Tensions are rising between the U.S. and Iran's military leaders over the presence of Navy ships in the Strait of Hormuz, a key passageway for the country's oil exports. Fears of imminent hostilities caused oil and gold to spike on Tuesday, but right now those fears look overblown. Beefed up sanctions by the U.S. targeting Iran's central bank have tightened the noose around the government's neck, but have hardly choked off the government's air supply. As long as money keeps flowing into Iran, the country's leaders will make sure to not cross the line.
This is the latest move in a complicated chess game between the U.S. and Iran. Each move made by the U.S. to undercut Iran is eventually countered somewhat successfully by the wily Iranian government. Hostile puffery by state apparatchiks and military officials from both sides tends to complicate matters and spook world oil markets, but at the end of the day, Iranian oil always somehow manages to flow out of the country and into the world market.
The latest drama revolves around beefed up sanctions imposed by the U.S. and its allies over Iran's long-running pursuit of nuclear weapons. In the last two months, both the United Kingdom and the U.S. pushed though mandates barring any company that deals with Iran's central bank from conducting any business in their respective nations. The European Union is expected to pass a similar measure this month and today has reportedly agreed to ban all Iranian oil imports.
But while this would complicate Iran's ability to sell oil, it will hardly kill it. There are enough banking institutions around the world with subsidiaries of subsidiaries that will facilitate the Iranian oil trade. Banks in Switzerland, India and China would be more than happy to help the Iranian central bank collect its cash. Iran's central bank could also engage in barter transactions with international banks, similar to what it did during the Iran-Iraq war when the U.S. imposed similar sanctions on Iran's banking system.
As for the potential European embargo, as long as oil demand from importing nations outside the embargo exceeds Iran's 4 million barrel a day production capacity, there will always be a home for Iranian oil. Iran's oil is relatively fungible, with both light and heavy grades, so it could run through most refineries with limited adjustments necessary to be processed into refined products, like gasoline and heating fuel. The limited amount of oil that Iran did export to the EU, mostly to Spain and Italy, will eventually be diverted to China or to another Asian country not participating in the embargo. While this change will have a destabilizing effect on the world oil market in the short run as the barrels get switched around, it will eventually work itself out.
Currency crash
But the bellicose comments out of the Iranian military have had an unintended consequence at home. The value of the Iranian rial has collapsed around 40% to the dollar in the last month to around 1800 rials to $1. The cutoff of the central bank, coupled with the possibility of war with the U.S., caused Iranians to rush out and buy dollars as a hedge to the rial. The rial lost 10% of its value over the weekend as lines formed at banks and in front of the homes of money changers that deal in dollars.
