Iran's Customers Start to Drift Away as Oil Sanctions Loom


"E.U. and U.S. sanctions targeting Iran's oil export revenues have yet to come fully into force but have already led countries and companies to take steps to reduce their purchases of crude from the Islamic Republic."

European Union (EU) and U.S. sanctions targeting Iran's oil export revenues have yet to come fully into force but have already led countries and companies to take steps to reduce their purchases of crude from the Islamic Republic.

An EU ban on the import and transport of Iranian oil, agreed to in January and modified in March, is not due to take effect until July 1 but many of Tehran's customers in Europe have already begun replacing their Iranian supplies.

Recent comments from Iranian oil officials suggest that Iran's total crude exports have already fallen by 200,000 barrels/day (200Mbbl/d from last year's levels.

Mohsen Qamsari, head of international affairs at the National Iranian Oil Company, told a news conference in Tehran on April 20 that current exports stood at 2.1 million barrels per day (MMbbl/d), making no comparison against previous levels.

But NIOC Managing Director Ahmed Ghalehbani, speaking at the same event, said that oil exports had averaged 2.3 MMbbl/d in the Iranian year that ended in March. This would imply a fall of 200 Mbbl/d so far, even before the EU sanctions come into effect in July.

The International Energy Agency estimates that the combined impact of the European and U.S. measures on Iran's crude exports could be as much as 1 MMbbl/d by midsummer.

Iran hopes to place in Asia, where oil demand is still rising, the roughly 500 Mbbl/d of crude that will no longer be able to go to Europe after June. But efforts by the United States to limit Tehran's options appear to be having some success.

The U.S. has been pressuring a number of countries to cut back on their Iranian crude purchases after new sanctions designed to curtail Iran's access to international banking systems were signed by President Barack Obama last December. These sanctions, related to the financing of purchases of petroleum and petroleum products, are not scheduled to take effect until June 28.

Exemptions for Import Cuts

Washington is offering exemptions to countries which reduce their purchases of Iranian oil and has already struck a deal with Japan, which has agreed to buy lower volumes of Iranian crude. In exchange, Japanese banks will be allowed ongoing access to the U.S. financial system. South Korea, which has been relying on Iran for close to 10% of its crude imports, and Sri Lanka, which has been more than 90% dependent on Iranian oil, are also hoping to obtain waivers.

China and India have said publicly that they won't curb their oil imports from Iran in response to U.S. pressure. But this may prove to be easier said than done because the practicalities of continuing to buy Iranian crude may be complicated by shipping insurance issues.

One provision of the EU sanctions has already caused shockwaves far beyond the shores of Europe—a ban on insurance cover for ships carrying Iranian oil. This is because much of the world's ship insurance is tied to EU-based P & I (protection and indemnity) clubs.

After lobbying from Japan, Brussels agreed in March that the third-party liability and environmental cover provided by these P & I clubs would be available until the end of June. But, in the meantime, Asian ship owners are still hesitant about sending vessels to Iran because of difficulty in obtaining other forms of necessary insurance. For example, the modifications introduced in March make clear that contracts for insurance covering damage to a ship's hull or its cargo may not be signed after March 24, when the latest version of the EU sanctions legislation was published.

The insurance issue is a serious one. Japanese shippers, for example, face the prospect of having to make up for some 70–80% of reinsurance cover normally provided by EU insurers that will disappear when the EU embargo comes into effect at the beginning of July.

But Japanese refiners have already taken steps to cover themselves with the inclusion of additional force majeure clauses in their contracts with Tehran that can be invoked if sanctions prevent or limit execution of the contracts.

Japan's term deals with Iran run mainly from April to March but many refiners delayed finalizing contracts for the year ahead while they waited for the outcome of the talks between Tokyo and Washington. Some companies have now renewed their term deals at lower volumes—including, according to sources, Cosmo Oil and Showa Shell, although the extent of the reductions remains unclear.

Showa Shell had been importing 100 Mbbl/d of Iranian crude under its previous contract that expired at the end of March, according to sources, while company data show that Cosmo Oil imported an average 36 Mbbl/d of Iranian crude last year.

Among those yet to finalize volumes with Tehran are JX Nippon Oil & Energy, Japan's second biggest buyer of Iranian oil, and Idemitsu Kosan.

India Mulls Sovereign Guarantees

India's government is considering providing sovereign guarantees for shipments of Iranian crude, but in the meantime shipping sources have noted a number of deliveries of Iranian crude being made to Indian west coast ports by the National Iranian Tanker Company in recent weeks.

Shipping concerns, in Europe as well as in Asia, are not limited to insurance issues but extend to the possibility that future additional U.S. sanctions could block ships from loading or unloading cargo in U.S. ports if they have visited Iran in the preceding 180 days.

Some European lifters now prefer to load their Iranian crude from Egyptian Mediterranean port Sidi Kerir instead of from Iran's main loading terminal at Kharg Island in the northern Persian Gulf.

Oil prices climbed above $128/bbl earlier this year, pushed closer to the all-time highs of more than $147/bbl in July 2008, in part by anxiety about supply from Iran. Prices have since fallen back below $120/bbl, alongside Iran's return to talks over its controversial nuclear program with six world powers.

The International Monetary Fund (IMF) said earlier this month in its latest World Economic Outlook that it expected oil prices to average $114.71/bbl this year, $15.62/bbl more than it forecast in January and $10.70/bbl more than the 2011 average, citing Iran-related supply risks as "the biggest concern."

As a result of the EU oil import embargo and tighter sanctions elsewhere, "the potential Iranian oil supply shock is morphing into an actual shock because lower Iranian oil production and exports seem inevitable during 2012 and beyond," it said.

The IMF also said that Iran-related geopolitical oil supply risks extended beyond the reduction in oil production and exports that already appeared to be "in the making" and to have been "priced in" by markets.

"Iran's location at the Strait of Hormuz, the choke point for shipment of about 40% of global oil exports. . .and its geographic proximity to other major oil producers means that there is a risk of a large-scale, possibly unprecedented, oil supply disruption in the event of military conflict or attempts to close the strait," it said, reiterating earlier warnings.

Stock Release?

The U.S. has said in recent months that it is considering whether to open its crude stockpiles to help rein in rising crude and fuels prices. But the world's biggest oil consumer has not confirmed whether it is working to build support among IEA members for a coordinated sale of government stocks.

In Europe, the French government of Nicolas Sarkozy has led talk of a coordinated oil stock release by industrialized nations as the EU ban on Iranian oil draws closer. But Francois Hollande, ahead of Sarkozy after the first of two rounds of voting in the presidential election now underway, may prove less keen on a stock release if he wins.

The IEA, meanwhile, says it will wait to assess the impact of the EU and U.S. sanctions on Iran's oil exports in June before deciding whether to coordinate a stock release.

Speaking to reporters in London in late April, the agency's deputy executive director, Richard Jones, pointed to "substantial" ongoing supply disruptions outside OPEC and said the IEA wanted to see if the sanctions created a supply shortage in the coming months.

"We'll see what actually happens when the sanctions go into place," he said. "We'll see what the situation is with the other disruptions and make a judgement at the time."

Unplanned output disruptions around the world currently amount to more than 1 MMbbl/d, with a "few hundred thousand" barrels of this the result of lower Iranian exports ahead of formal sanctions, Jones said.

Earlier in April, the IEA predicted non-OPEC supply outages of 1.2 MMbbl/d during the second quarter of this year due to a combination of political turmoil in Sudan, Syria and Yemen and as technical issues disrupt output from the North Sea, Canada and Australia.

At the same time, it estimated that curbs on banking facilities with Iran had already choked off some 250 Mbbl/d of Iranian oil exports, and that unless Iran was able to find alternative buyers for its crude its output could plummet to 2.6–2.8 MMbbl/d by midsummer. The IEA estimates Iran's March production at 3.3 MMbbl/d.

U.S. EIA report suggests supply is sufficient.

Meanwhile, a new report issued on April 27 by the U.S. Energy Information Administration (EIA) suggested that supply to world oil markets was sufficient despite constraints on exports from Iran.

Entitled "The Availability and Price of Petroleum and Petroleum Products Produced in Countries Other Than Iran," the EIA report is the second in a series required by U.S. law to determine if enough alternative supply exists to allow countries to reduce their purchases from Iran.

The latest report said that world liquid fuels production had exceeded consumption by 500 Mbbl/d in March and April, and that while global spare capacity remained tight by historical standards, it had not fallen in the past two months. It said increased production from the U.S., Saudi Arabia and Kazakhstan had at least partially offset unplanned disruptions from politically unstable areas such as South Sudan, Syria and Yemen.

The report said that global oil inventories had also increased by 500 Mbbl/d in March and April—but it noted that this was largely because Iran had been forced to stockpile oil it had been unable to export because of sanctions.

And it cautioned that the production increases of the past two months in some areas of the world were subject to disruption, which could alter the global outlook.

Libya's production gains, for instance, are contingent on the country's ability to continue its political progress, increase internal security and attract overseas investment.

And while Iraq's production has exceeded its recent average, production in the north of the country was curtailed in April due to a dispute between the Kurdistan Regional Government and Iraq's central government, the report noted.

The analysis drew no definite conclusion on whether enough oil and petroleum products were produced in countries other than Iran to permit consumers to reduce significantly their purchases of Iranian crude and products. In March, and basing his conclusion in part on the first EIA report issued in February, U.S. President Barack Obama determined that there were enough alternative supplies to move forward with sanctions.

The step-up in sanctions to target Iran's economic lifeline—its oil exports—is aimed at persuading the Islamic Republic to halt its uranium enrichment work. Iran says it wants to develop nuclear power for electricity but the West suspects that Tehran wants to build nuclear weapons.

The first session of a new round of talks between Iran and six world powers—Britain, China, France, Germany, Russia and the U.S.—took place in Istanbul earlier this month and appears to have given rise to some optimism about the course of future negotiations. The next meeting will take place in Baghdad on May 23.

Margaret McQuaile

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