Why Iran Oil Works in China’s Favour

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Speaking of which, Europe’s finance ministers are meeting AGAIN this week to try and finalise a Greek rescue package. Between the last one and the new one, the Greeks need around €170 billion. Remember, Greece has €14 billion in bonds maturing on March 20th. Elections are in April.

Poor old democracy! Greek leaders are obliged to do the bidding of the European Central Bank (ECB) and the International Monetary Fund (IMF). You wonder if any deal in March will be undone by the elections in April. In the end, default still seems like the best option for Greece and the most likely scenario.

For Aussie investors, the important question is whether a Greek default is a deflationary event or an inflationary one. That is, will commodities get smashed again like they did when Lehman Brothers collapsed in 2008? Or will there be exceptions to the rule, like higher oil and gold prices?

Oil is doing just fine at the moment, even with the drag of Europe and exports contracting in Japan. Brent crude crested $120 per barrel on Friday. One factor keeping oil prices high is the situation with Iran. The European Union has agreed to stop buying Iranian oil. But the EU gave member states until July 1st to stockpile inventories before cutting Iran off.

Iran had enough of that this weekend. The country’s oil ministry announced that it would cut off oil sales to French and British companies. News reports suggested the French and British had already stopped buying. If that’s the case, Iran’s announcement is more of a verbal shot than a real one.

But this brings us to an obvious observation: strategic assets like oil are only valuable if you can sell them. The Iranians must sell oil in order to bring in foreign currency to the economy. The sanctions theoretically free up Iran to sell another 500,000 barrels of oil per day to customers in China and India.

China is already the number one destination for Iranian oil exports. You’d have to think the Chinese are pleased with the situation. Western nations willingly remove themselves as buyers for Iranian oil. China gets more oil and probably more leverage over the price, given that so few other countries are willing to do business with Iran.

China doesn’t care. It is the honey badger of nations on the global scene. It will pursue its interests and studiously ignore the internal politics of its trading partners.

None of this clarifies how oil prices would behave if Greece defaults on its debts. Whether oil rises or falls on a Greek default depends on two things. First, if there is a lot of investment demand baked into the oil price and a Greek default triggers a flight to liquidity (the US dollar and US government bonds), the oil price will correct (and probably quite severely). That’s what happened in 2008.

The difference between now and 2008 is that a war between Iran and Israel looks a lot more possible. That possibility underpins the oil price. It’s also what’s contributing to soaring share prices for long-term unconventional alternatives to Middle East oil…like shale gas or oil from shale formations. More on energy and credit tomorrow.

Regards,

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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