My man U.S. Treasury Secretary Tim G. visited Beijing earlier this week, and while the value of the yuan and the European debt crisis were also on the agenda, the issue that took the spotlight was that of Iranian oil.
If you remember last week, I pointed out that both the U.S. and EU have decided to introduce measures that would prohibit the importation of crude oil from Iran. The two Western bodies argue that Iran is using the moolah it gets from its oil trade to finance its nuclear power military program.
U.S. legislators have passed new laws that would enable the government to place sanctions on companies (both local and foreign) that deal with the Iranian central bank. These companies wouldn’t have to cut off their buying from Iran completely, but they could be given exemptions if they support the movement by significantly reducing their orders.
Meanwhile, EU nations are in talks of implementing an oil embargo on Iran. Oil refineries are already refraining from participating in spot transactions, and discussions are underway as to how to deal with existing longer-term supply contracts.
Now that EU is on board, the U.S. wants to add another wrinkle to its game plan by asking the Chinese to support the movement as well. Take note that Chinese demand represents of 22% of total Iranian oil trade, so China’s stance could prove to be the final blow.
The problem though, is that the U.S. and China have a very delicate relationship. In the past, they’ve butted heads on issues revolving around the value of yuan and U.S. debt. Both nations have had to walk a very thin line when “suggesting” what the other should do.
For now, China has refrained from publicly supporting the U.S. movement, but it must also consider the political ramifications of “opposing” its brothers from across the Pacific.
Being friends with the U.S. and knowing that its military has your back is definitely something its allies want. It’s too bad that getting on the U.S.’s good side may come at a price… or in this case, higher prices.
On a macroeconomic perspective, a drop in oil supply could lead to a rise in oil prices. Remember that in Economics 101 we were taught that when the supply of a good moves lower, given that demand stays constant (or increases), then price should also rise. And we are already seeing economic theory unfold right before our very eyes!
Since Iran started playing hardball and warned about shutting down the world’s most critical chokepoint, the Strait of Hormuz, oil has risen more than $110 per barrel. Some market junkies even say that unless the U.S. and Iran resolve their issues, we could see oil spike up to as high as $200 per barrel. Yikes!
This doesn’t bode well for a booming economy like China, which needs oil to sustain its current production levels.
But don’t panic just yet. As I’ve mentioned in my previous article, this isn’t the first time that Western countries have ganged up against Iran. During those instances, the sanctions had very limited impact on oil prices.
Looking at the glass half-full rather than half empty, all this political wrangling may even be a blessing in disguise. Keep in mind that China plays a huge role in the global economy. If it were to publicly express its support for the Western campaign against the importation of Iranian oil, markets might see that amid crises, there is unity among the world’s largest economies.