The Iranian Oil Spike
In addition to what I write for Oil & Energy Investor, Energy Advantage, The Energy Inner Circle, and the new Energy Sigma Trader, I also pen the lead Iranian/Iraqi oil and gas analysis for each edition of Thomson Reuters' Caspian Investor.
(It's true – I just can't get enough of this stuff.)
That means I have a unique opportunity today to give my OEI readers a sneak peek at what I'll be telling Thomson's high-priced corporate- and government-level subscribers next week.
As you've no doubt noted, crude oil prices have moved up sharply since the beginning of January.
The Brent benchmark set in London is once again approaching $115 a barrel, increasing 3.6% since January 3. Meanwhile, West Texas Intermediate (WTI), set in New York, has been above $103, but increasing at less than half the growth rate of its London counterpart.
The spread between the two is again in double digits, with Brent higher than WTI by some 11%. That is well less than half of what the difference was a month ago… and less than one-third of the figure in mid-October.
However, it is widening again.
And this is a big deal for oil and energy investors like you and me.
A Variety of Factors Impacts Pricing
Even without the geopolitical situation, there have been several factors prompting a rise in prices anyway. Demand is increasing, and inventory is declining, for example, both usually mean an upward pressure.
On the other hand, most pundits have identified the decline of the dollar against the euro as the usual culprit behind price increases.
But this time around, the euro is declining against the greenback.
Meanwhile, both oil prices and the Brent-WTI spread are moving up.
Well, Iran is what gives.
Boycott Tensions are Accelerating
This is not a result of the recently concluded Iranian naval exercises or the country's threat to close the Strait of Hormuz.
The oil markets largely discounted both of those factors.
For one thing, Iran could periodically close the strait, but it does not have a large enough navy to introduce a blockade.
And then there is the U.S. Fifth Fleet.
No way would the U.S. tolerate a closure of the largest passage for oil tankers in the world.
Rather, the Iranian impact has actually resulted from an action taken in Europe. There, after much discussion, and with a few wrinkles still to iron out, the European Union has just made a major move.
EU headquarters in Brussels announced on January 4 that the organization's membership had agreed to stop importing oil from Iran.
This is a major blow to Tehran. The EU is currently the second-largest importer of Iranian crude after China. Concerns have been raised over the effect the move will have on prices in the European market.
EU contacts insist that the new sanction will not create serious problems for the continent, but the markets are not so sure.
An “Iranian spike” has pushed prices north in short order.
Here is why this new development is likely to have a significant impact on the oil markets moving forward – one that will provide advantages for us as energy investors.
The Nuclear Sanctions are Starting to Hurt
Tehran cannot combat mounting domestic economic problems without increased sales revenues from crude production.
These sanctions, of course, are aimed at suppressing the Iranian nuclear program. (The West claims that Iran is developing nuclear weapons, while Tehran claims the program is for peaceful energy purposes.)
Until mid-2010, attempts to eliminate foreign involvement in Iranian oil and gas have had some results. But the loss of Western majors merely provided the Chinese an opportunity to move in.
Yet changes in sanctions strategy, beginning in June 2010, started hitting Iran where it hurt: U.S., EU, and UN moves restricted the country's use of international banking.
Access to foreign exchange is essential in a market like oil, where international contracts are denominated in dollars.
Then last summer, U.S. pressure resulted in the closure of several Iranian foreign banks, most noticeably one in Germany, licensed by the German central bank and the conduit for much of Iran's oil sales.
Washington argued (almost certainly correctly) that this small German-registered but Tehran-controlled financial institution was a primary way in which arms were purchased for Iranian use, along with equipment obtained for its nuclear program and assistance sent to augment terrorism abroad, especially by Hezbollah.
These closures dramatically increased Iran's costs of selling its oil and buying the gasoline and heating oil needed back at home. It may be the second-largest exporter of oil in OPEC, but Iran's internal refinery capacity is far too low to meet either an expanding domestic need for processed products or minimum safety levels of product quality.
These earlier sanctions have resulted in a difficulty for others as well.
Indian refineries had problems acquiring Iranian crude. India is a major Asian importer of Iranian oil, but no longer could use a pan-Asian clearing bank to exchange currency. This bank had included Iran, but dropped facilitating its oil deals after pressure from the U.S.
Now, with the latest European decision, Iran may have to find immediate substitute buyers for its already profit-imperiled crude oil, or risk a domestic economic meltdown.
The threat to close the Strait of Hormuz was telegraphed before Europe's boycott of Iranian oil, in the hope the move might prompt Brussels to rethink its strategy.
It did not work.
Two Results Follow This Week's Events
First, Tehran will agree to initiate a new round of dialogue on its nuclear project, open up additional sites for inspection by the Vienna-based (and UN-affiliated) International Atomic Energy Agency (IAEA), and strike a more conciliatory posture.
All of this will be an attempt to gain some time and perhaps delay the EU move.
Few in the West believe it will be genuine.
The second result, however, involves the EU itself. Brussels still has to work out how the boycott will affect the various member markets. Greece, for example, gets a large percentage of its crude from Iran, and a rapid shut-off would merely exacerbate an already serious financial crisis there.
The Spanish domestic picture would also come under pressure.
And then there are the de facto oil swaps in Europe that employ (directly or indirectly) Iranian consignments in contract bridges to stabilize pricing. How much is involved here depends on whom you talk to and where the oil will end up.
I expect additional crude will be coming into the European market from Russia to brunt some of the boycott.
Unfortunately, that simply introduces another energy problem already plaguing the EU.
Too much Western European reliance on Russian natural gas has caused some protracted political reactions in Brussels. Placing any more reliance now on Russian crude would only make things worse.
All of this means the EU is introducing a new approach against Iran that is likely to make the oil markets nervous for some time to come.
On balance, that means – what else? – rising crude prices.