London, 25 November 2011: Reuters

European countries appear to be edging toward imposing an EU-wide ban on imports of Iranian crude in a bid to cut Iran's export revenues and step up the pressure over Tehran's nuclear ambitions. If the EU goes ahead, it would mark an odd reversal of the 1970s oil weapon when Arab countries led by Libya and Saudi Arabia embargoed exports to the United States, the Netherlands and other countries. Only this time the weapon will be held by the European countries and pointed at themselves.

The amounts of crude involved while not huge are still significant, 450,000 barrels per day to the EU. But it could be replaced from other sources, especially now Libya's crude production is being gradually restored. But it is a perverse policy that will damage European refiners, while having only a modest impact on Iran itself, and conferring a windfall benefit on refiners in China, Iran's leading customer, and the rest of Asia.

European nations cannot shut off the flow of Iranian exports to customers in Asia so Iran's oil will continue to flow. The main impact of any ban will be to redirect the flows, cut the choice of grades available to European refiners, and force them to replace sanctioned Iranian oil with more expensive oil from other sources.

European refiners are already struggling with excess capacity, limited flexibility in terms of the oils they can process, and poor refining margins. Banning Iranian imports will force them to buy more expensive oil, and because the market will see them as "distressed" purchasers of alternative grades, premiums for similar non-sanctioned grades are likely to strengthen.

European refiners have been badly hurt by the loss of suitable crudes from Libya, the North Sea and Azerbaijan in 2011. Banning Iranian imports will harm them just when the sector was hoping for some relief from the resumption of Libyan production. It is an empty political gesture they can ill afford.

A European ban would also narrow Iran's selling options. It would reinforce the long-standing U.S. boycott. Iran may be forced to cut its selling prices in order to seize more market share in its prime Asian customer region and maintain volumes. Asian refiners will therefore be the main beneficiaries of any unilateral EU action.

In a final irony, Asian refiners will be able to process (cheaper) Iranian crude and then sell refined products back into the EU or third-country markets in direct competition with European refiners relying on (more expensive) non-Iranian oil. Asia's massive new refineries already have significant cost advantages over their European counterparts.

Unilateral bans will simply make that advantage even wider. Advocates of a unilateral ban believe it will cut Iran's oil revenues at the margin, turn up pressure on the government, while leaving overall volumes in the oil market unchanged, thereby avoiding a damaging price spike.

At the margin that might be true. But cheaper Iranian exports to Asia would directly compete with grades from Saudi Arabia and other OPEC members (cutting their revenues as well). The only way to maintain Saudi and other OPEC volumes would be to raise sales into Europe, where exporters would either raise official selling prices or be forced to subsidise European refiners by selling at a discount. Unilateral boycotts make for odd policy in the oil market. If European countries want to unsheathe the oil weapon, they need to make sure which direction it is pointing in first, rather than wave it around like an inaccurate blunderbuss.

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By John Kemp, Reuters market analyst – for Commodities Now with permission.

The views expressed here are his own.