(John Kemp is a Reuters market analyst. The views expressed are
By John Kemp
LONDON Dec 6 Oil markets remain relaxed
while a significant diplomatic and military effort is clearly
under way to raise the pressure on Iran's government to abandon
its uranium enrichment programme.
Markets have not moved despite the risks that conflict could
escalate between Iran and western countries or that the EU could
ban imports of Iranian crude.
Prices for Brent crude futures expiring in February
and March, which would be the first impacted by any
embargo, continue to trade below $110 per barrel, well below the
previous high in October, let alone the peak set in April.
Implied volatilities for Brent call options are modest and
more than 10 percentage points below equivalent downside puts.
The strong downward skew, which has been in place since the
summer, suggests the demand for protection against a fall in
prices still outstrips anxiety about a price spike.
Media reports about sanctions and the "war in the shadows"
remain confused, in part because of extensive spinning by
foreign ministries across Europe and the United States. But it
is clear there has been a substantial intensification of efforts
to delay or derail Iran's enrichment programme.
Tensions have come close to boiling point after the storming
of Britain's embassy in Tehran. The conflict is close to
emerging into the open. Or to use an old analogy, the cold war
has come close to turning hot.
What is less certain is whether the crucial policymakers in
either western capitals or Tehran think the time is ripe to
escalate further, or intensify sanctions, and risk a military
Warlike rhetoric has certainly ratcheted up in the past two
months, mostly as a result of a series of leaks in Israeli
media. However, on Dec. 2, U.S. Defense Secretary Leon Panetta
issued his strongest warning yet about the need to avert
He warned Israel against launching a strike on Iran's
nuclear facilities. Panetta said it risked "an escalation" that
could "consume the Middle East in confrontation and conflict
that we would regret"..
Panetta's public admonition backed up a warning he
reportedly delivered in private to Israel's defence minister,
Ehud Barak, last month - including a warning about the impact a
strike would have the on the world economy.
The risk of a strike remains shrouded in strategic
In what appeared to be a significant de-escalation, Barak
told Israel Radio last week, "We have no intention, at the
moment, of taking action, but the State of Israel is far from
being paralysed by fear ... It must act calmly and quietly -- we
don't need big wars."
But all options remain open. Barak noted that the government
of Israel "greatly respects the United States" but "one must
remember that ultimately, Israel is a sovereign nation and the
Israeli government, defence forces and security services -- not
others -- are responsible for Israel's security, future and
EU OIL EMBARGO
On the sanctions track, the EU has postponed a final
decision on an embargo. According to the Financial Times,
British and French diplomats say Greece, which receives 25-30
percent of its oil from Iran, is the only state raising serious
objections but that these should be overcome by the EU's
self-imposed January deadline ("London and Paris to press EU for
Iran oil embargo", Dec 6).
The newspaper quotes a diplomat as observing, "We have to
help Greece find alternative sources of supply. But we think
other sources can be found and the entire sanctions package is
likely to be agreed."
Reuters cites a western diplomat as saying, "What's going to
happen now is talks with the Saudis, Chinese, Koreans and
Indians. Although the political will to impose the sanctions are
there, they would only be effective if all the above players
helped out -- not followed the sanctions but co-ordinated their
EU members have achieved an internal consensus, according to
EU Energy Commission Guenther Oettinger, but it
is not clear precisely how sanctions are expected to work.
Some reports suggest an EU crude embargo would be imposed
only if it would not affect overall oil supply and risk a spike.
If the EU imposed an embargo, Iran would be able to continue to
sell crude to China and other customers in Asia, albeit at a
painful discount, cutting the Islamic republic's revenues.
Under this interpretation, Saudi Arabia would switch cargoes
from Asia to make up the shortfall in Europe. Overall global
supplies would remain unchanged.
Other reports suggest the aim is to cut Iranian export
volumes. "Our assessment is that Iran will find it very hard to
get other customers. The Chinese are already taking 22 percent
of all their oil imports from Iran", and importing more would be
"very dangerous" given the "potential instability", according to
another anonymous diplomat cited by the Financial Times.
Attempting to cut Iran's exports would be far more risky.
While Saudi Arabia could raise its own production to cover the
losses, not just switch cargoes from Asia to Europe, that
increase in output would cut spare capacity in the oil market
and, other things being equal, push prices higher.
In a sign of how muddled policy has become, the Financial
Times has one European diplomat warning, "The worry that we have
is that the U.S. and Russia will try to compensate for the tough
stance of the Europeans by offering Iran some carrots to come
back to the negotiations."
The briefing war has resulted in a long list of partially
contradictory views about how sanctions will work and their
likely effects. It is one reason why official diplomatic
briefings on an anonymous basis are so unsatisfactory for
traders and analysts -- however convenient they may be for
But in the meantime all the hawkish rhetoric about military
action and sanctions has had no discernable impact on oil
futures markets. Why?
One possible explanation is that enhanced geopolitical risk
is offsetting a deteriorating economic outlook and keeping
prices steady at a time when they would otherwise have fallen
sharply on growing fears about an economic slowdown.
A second is that the market thinks any sanctions will be
exquisitely tailored to leave European and global oil supplies
A third is that the market simply does not believe all the
warlike and sanctions rhetoric. Geopolitical risk has appeared
to escalate many times before over the last five years, only to
It is impossible to price geopolitical risk on Iran
accurately. The number of real decision-makers is very small;
access to information tightly controlled; and the significant
decision-makers may not even have decided what they will do in
various scenarios yet. (Senior policymakers generally prefer to
keep options open until the last minute).
The market may simply be discounting incalculable risks
about military action and sanctions, waiting to see how events
turn out, to focus on the things it can price effectively.
In any event, the market remains blithely unaffected.
Geopolitical factors currently have less impact on oil prices
than the weekly U.S. inventory numbers.
(editing by Jane Baird)