet. I believe that this is what will happen over the next three years.

As for the Saudis, even if sales of Iranian oil come to a complete halt, Saudi Arabia has surplus production capacity of over three million barrels a day, and it can make up shortage from the loss of Iranian oil. The Saudis have a paramount interest for the US and Europe to continue to pressure Iran not to produce a nuclear bomb that will directly threaten them more than any other country in the world. The Saudis fear that high oil prices will end the pressure on Iran, so they will be happy to make up any shortfall, if necessary, to prevent prices from rising.

On the other hand, the Chinese, Indians, and other oil importers are unlikely to stop buying Iranian oil. On the contrary, they will probably increase their Iranian oil purchases at the expense of the Saudis, who will sell more oil to Europe and less to Asia.

As for the US and Europe, in the current conditions of a global economic crisis, they presumably do not want an oil price hike or oil shortage. It seems that the EU oil embargo and the entry of a US aircraft carrier into the Persian Gulf are gaming in an effort to reach equilibrium that both Iran and the West can live with.

That is why, from an economic perspective, there is little likelihood that the situation will deteriorate and cause a jump in the price of oil or a closing of the Straits of Hormuz by Iran. Despite everything, I hope that the cumulative effect of economic sanctions on Iran will force it to scale back its development of the Bomb over the next three years.

Where is the price of oil headed?

The current high price of oil is due to strong demand by China in the past few years, which was not taken into account in global oil production planning in the late 1990s. China's demand for oil has tripled from three million barrels a day in 2000 to nine million today.

Since 2005, with the rise in the price of oil and expectations of continuing growth in Chinese demand, oil exploration at every potential site has been greatly expanded. This process takes a long time - a decade is needed from the start of drilling to commercial production, but it is clear that when completed, there will be a large oil surplus. At the same time, in view of the rise in the price of oil to around $100 a barrel, immense efforts are being made to conserve oil through efficiency measures. This process also takes about a decade, and will likely result in a capping of global oil demand.

OPEC is effective only when there is no surplus supply. Today, all the world's oil producers are operating at full capacity, except for Saudi Arabia, which is the sole controller of major quantities of oil reserves. When the surplus supply becomes large, the Saudis will be ineffective, and the OPEC cartel will collapse, just as it did in 1986-2005.

During the 1981 oil crisis, conventional wisdom held that there was a chronic global oil shortage, which would cause prices to rise steadily over time. Instead, the price fell from $110 per barrel to $25 per barrel for almost 20 years, until 2005.

In view of the lesson of that oil crisis, combined with current developments, I predict that, within three years, by 2015, there will an oil surplus of more than seven million barrels a day, and that the price of oil will fall accordingly.

The price could fall to below $70 per barrel, and I would not be surprised if it temporarily fell to as low as $50. This prediction currently seems as hallucinatory as the predictions of 1981.

The expected plunge in the price of oil in the coming years is the real sanction on Iran. When an oil surplus emerges, nothing will help it. Its oil revenues will shrink sharply and its very weak economy will teeter on collapse. It is hard to believe that it will be able to survive like North Korea, so it will be forced to stop developing the Bomb.

Published by Globes [online], Israel business news - www.globes-online.com - on January 24, 2012

© Copyright of Globes Publisher Itonut (1983) Ltd. 2012

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