Oil price nudges $120 on Iran tensions

Oil traders suspect the Iranians are sabre-rattling – but are they right to be so sanguine?

The price of a barrel of Brent crude was nudging $120 on Thursday as the commodity markets tried to assess the implications of Iran’s threat to cut off oil supplies to six European countries.

Traders suspect that the Iranians are sabre-rattling, talking tough in an attempt to disguise the fact that the sanctions imposed by the United States in response to Iran’s development of nuclear weapons capability are beginning to bite. Hence the relatively small price movements in the oil market since Tehran called in ambassadors from the six European countries to advise them of the proposed embargo.

Are the markets right to be so sanguine? With one important caveat, they probably are. The reality is that Iran is in quite a weak bargaining position. The affected European countries are likely to see demand for crude drop this year because of the weakness of their economies, while the much more rapid than expected recovery in Libya’s oil production means there is an alternative to Iranian oil on the doorstep for countries like Greece, Spain and Italy.

What’s more, those countries that are still importing oil from Iran – such as China – are driving a hard bargain, hitting Iran’s foreign currency earnings. The regime in Tehran appears to want to show the world that it won’t take the threat of EU sanctions lying down, but would be hurting itself if it made good on its threat.

The caveat is that when governments are forced into a corner they often make decisions that look irrational. Few traders expect Iran actually to cut off supplies to Europe, let alone go as far as taking military action to close the Strait of Hormuz, through which about 35% of seaborne traded oil moves. But they can’t be entirely sure, which is why there is a chunky geo-political risk premium in the price of crude.

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from Larry Elliott

via http://www.guardian.co.uk/business/economics-blog/2012/feb/16/oil-price-120-iran-tensions

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