Iran has threatened to prematurely cut its oil ties to Europe. It may be just a bluff, but there would be no winners if Tehran abruptly stops crude exports to the European Union ahead of a full embargo, due to come into full effect in July. The Islamic Republic may see some short-term gains, but leaving aside the politics of the move, the financial risks outweigh the benefits.
Oil prices are expected to go up as a result of the EU sanctions, whenever they come into effect. Brent could hit $130 (U.S.) per barrel, Barclays Capital estimates, in a scenario where China and India buy up extra Iranian crude to fill their strategic reserves but maintain imports from other big producers like Saudi Arabia to protect their long-term relationships.
Markets may panic, and prices go even higher, if Iran also shuts off the 450,000 barrels shipped daily to the EU before it has had a chance to secure alternative sources of crude. Working out the logistics of alternative supply and payment might take time for some buyers, says independent oil analyst John Hall. That's why the EU is allowing its members a six-month grace period.
Higher prices would be a buffer if Iran has to sell its remaining crude to Asian buyers at a discount. The IMF reckons Iran needs less than $90 per barrel at usual production levels to balance its budget. But any significant jump in prices would likely prompt the International Energy Agency to make a second release of emergency crude reserves in less than a year. Swing producer Saudi Arabia may also turn up the pumps.
That risks moving crude markets from balance into oversupply for a time, just as Iran can't afford to cut its own production. Around 60 per cent of government revenue comes from oil and the economy is already reeling from economic sanctions. By acting first, Iran will inflict pain on itself before it is even clear that EU sanctions will work. And in a supply glut, Iran wouldn't be the most attractive supplier as sanctions make payments tricky, and politically problematic for buyers eager to stay on the right side of the West.