Crude oil and the impact of EU sanctions against Iran

The EU today agreed to impose an embargo on crude imports from Iran. The move which was widely expected is part of sanctions over its nuclear intentions and in order to accommodate countries currently relying on Iranian oil existing contracts can be fulfilled until July 1 leaving them time to seek alternative suppliers.

Ahead of the announcement today six warships from America, Britain and France passed through the Strait of Hormuz over the weekend and the market is now nervously awaiting the response from Tehran. Several times during the past month Iranian authorities have threatened to close this important strait through which some 20 percent of global oil is transported daily.

Western governments led by Britain and America have stated that they can keep the strait open and will do what is necessary to secure the safe passage of oil produced by countries within the Persian Gulf. Europe imports some 450,000 barrels a day and key recipients such as Greece, Italy and Spain will now have to look elsewhere for supplies with attention naturally turning to Libya where oil exports have been rising steadily since the civil war ended.

The risk of a conflict that gained attention during December helped drive the price of Brent Crude up by 10 dollars until the early parts of January before focus shifted to the fragile outlook for oil demand during the first half of 2012.

Iranian officials  will probably have to tread very carefully now as the resolve by the international community has been clearly shown and they know that an attempt to block the Strait of Hormuz will most likely cause a damaging spike in prices which will hurt every oil consuming nation, including China, its biggest customer.

The price of Brent crude rallied one dollar to USD 111 per barrel still some four dollars below the high point reached earlier this month. The limited reaction showed that that the announcement had already been priced in and a further escalation is needed for prices to move higher. Speculators have continued to increase net long positions in the market on the back of raised geopolitical risk and it helps to explain why the initial move higher on the announcement was not greater

Over the coming days and weeks however the market will be nervously awaiting the next move from Iran and in the unlikely event it leads to a military conflict the price of oil has the potential of spiking higher by anything between 20 and 40 dollars depending on the impact on free passage through the Strait. Such a spike, if prolonged, will undoubtedly raise the spectre of a 2008 to 2009 styled global recession and oil demand could be seriously impacted thereby increasing the subsequent risk of a collapse in the price, which no one, not least Saudi Arabia would want at this stage.

Given what we now right now in terms of supply and demand we probably feel that oil prices are trading expensively but the geopolitical risk premium will stay with us for the foreseeable future leaving selling interest only in the hands of brave hearts.