Cost of oil sanctions to world's consumers

Question

Crude oil prices could sink by as much as $30 a barrel if China decides to buy Iranian crude oil in retaliation to the latest U.S. tariff measures, according to Bank of America Merrill Lynch.

CNBC Aug 5 2019

If true, this seems to imply that the US sanctions are costing consumers an extra $30 per barrel (since removing the sanctions would have the same effect on prices). This adds up to about $1Trillion per year globally. Of course, this is good for producers.

High oil prices are painful to some countries, and higher prices slow economic growth.

Yet, there does not seem to be much concern about the price issue. Why is this? Sometimes people get very upset over smaller price changes.

Answer 1

A rule of thumb from the 1980s: In the short term, a 1 percentage point shortfall in world oil supplies causes a 7 percentage point increase in oil prices. In economics jargon, the price elasticity of oil demand is 1/7.

During the summer of 2019, oil prices ranged between 50 and 60 dollars per barrel, which is between $ 1.20 and $ 1.45 per gallon of crude oil.

Iran is capable of producing 4.5 million barrels per day of oil. During the spring of 2019, the U.S. managed to reduce Iran's oil exports to less than half a million barrels per day. Total world oil production is about 83 million barrels per day.

Thus, the short-term worst case change in oil prices caused by preventing Iran from exporting oil is (4 million barrels per day) / (80 million barrels per day) * 7 * $ 55 / barrel = (5 %) * 7 * $ 55 / barrel = (35 %) * $ 55 / barrel = $ 20 per barrel.

But it has already been five months since the U.S. managed to prevent Iran from selling most of its oil, and the price of oil is now in the 50 - 60 $/barrel range. Over the 12 months from September 2018 through August 2019, the price has ranged from 45 - 75 $/barrel. The peak was in October 2018; the low was in January 2019. Interestingly, the price rose from 45 $/barrel to 65 $/barrel during January - May 2019, which is consistent with my 20 $/barrel estimate of the worst-case effect of cutting off Iranian oil exports.

This is because the North American oil industry (frackers and tar-sand melters) can profitably produce oil in the 40 - 60 $/barrel range. With a lag of a few months to a couple years, North American oil production tends to adjust to keep prices in this range. If the prices are below this range, some frackers go broke, and stop producing; this has the longer lag. If prices are above this range, Albertans melt the tar sands faster.

So over the medium term (several months to a couple years), the market adjusts around an equilibrium price.

Peter Zeihan has given a series of speeches over the last decade about how improving fracking technology changes the strategic calculus of the international oil trade. This Youtube link goes to one of his 2018 presentations.

Answer 2

If China buys Iranian oil, they aren't buying from the general pool that all nations use... which Iran is largely excluded from today due to sanctions.

Therefore, there will be a drop in demand. Since China now consumes quite a bit of oil, and has few internal oil sources, that would represent a substantial drop in demand from the normal supplies.

Demand goes down, supply goes up, price goes down. As oil is auctioned off as futures contracts, fluctuations in supply and demand tend to affect the price fairly quickly.

As to how much a drop and for how long, that's open to debate. The article you link to doesn't detail how that figure was arrived at, just mentioning that oil 'could' sink as much as $30/barrel, not that it definitely will.

The oil producing nations can just curtail their output to prop up prices, as they have done in the past.

However, if the price rises too high, then the shale/sand/fracking operations in the US and Canada become profitable, and supply goes back up. Since the oil producing nations depend on that oil revenue to contribute to their national economy, a major reduction in income can have very negative impacts on their economy.

The oil producing nations walk a very thin line these days. Not as simple as turning on the taps and raking in the cash.

Answer 3

High oil prices are painful to some countries, and higher prices slow economic growth.

Your assumption isn't entirely true. When Oil prices continued to grow till 2015. The growth of China and India during this period was continuously growing. Now, the oil is at ~55 and these countries growth is faltering. Why?

If the oil is expensive, More money flows through the hands of people and the GDP is high. All the exports of that nation will be slightly expensive. The additional amount expended to purchase oil will be compensated by the higher value of exports. Inflation growth remains at a steady rate.

This equation fails, if a nation doesn't export as much as it imports. And yes, such countries will find it more painful. But almost all countries export something.

The growth of a nation is a relative term and is dependent on multiple factors, including the sentiment of people.

Yet, there does not seem to be much concern about the price issue. Why is this? Sometimes people get very upset over smaller price changes.

Let me try this with an example. The cost of oil in some EU nations is ~1$ per litre. But the crude barrel costs hardly 60, which gives ~90 Liters of Gasolene. The same is the case with China, India, which sell a litre for 1.1$, essentially taking away more money from the hands of people. This causes dissatisfaction and it grows.

If the additional funds collected were invested in infrastructure/research, essentially creating more jobs and putting more money into people's pockets for additional consumption, this wouldnt be a significant problem(US, EU nations, and to some extent China)

If the funds were used to fund political promises to spend on stuff, which doesn't raise people's wages, there would be more dissatisfaction. (India, Pakistan, Bangladesh, etc)

US sanctions are costing consumers an extra $30 per barrel. This adds up to about $1Trillion per year globally. Of course, this is good for producers.

The US is an oil producer, so they are mining their own oil. So, the additional amount is either going into the domestic producer's pockets (More taxes and Jobs) or into the nation's pocket. This allows the US to spend more on their Defences, nuclear power, infrastructure, etc. This is a good thing, isn't it?

The cost of Gas should be affordable to all. It doesn't matter if it costs 1 or 10. If the people can make enough to afford it, it's not a problem. If people's wages are constant (falling, if you adjust to inflation) and expenditure is rising, then this is.