Iranian Sanctions Will Push Oil Over $250

Includes: SZO, UCO, XOM
by: Tim Worstall

Sanctions will push oil over $250-- that's what the Iranians themselves say anyway. And if that's true, then imposing sanctions upon Iranian oil exports would clearly be something very definitely contra-indicated. Yes, even if they really are building a bomb.

No point in screwing the world economy into the ground so that we can be both poor and blown up.

There are two reasons to think that the price won't be that reactive. The first is that no one is actually suggesting that there be a blockade of Iran. Rather, only that the EU won't buy any Iranian oil and that the U.S., which already doesn't, will impose sanctions on those banks which aid in Iranian oil trading and shipping. That the EU doesn't buy much Iranian oil makes this not the most appalling of threats. We have a world full of would be Marc Rich types who would be just delighted to aid in side-stepping the restrictions, as they have been in other sanctions scenarios.

The second is that oil is fungible. Whatever Iranian oil currently flowing to Europe will simply flow elsewhere-- Pakistan, India, wherever, and will displace Saudi, Indonesian or whatever oil that was originally destined for those markets. That displaced oil will end up being sold in Europe. The net effect is a bit of re-routing of shipping, a little pain and grief for logistics managers, and not much else.

However, let us consider what would happen if Iranian oil really were to come off the market. What would we expect the price to be then? We do actually have a method to do this, we can look at the elasticity of demand for oil and calculate it that way.

Iranian oil is in the 2.5 to 3 million barrels a day range as exports, out of some 90 million used a day, or the perhaps more relevant 40 million or so of daily exports. Please note, these are very rough figures and this doesn't matter much as the next figure we're going to use-- estimated elasticity-- is only very roughly known.

But Iran's exports are somewhere between 3% and 7% of the global market. Depending on who you believe, we have a low estimate of elasticity in the short term of -0.02, or a higher (and more like the mid-range of estimates) of -0.05. A 1% increase in the price leads to a 0.02% decrease in consumption or a 0.05% decrease. Or, running it the other way, a 0.02% decrease in supply leads to a 1% rise in price.

We're talking about a 3% to 7% decrease in supply, depending upon whether we're talking about total supply or just export supply. Which means, at one extreme, a 350% increase in the oil price, taking the low elasticity and the market as being just the export one (7% of market times 0.02) or at the other end a 60% increase in the price (3% times 0.05).

With a current Brent price of $110, that means something in the range of $495 to $176 a barrel if all Iranian oil comes off the international markets.

This is too wide a range to really be all that useful in planning anything, certainly too wide a range to be useful in looking at any futures or options plays. Except perhaps in one sense. Not even our own politicians are going to risk putting oil up to near $500 a barrel. So they won't impose proper and strict sanctions on Iranian oil exports.

Further, even if they did-- blocked the Straits of Hormuz, prevented tankers from leaving-- there's just so much profit to be made there that a blockade would leak anyway.

In short, a real blockade of Iranian exports would be so expensive to us all that no one is going to implement a proper blockade of Iranian oil.

If you'd like to trade based on the above surmise, then the major oil companies (say, Exxon, (NYSE:XOM)) are essentially geared plays on the oil price. If you want further gearing there are ETFs that double the play on oil prices like this from UCO from ProShares, or SZO for shorts from PowerShares.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.