6:25pm

Sat June 30, 2012
Middle East

Sanctions May Squeeze Iran ... And Raise Oil Prices

The sanctions noose around Iran is set to tighten Sunday as the European Union imposes a total embargo on all purchases of Iranian oil.

The new sanctions are aimed at putting pressure on the Islamic Republic to make concessions on its nuclear program. Iran insists the program is limited to peaceful, civilian purposes, but many Western nations believe Iran has nuclear weapons ambitions.

The move against Iran comes at a time when oil prices have been dropping for the past couple of months.

The EU action could potentially reverse that trend and push world oil prices higher over the next few months. Analysts surveyed by Bloomberg News forecast that the price for premium crude will rebound to more than $114 for the third quarter of this year.

That would be back in the territory where oil prices were in March, when U.S. gas prices surged.

Many Components To Oil Prices

But there are multiple factors driving the world price of oil, including the changing oil dynamic in the Middle East, which produces around 40 percent of the world's oil.

Iraq's oil production is finally recovering from the damage of war, sanctions and neglect over the past three decades, and that is making up for some the Iranian oil that's coming off the market.

Saudi Arabia, the world's largest oil exporter, is also pumping more to help make up for the loss of Iran's oil.

In addition, worldwide demand for oil has been soft owing to economic turbulence in many parts of the world, including Europe.

Analysts say it could be hard to tell how much impact the sanctions will have on Iran's oil industry because the Islamic Republic has been taking dramatic steps to camouflage its exports.

That includes trying to make much of its oil-tanker fleet invisible by changing the names, flags and home ports of the vessels so they won't be so easy to track.

A significant amount of Iran's oil goes to countries such as India and China.

The U.S. is willing to cut some slack for countries that are heavily dependent on Iranian oil, granting exemptions from sanctions to those countries that can show that they have "significantly reduced" their volume of oil purchases from Iran.

Secretary of State Hilary Clinton has already issued exemptions to 20 such countries, adding China and Singapore to the list just this week.

Iranian Output Already Down

Even with the exemptions, U.S.-led sanctions against Iran are already believed to have reduced Iran's oil output to its lowest level since 1989.

An Iranian Oil Ministry official recently told reporters that his country's oil exports have fallen by as much as 30 percent.

When the EU sanctions take effect, Iranian oil exports are expected to drop still more — by as much as 1 million barrels a day, according to the International Energy Agency.

Meanwhile, Iran's neighbor and former rival Iraq is seeing a resurgence of production, topping 3 million barrels a day in June. That puts it on track to overtake Iran as the second-biggest oil producer in OPEC by the end of this year.

"It looks like they'll hit their [production] target this year," says Ben Lando, Baghdad bureau chief of the Iraq oil report.

Lando notes that the increase in Iraq's oil production is a result of long-delayed efforts to rebuild its oil infrastructure, and not a response to the decrease in Iran's production.

"It's more a coincidence that this is happening as Iran's output is declining," he says. "It just so happens that Iraq gets some benefit from the need in the market."

Saudi Arabia's Concerns

Saudi Arabia is a fierce rival of Iran, and the Saudis are currently pumping more oil to help make up Iranian oil that's lost to sanctions.

But the Saudis have budget worries of their own, and that means that eventually, they're going to look for higher prices.

"What determines the oil production of all these countries is the break-even price they need to sustain their economies," says Gal Luft, the co-director of the Institute for the Analysis of Global Security, a think tank focused on energy issues.

The Saudi royal family maintains its power by providing its people with jobs and social programs, all of which must be paid for by oil revenues.

"Even today, they need over $90 a barrel as a break-even price," says Luft.

Because of their huge foreign-currency reserves, the Saudis can sustain a drop in oil prices much longer than the Iranians can, he adds. But sooner or later, the Saudis will want prices to go up.

Luft is also not especially optimistic that the resurgence of oil production in the United States and other countries will have a significant effect on overall world oil prices down the road.

"We don't own this playing field, and it doesn't matter how much we drill," he says.

"We're in this era in which we are all congratulating ourselves," Luft argues. "It's nonsense. You've got countries [such as the OPEC nations] that can produce very little other than oil. They need the money, and they are still in control of almost 40 percent of the world's oil. When the price goes down, they are going to adjust their production down."

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