Following recent reports from the International Atomic Energy Agency outlining Iran's ramping up of its nuclear program and the November 2011 attack on the British Embassy in Tehran, the European Union has threatened an oil embargo against Iran. The EU accounts for approximately 450,000 of Iran's total of 2.6 million barrels of crude oil exported daily. Iran's foreign ministry has warned that such an embargo would result in the immediate jump in the price of crude oil to $250 a barrel, up from its current $114.
Iran is the third largest oil producer in the world and an integral OPEC producer. OPEC as an organization will face a dilemma if the EU embargo takes place. It can do one of two things: boost oil exports from other OPEC producers to cover the shortfall and stabilize prices, or allow a shortage and have prices skyrocket. It is a political decision as much as an economic one. (Want to know more about the Organization of Petroleum Exporting Countries? Read Meet OPEC, Manager Of Oil Wealth.)
If other OPEC countries rush in to dam the shortfall, it will be seen by Iran as support for the EU and could cause further conflict in the organization and the Middle East in general. On the other hand, if overall production is not increased and prices rise precipitously, OPEC runs the risk of tipping Western countries over the edge into developing more efficient and domestic sources of energy.
1973 U.S. Embargo
OPEC has seen the impact of such an embargo before. In Oct. 1973, the organization along with Egypt, Tunisia and Syria, declared an oil embargo against the United States and several other Western countries. The declaration was a reaction to the United States' role in supplying arms to Israel and the other countries' foreign policies with regards to the Israeli conflict. The price of crude quadrupled within the space of a few months and the United States suffered one of the worst energy shortages in its history. This "oil weapon" was quickly effective, changing America's role in the Middle East and brokering peace deals.
What OPEC had not expected was the long-term impact of the embargo. The disruption of cheap oil threw the U.S. into recession and impacted almost every industry. Japanese automakers saw an opportunity to begin to make small, fuel-efficient cars for the U.S. market and a permanent reduction in oil usage began as a result of this conflict. The U.S. put resources into finding and developing domestic oil reserves and its reliance on Middle Eastern oil dropped. OPEC stands to lose even more oil exports in the future, if it allows shortages to occur.
Where does this leave Iran? It has no option but to hope that an embargo does not happen and, if it does, that fellow OPEC members won't jump in to restore the flow of oil. According to the Iranian foreign minister, Saudi Arabia has already confirmed that they will not increase production. There are few OPEC countries that would even have the capacity to ramp up production so quickly. Iran will have to hope that the economic instability an embargo would cause in the EU and the United States will end quickly, before it impacts Iran.
The Bottom Line
A European Union embargo on Iranian oil would hurt the economies of both sides. It is also likely to increase conflict within OPEC's membership and raise tensions in the Middle East. Because of Europe's dependence on Middle Eastern oil, an embargo, if it occurs at all, is likely to be short-lived and will not accomplish the changes in Iran's foreign policies that the EU is hoping to achieve. (For more, read A Guide To Investing In Oil Markets, Peak Oil: What To Do When The Well Runs Dry, and Uncovering Oil And Gas Futures.)