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How the Iranian Sanctions Will Increase the Price of Oil

by | published July 26th, 2010

I am leaving today for Washington, for a couple of days in Capitol Hill meetings with Congressional committee staffs and elected officials. The regulatory changes under review in the aftermath of the Gulf of Mexico spill were supposed to be the main part of the agenda.

That is, until this weekend.

I have spent the past six weeks immersed in the BP (NYSE:BP) disaster, advising oil clients, Wall Street analysts, investment managers, and the occasional government official.

But one thing you learn in this business is that the target shifts.

No sooner does the BP situation calm down (if only until we find out whether the relief well will work), than another of my specialty areas blows up.

And what is happening there will increase the price of crude oil…

Iran’s Vulnerable Energy Sector

I cut my teeth doing deals in the Soviet Union and still spend a lot of time consulting in Russia and the Caspian Sea basin. These days, my work takes me all over the globe. But the part of the world where my career began still holds the key for future oil supplies.

Especially the Caspian.

This land-locked body of water borders five countries, each having major oil and gas reserves… including Iran.

And that is, once again, where the problem is. What is happening there is already trespassing on what had been my agenda – the BP oil spill aftermath – for the next few days of meetings in D.C.

Here’s why.

The U.S., European Union, and U.N. have passed new sanctions, hoping to compel Iran to stop its nuclear enrichment program.

And this time, they’re aimed at Iran’s energy sector.

These sanctions make it more difficult for Iran to access banks, exchange currency from oil sales, and import fuel. Despite having the second-largest oil reserves in the world (after Saudi Arabia), Iran has insufficient refining capacity, so it needs to import gasoline, diesel, and heating oil to meet domestic needs. Four months ago, I explained how this situation will impact prices in “How to Profit from the New Iranian Sanction.”

But here are the two major effects of the new sanctions:

1. Iran needs to import about 125,000 barrels of gasoline a day. And the sanctions will make that much more difficult

Most oil traders in the world are pulling out of deals with Tehran for fear of reprisals from the global powers who created the sanctions. China and Venezuela are still sending gasoline, but both have pressures at home against doing very much of that for very long. China has its own rapidly accelerating need for gasoline to deal with, as its driving population grows. And Venezuela has the lowest domestic prices in the world – about 6 cents a gallon. That makes for a very inefficient refining structure and insatiable demand.

2. The second impact is more important and provides the key to understanding the pop in crude oil prices coming and the investment profits that will result.

The sanctions will prevent Iran from doing oil sales in dollars or euros. Since virtually all oil contracts worldwide are in dollars – with euros being a distant second – that puts Tehran in a difficult position. Iranian banks cannot acquire either currency anymore. They will need to move to others in a very inefficient attempt to continue doing business.

They have already signaled a move to the yuan (the currency of China, Iran’s current primary oil trading partner) and the dirham (of the United Arab Emirates) – to gain access to Dubai banks, Abu Dhabi oil swaps, and a backdoor into dollars and euros, although at a premium.

All of this will significantly cut into Iran’s oil sale revenues, because the rest of the world still denominates oil exchanges in the very currencies Iran can no longer use.

As this situation unfolds, it is certain to add jitters to the market, reflected in crude oil contracts denominated in both dollars and euros. It will also increase the “crisis premium” on setting prices in futures contracts.

Because Tehran will not be giving up their nuclear ambitions any time soon, it means the pressure on hard currency pricing for oil will increase.

But it also means I need to be careful…

I do hundreds of media interviews each year. In the middle of all of this blowing up, the phone rang early Saturday morning. It was IRNA – the Iranian state news service. They asked if they could talk to Dr. Moors for his reaction on the sanctions and their impact.

Now, I’ve been in the geopolitical equivalent of a barroom brawl before. So as to my response, the decision was simple – told them I wasn’t in the office!

Kent

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  1. Paul H. Boisvert
    July 29th, 2010 at 09:02 | #1

    As you stated that Iran can still backdoor the process for U.S $ and Euros.

    What is your projection regarding China’s move to join in on the sanctions?

  2. JOHN J. DUNN
    August 15th, 2010 at 20:00 | #2

    THIS SOUNDS SIMILAR TO A SITUATION OF AN INDEPENT GAS STATION NOT FAR FROM HOME WHO ALWAYS BEAT HIS COMPETITION BY A CENT OR TWO. HE TOLD ME THAT HE ALWAYS USED HIS BINOCULARS TO CHECK HIS COMPETITION EVERY MORNING BEFOR OPENING UP. BY THE WAY IT WAS SHELL.

  3. Allan Hochman
    September 28th, 2010 at 11:31 | #3

    Dear Kent,

    I would very much welcome your advice as to how we could best play the inevitable increase in oil prices. In order to diverisify our position, i would appreciate your recommending several companies.

    Thank you,

    Allan Hochman

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