The Saudi Sanction

Normally losing Iran’s 2.5 million barrels of oil a day would be a huge problem for the global economy. But Saudi Arabia appears to be sustaining net output levels as they quietly lead the effort to deny Iran the bomb.

Sanctions against Iran have been building up for some time but now the vice is getting really tight. The US is about to implement a law that cuts off countries from the US banking system if they import oil from Iran. With a few exceptions, many countries are already reducing their imports, including China, Japan, and India. For its part, the EU will soon impose a ban on insuring any tanker that carries Iranian oil. Since 95% of the maritime insurance industry goes through Europe, the ban will effectively shut down most of Iran’s exports by sea.

The IMF calculates a “fiscal breakeven” price of oil for the countries in the Middle East and North Africa. The calculation starts with the cost of production, including equipment and labour, with the big swing factor being accessibility: oil is cheaper to drill in Saudi Arabia than in Iran. Both are more accessible than oil shale in the US or Brazil’s deep sea reserves. Additionally, the breakeven price includes taxes and other government claims on oil. Many oil-producing countries finance their social programs with oil revenues; those outlays surged when popular unrest swept the region.

In 2010, Iran’s breakeven price of oil was $68 (the blue bar). By early 2012 it had gone up $49 (the orange bar) to reach $117 (the blue dot), well above the current price of $96 for Brent (the black line). At OPEC’s recent meeting, Iran led the countries with high breakeven costs who wanted to reduce quotas and push prices higher. On the other side of the breakeven divide, Saudi Arabia sought to increase production, ostensibly to support flagging global growth. Officially, both sides agreed to leave the quotas unchanged. Unofficially, OPEC oil production remains 10% above quota, buffering Iran’s reduced exports.

Since the start of 2012, sanctions have already shut down 40% of Iran’s oil exports, pushing its effective breakeven oil cost to $195 (the red dot). With outlays vastly surpassing revenues, Iran’s foreign exchange reserves are being depleted. Meanwhile, Iran shows little inclination to yield on the core issue of uranium enrichment as the full force of sanctions loom.

Not that long ago, the loss of Iran’s oil might have caused oil prices to spike and tipped the global economy into recession. However, the world is united in thwarting Iran’s nuclear ambitions and Saudi Arabia is taking the lead to keep oil supplies higher than demand, one of several forces keeping a lid on global energy prices. And unlike other major producers that are already pumping at full tilt, Saudi Arabia still has spare capacity to tap. Saudi Arabia is the central bank of oil: it is the supplier of last resort.

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