(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Feb 28 U.S. and EU sanctions on
Iran's crude oil exports and its central bank were not supposed
to affect either the volume of oil available or its price,
provided markets reacted "rationally".
That was the conclusion of an influential report on the "Oil
Market Impact of Sanctions Against the Central Bank of Iran",
circulated by sanctions advocates at the Foundation for Defense
of Democracies in Washington.
The idea that sanctions could reduce Iran's oil revenues
without boosting prices for oil-consuming countries was crucial
to persuading policymakers in the United States and Europe to
impose far-reaching restrictions on Iran's oil sector.
But the policy has backfired. Oil prices have surged,
harming consuming countries and offsetting the impact of lower
exports on Iran's revenues.
U.S. and EU sanctions were written very carefully to include
plenty of flexibility to ensure they would not risk a spike in
U.S. sanctions, set out in Section 1245 of the National
Defense Authorisation Act for Fiscal 2012 (HR 1540), apply only
if the president determines "the price and supply of petroleum
and petroleum products produced in countries other than Iran is
sufficient to permit purchasers .. to reduce significantly in
volume their purchases from Iran".
Sanctions do not apply if the president determines an
importer has "significantly reduced" its volume of crude
purchases from Iran, and the president can waive them altogether
if it is in the national interest.
The law mandates experts at the Energy Information
Administration (EIA), in conjunction with the departments of
Treasury and State and the head of the intelligence community,
to review the availability of alternative supplies every 60
days. The first review is scheduled to be delivered to the U.S.
Congress this week.
For supporters, the game plan was (1) to divert Iranian
crude away from developed markets in Europe and Asia to
developing countries; (2) grant emerging markets a pass provided
they cut imports or negotiate steep discounts for Iranian oil;
(3) line up alternative sources of supply by extracting promises
from Saudi Arabia to boost exports; and (4) maximise publicity
for all these arrangements to ensure oil markets did not bid up
prices on supply concerns.
It has not worked. Brent oil prices have risen around $25
per barrel, or 25 percent, since sanctions momentum first
started to build in earnest in late October/early November, and
almost $18 since they were signed into law.
The steeply backwardated structured of futures markets
suggests there are concerns about the availability of
alternative supplies, despite Saudi offers of extra barrels.
Hedge funds and other money managers have boosted long exposure
to crude futures and options by more than 80 million barrels
since the start of November and by more than 65 million since
the start of the year.
Two things have gone wrong. First, sanctions are interacting
with other supply disruptions (in South Sudan, Yemen, Syria) to
reduce supplies and exhaust the cushion of spare capacity Saudi
Second, the thicket of sanctions on Iran imposed by the
European Union and United States is now so complex it is
becoming hard to conduct trade that is supposed to be permitted.
A provision for permitting countries to continue buying
Iranian oil provided they reduce the volumes or secure a U.S.
presidential waiver is not much help if cargo and shipping
insurance is not available because of other sanctions
Sanctions strategy rested on the concept of permitted
non-compliance and selective prosecution by the United States of
countries and refineries that continued to purchase Iranian
crude. But the sheer level of arbitrariness makes normal
commercial activity almost impossible. Importers fear their
waivers and permitted non-compliance could be removed at any
The result is that many emerging markets have not taken up
the extra Iranian barrels no longer being delivered to Europe,
and most are scrambling to cut their reliance on Iranian
Sanctions cannot be blamed for the entire increase in oil
prices. Other stoppages, sabre-rattling by Israel and Iran, an
improving U.S. economic outlook and another bout of massive
monetary stimulus from global central banks have all helped push
Sanctions supporters argue that Iran's nuclear programme
required some response and that sanctions were the least bad
option. Military confrontation would have generated an even
bigger rise in prices and more uncertainty and damage for the
But sanctions (especially those legislated by the U.S.
Congress) are a notoriously blunt instrument with a questionable
track record. In this case, the potential for sanctions to
backfire, imposing significant costs on consuming countries, was
well understood by outside observers as well as many energy
experts within the U.S. administration and European governments.
Unfortunately, the political momentum for sanctions
outstripped a proper analysis of the likely impact. In November
and December, both the United States and the EU found themselves
publicly and politically committed to a sanctions strategy
before the detailed technical work had been done to assess the
likely impact on Iran's revenues and oil prices.
By the time foreign policy officials began reaching out to
colleagues in energy ministries as well as experts in the
industry and at the International Energy Agency at a series of
meetings late last year and in January, the momentum for
sanctions had already become unstoppable.
REFINING THE STRATEGY
Oil sanctions are a classic example of poor policymaking
under pressure from outside influences with insufficient
attention being paid to detail and seeking expert input. The
consequence is visible in the sharp rise in the cost of gasoline
and diesel hitting consumers and businesses across North America
and Western Europe.
It is likely sanctions policy will be refined in the coming
months to soften the impact on consumers as well as reverse the
rise in oil prices, which is currently benefiting rather than
Neither the United States nor the EU is likely to lift
sanctions, unless and until there is significant progress in
engaging with Iran, which at the moment seems a relatively
distant prospect. But there are less visible steps that could be
used to adjust their impact.
The EIA's first 60-day assessment of alternative supplies
will provide an opportunity to examine how sanctions are
interacting with other disruptions and whether Saudi Arabia is
managing to plug the gap.
In another 30 days, the president will make the first
determination of which countries are significantly reducing the
volume of their imports. Waivers and non-applicability decisions
will allow the White House to start demonstrating some
flexibility in an attempt to reassure markets.
Intense diplomatic pressure will be applied to Sudan and
South Sudan to resolve their dispute over transit fees.
Western policymakers may also step up the pressure on Saudi
Arabia to increase its exports and go public about how much
extra oil is flowing. There is also likely to be an effort to
reassure Asian refiners in China, India and certain other
markets they will not be penalised for continuing to take
Iranian crude, especially if they secure discounts.
Finally there is likely to be a renewed push to explain the
impact of sanctions to financial investors in a bid to get the
market to view them in a way that policymakers see as more
Whether all this will be enough to avert a further damaging
rise in prices is unclear. But having set the process in train,
the onus is on foreign policy officials and sanctions supporters
to show the consequences can be controlled.
(editing by Jane Baird)