The Cost of A Tougher Iranian Oil Boycott

Today's Wall St. Journal (subscription required) includes an op-ed calling for a stricter US boycott of Iran than the current one that prohibits importing Iranian oil. The proposal from Reuel Marc Gerecht and Mark Dubowitz of the Foundation for the Defense of Democracies would go a step farther, barring the importation of petroleum products that contain any components processed from Iranian crude elsewhere. Before any fuels or petrochemical products could be brought to the US, exporters "would have to certify that no Iranian oil was involved in its manufacture." Yet while the authors have clearly thought about how to maximize the impact of such a rule on the government of Iran, I'm not sure they've examined the potential impact on the US carefully enough. If their arguments about how European refiners would react to such a boycott are correct, then U.S. gasoline prices would likely rise as a result of these restrictions.

The logic of the proposal is grounded in fact. The US imports significant quantities of gasoline from Europe, though lately most of it is in the form of gasoline blending components, rather than finished gasoline that is ready to be put into a pipeline or sold over a refinery's or blending facility's truck rack. Last year total US gasoline imports averaged almost 900,000 barrels per day, with 39% coming from EU countries led by the UK, Netherlands, Spain and France. It's also true that many European refineries process some Iranian crude. In 2010, the EU imported 471,000 bbl/day of crude oil from Iran, comprising just over 4% of total EU oil imports of 11.1 million barrels per day. (Compare that to US oil imports in 2010 of 9.2 million bbl/day.) This amounts to roughly a fifth of total Iranian crude oil exports. At least on the surface, it looks like it shouldn't be too hard for European refiners to forgo this small input, in order to be able to continue exporting gasoline and other oil-derived products to the USA.

In practice, I think it would be more difficult for European refiners to make that adjustment than the authors imagine. For starters, those refineries capable of exporting gasoline to the US must generally be located near ports, rather than inland, and likely run more Iranian crude than the EU average, since this oil is delivered by large tankers. Then there's the question of how much Iranian crude a refinery could run and still be able to certify its products to be Iran-free. If the standard were simply that you couldn't export a larger proportion of your products than the proportion of non-Iranian oil in your crude slate, that probably wouldn't change what any refiner is currently doing, since most of their output goes into the local market. Certifying that there were no molecules of Iranian origin in any products destined for the US would essentially require running no Iranian crude at all, because of the way that most refineries operate and manage their inventories of crude oil and unfinished products.

I presume that's what the authors have in mind, because it would certainly exert the greatest market pressure on the price of Iranian crude. However, substituting one crude oil for another in a refinery isn't like substituting one brand of cola for another in a fast-food restaurant. We've seen a prime example of that recently with the disproportionately large disruption caused by the curtailment of exports of high-quality oil from Libya. Refineries tend to be optimized around certain proportions of well-known crudes, with shifts in those proportions mainly driven by changes in the value of the products they yield, within a range set by the capabilities of the specific hardware. In other words, if your refinery model is telling you to run x% of Iranian Light, then choosing something else in order to be able to sell into the US market comes at a cost.

That cost would be passed on to companies importing European gasoline into the US in two ways. First, it would require a higher price to make it worthwhile for the exporting refinery to produce a cargo to US specifications. Less directly but just as significantly, it would reduce the number of refineries competing for the export opportunity, because some would simply find the changes too onerous, unless the premium they collected was really large. That would create a smaller pool of suppliers with higher costs. That's not what you want to face as a buyer.

Market dynamics might also amplify this effect. A portion of the gasoline exported from Europe to the US flows not under long-term contracts, but as "spot" cargoes shipped in response to occasional wide price differences between there and here. That's exactly the kind of trading I was involved in when I worked in London in the early '90s. Such "arbitrage opportunities" often result from supply problems such as refinery accidents and other unanticipated shutdowns, large weather events, or other situations leading to a local or regional price spike. As a result, much of the impact on the US from the authors' proposal could be delivered when gas prices here would already be rising, thus adding to the economic impact of a price spike.

Perhaps paying more at the pump to drive down the value of Iranian crude in the global market is a price most Americans would be willing to accept. I'd gladly kick in a few cents per gallon for that purpose, since I remain extremely skeptical of Iranian assurances that their nuclear program is entirely for peaceful purposes. Nothing has materially changed my view of that since my detailed analysis in 2005. However, I suspect that the strong likelihood that such a boycott would entail a certain amount of "blowback" at home would complicate the politics of passing the necessary legislation, particularly when gas prices are already quite high by US standards.