Unexpectedly Intriguing!
February 23, 2012

John Iacovelli recently ran some "back of the envelope" calculations on the potential impact of Western country sanctions on Iran upon world oil prices. He estimated:

The U.S. Energy Information Administration in its latest tables stated that the Persian Gulf states produced 23,714 thousand barrels per day of crude as of October 2011, which we'll round to 23.7 million.

At the current time, Saudi Arabia is already producing more than usual to make up for the drop in Libya oil production. Let us arbitrarily state, then, that the other Gulf states will make up no more than 20% of the shortfall in Iranian production; thus, the calculation would be as follows:

  • 23.7 million, total Gulf production
  • minus .8 million (loss of 1 million Iran, plus .2 additional additional from Saudi Arabia and/or others)
  • equals 22.9 million as the new production level.
  • .8 divided by 23.7 equals a percentage drop of 3 and 1/3 percent. (-0.033)

Taking our PED formula and the Wikipedia coefficient for world oil, then:

  • -.4 times -.033 = +1.33 percent change in the price of Persian crude, based upon the drop in supply.

The January 2012 price of Dubai crude (the benchmark for the region) is $110. Adding 1 1/3% puts the new price at $113.63.

I'm neither a mathematician nor an expert in oil pricing, and so would love to hear from anyone who has experience in the subject regarding this exercise. I know enough to know that my calculations could be hysterically off the mark.

But are they hysterically off the mark? To find out, we'll adapt a tool we originally developed in November 2011 to estimate what the impact would be upon world oil prices if the United States increased its production of oil by 25%.

Here though, we'll use the CIA's current estimate for world oil production in 2010 of 89,346,535 barrels per day, the most recent year for which the data is available (even going by the Energy Information Administration's world data, which as of 12 January 2012, only covers 10 months of 2010.)

The CIA's data indicate that Iran, the fourth largest producer of oil in 2010, produced 4,252,000 barrels per day that year. If sanctions imposed by Western nations only affect 25% of Iran's production, then the effect would be to reduce the daily supply of oil to the world by 1,063,000 barrels per day.

Because most of the oil that would be affected by sanctions upon Iran would be shipped to Europe, we'll use the average January 2012 spot price of $110.69 per barrel for Brent crude oil in Europe as our price reference.

The results may be found by clicking the "Calculate" button below!

Oil Production and Economic Data
Input Data Values
Daily Oil Production Data
Change in Amount of Oil Production [Positive if increase, negative if decrease]
Oil Price (per Barrel)
Demand Elasticity
Supply Elasticity

Estimated Price Change
Calculated Results Values
Projected Change in the Price of a Barrel of Oil

As always, you're more than welcome to update our tool with more recent data or to consider other assumptions or scenarios!

Using our tool, we would anticipate that the price of Brent crude oil in Europe would rise by $4.39 per barrel, from $110.69 in January 2012 to $115.08 as a result of Iranian oil being embargoed by Western nations, if not offset by increases in the oil production of other nations. Such as the United States, which is experiencing somewhat of a boom in new oil production.

If Iran's oil production were completely shut off from the world, and no other oil producers adjusted their supplies to compensate, the effect upon European oil prices would be to increase the cost of each barrel of Brent crude oil by by $17.39.

So all in all, we find that John Iacovelli's math appears to be largely on target, as the results are consistent with what we find using slightly different assumptions about the elasticity of oil supply and demand.

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