Why the EU's oil embargo won't work

History suggests that limited oil boycotts, like the one imposed against Iran by the EU last week, are ineffective – they simply rebalance the market.

The European Union voted last week to ban oil imports from Iran. The EU will immediately ban the signing of any new oil contracts with Iran, while the existing ones will be fulfilled up to July 1. According to EU officials, this gradual approach has been devised so that the oil market can absorb the embargo’s impact.

In response, Iran has said it may cut crude oil shipments to Europe early. Iranian officials have threatened to stop exporting crude to the EU promptly in order to provoke a surge in prices and prevent European countries from finding other supplies at similar costs in the short term.

Many analysts have predicted that the oil prices will increase as a result of either, or both, of these actions.

Earlier this month I wrote that an oil embargo would do little to curtail Iran’s nuclear activities. I would also argue it will do little to affect supply, demand or the price of oil.

The EU embargo may push world oil prices to $150 per barrel, the head of Iran’s state oil company has said. "It seems that we will witness prices from $120 to $150 in the future,” Ahmad Qalehbani, head of the National Iranian Oil Company, said in an interview with IRNA news agency.

Meanwhile, the International Monetary Fund warned that sanctions on Iran could push oil prices up 20-30 per cent to $140 per barrel unless alternative supplies from developing countries come on line.

But history tells us that the embargo from either side will not have a significant effect on the international oil market and will not be effective in achieving political objectives. The 1973–74 oil price increase was not caused by the oil "embargo” (refusal to sell) that the Arab members of OPEC directed at the United States and the Netherlands.

Instead, OPEC reduced its production of crude oil, raising world market prices sharply. The embargo against the US and the Netherlands had no effect whatsoever: people in both nations were able to obtain oil at the same prices as people in all other nations.

The bottom line is that limited boycotts or embargoes of fungible commodities, such as crude oil, are ineffective. Total boycotts are effective (until the smugglers spring into action), but not limited ones. When a limited boycott, or embargo, is employed, the market simply gets rebalanced.

A selective embargo causes some inconvenience, but is easily circumvented by reshuffling suppliers. In 1973-74, the countries selectively embargoed (the US and the Netherlands) shifted suppliers to non-Arab countries, and more Arab oil went to the countries previously supplied by the non-Arab producers. This failure of the embargo was predictable, in that oil can be resold among buyers, and moved around easily and on short notice.

The US and EU pressure on Iran has already caused changes in oil import-export patterns in 2011. OECD countries have been "aggressively seeking alternative supplies, especially [from] Saudi Arabia,” according to the IEA. Iranian oil shipments are increasingly heading toward non-OECD Asian buyers, China and India.

This trend will continue. In 2010, the EU’s oil imports from Iran accounted for 6 per cent of its total, about 450,000 barrels per day (bpd), or 18 per cent of Teheran’s oil exports. This is barely 0.5 per cent of global supply – not a large amount of oil. Thus, it will not take long for Iran to secure new contracts with China or India, or for the EU to secure new contracts with Saudi Arabia, Kuwait, UAE or Russia.

The price of oil depends in part on supply and demand, neither of which is likely to be affected directly by the EU oil embargo or Iranian EU export ban. Prices of oil will not be affected by the EU’s or Iranian actions as long as their respective oil demand and supply (Iran) remain steady.

Only cuts in oil production or total boycotts will have an effect on the oil market, as in 1973-74. But Tehran is not going to cut oil production, thus cutting its main revenue stream. Besides, a production cut would not just hurt the target (the EU), but all consumers equally.

Neither is a worldwide boycott of Iranian oil likely to materialise. China and India are reluctant or absolutely against complying with the US and EU sanctions on Iranian crude. Similarly, all of the major global oil suppliers will not ban exports to the EU. If the Iranians stop exporting oil to the EU, other suppliers will simply step in.

Vlado Vivoda is a Research Fellow at Griffith Asia Institute, Griffith University. This story first appeared on The Conversation. Reproduced with permission.

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