Iran's Oil Embargo: Impact on the E.U.

Ioannis Michaletos, April 12, 2012

Over the past few weeks, Iran, due to the embargo imposed upon it, has decided to stop exports step by step to almost all European countries, the latest being Greece and Spain. In parallel, Iranian President Mahmoud Ahmadinejad relayed to the public that his country could easily adapt to a conclusive oil export embargo for up to three years. If that is the case, then hard times are ahead for the E.U. economy. Iran's oil production contributes to about 5 percent of the world output, and an exclusion of this amount from the market cannot be easily replaced by other producers. The price will be driven up.

It is estimated that for 2012 the 27 E.U. member states will have to pay about $400 billion for oil imports alone, which is $40 billion above 2011—a year that was already marked by high prices due to the war in Libya and the Arab Spring. Southern E.U. states are going to be hit especially hard economically.

From Portugal to Greece, local economies are already one step from bankruptcy, with threatens the European Union as a whole. For every increase of 10 percent in the price of oil, Greece, Ireland, Spain, Italy and Portugal lose at least 0.8 percent of their GDPs, which already have negative outlooks. Greece experienced a 7 percent decrease in 2011 and is expecting a similar decrease in 2012. Combined with losses in the southern E.U. stock market and the real estate and industrial sectors, increase in oil prices would further deteriorate the E.U. economies.

Greece imported a third of its oil from Iran—some 150,000 barrels per day. Spain imported a similar amount, and Italy consumed more than 200,000 barrels per day. Iran was providing oil mostly in open credit terms and in lower prices, so diversification from suppliers such as Russia or Saudi Arabia will have the dual effect of raising the prices for these E.U. states as well as for the rest of the world, especially since there are no evidence that production is increasing.

According to the International Energy Agency in Paris, world oil consumption for 2012 is estimated at 90 million barrels per day, approximately 1.4 percent more than last year. The European Unionalone would lose 600,000 barrels that were exported by Iran. Additionally, Iraq has been experiencing tension between the central government in Baghdad and the autonomous oil producing region in Kurdistan, which affects supply. And political instability limits Libya's ability to produce more oil.

The increasing appetite of China for oil, as well as that of India, Vietnam and Brazil, assists in keeping the prices up even if demand slows down in the European Union and United States. Moreover, Japan after the Fukoshima nuclear disaster, is increasing considerably its oil imports in order to replace the power generation lost by nuclear power stations that are set to be closed.

The United States, along with France and the United Kingdom, are seriously considering releasing quantities of strategic oil reserves in order to force the market price index down and avert the potential of an economic crash in the European Union. In 2011 a similar move was made when 60 million barrels from the strategic reserves were released, albeit with no effect on prices: This was due in part to tremendous liquidity in world markets, fuelled by decisions of the U.S. Federal Reserve and the European Central Bank to essentially increase money printing and pump credit lines into the world banking system, which in turn gets invested in commodities and spikes prices.

The U.S. Energy Information Administration (EIA), in its 2011 report on long-term energy assessment, estimates that by 2035 global energy demand will increase by 53 percent from the base year of 2008. Half of this increase will derive from China and India, who will consume 31 percent of global energy in 2035, up from 21 percent in 2008. Furthermore, the EIA calculates that daily consumption will rise to 122.2 million barrels in 2035, up from 88.2 million in 2008.

To estimate the potential of oil prices in the long-term, one must consider where the excess quantities are going to be found. Currently, research and exploration is underway in promising fields off the coast of Brazil, in the Arctic Sea, Alaska, Siberia, Canada and various offshore locations across the planet. The problem is that the extraction of those oil reserves would require investments of hundreds of billions of dollars, and with the prerequisite that oil prices remain high so as to entice those investors.

The overall estimation is that the European Union, especially its southern member states, will face tough economic years ahead, not only because of their debt level but also because of their dependency on oil, which will further hinder their prospects of recovery. At the same time, the whole of the Eurozone will face a big risk of derailing. If a crisis expanded to Germany, the future of the euro as the European Union's common currency could be at stake.

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