III. The Impact of Sanctions on Oil Markets
A. Unilateral U.S. Oil Sanctions
Unilateral U.S. oil sanctions include two different types of policy initiatives, one aimed at denying a sanctioned regime's oil access to world oil markets, and a second aimed at preventing investment in the sanctioned regime's oil industry. Unilateral measures to deny a country's oil access to markets essentially amounts to compelling U.S. firms not to purchase such oil nor to transport or market it.
What are the effects of such a form of sanctions? If all oil is perfectly
interchangeable, there is no effect. The targeted country simply diverts its
exports elsewhere while U.S. refiners change the sources of their supply.
However, if the target’s oil is different in quality or location from others,
there will be some small effects. In figure 1A we provide a notional
illustration, in which the demand for a notional country A's oil shifts
slightly inward . Arguably the sanctions have a small impact on the cost
of the country's exports through forcing slightly less efficient transport
arrangements, and hence A's netback at the wellhead is slightly reduced.
Even that is uncertain once sufficient time passes to rearrange oil flows,
but if the effect is as much as 1˘ per barrel, then a country exporting say
one million barrels per day will incur higher costs of about $3-4 million per year. At an assumed price per barrel of $20, this amounts to about .05 of
one percent of total revenue.
Effects of Unilateral Sanctions on Country A Crude Market
In these circumstances U.S. refiners suffer slight cost increases, as shown notionally in figure 1B. This occurs because these refiners presumably were geared to process at least some of country A's oil and now must adapt to a different set of crudes and transport. Plausibly the forced alternative is somewhat less efficient than the freely chosen prior arrangement and so costs rise, at least for a time. Since U.S. refiners compete with foreign refiners who are not adversely affected by the sanctions, the former will not be able to pass through much if any of the cost increase.
What about unilateral U.S. sanctions against investment in some other
country’s oil industry? Such sanctions apply to U.S. companies, which are
compelled not to invest in the targeted country and sometimes also to
divest themselves of investments already made.
Effects of Unilateral Sanctions on U.S. Refiners
We assess first the market impact if U.S. oil firms, including suppliers of
oil field goods and services, are but a small part of a uniform world market
and hence can be considered price takers. In this case, the loss of country
A's market (the targeted market) to U.S. suppliers has no relevance for the
world market, with country A simply buying wares elsewhere and U.S.
suppliers shifting accordingly. Not much then is changed though U.S.
suppliers may be handicapped by knowledge in the oil markets that their
ability to adhere to supply contracts is subject to U.S. government foreign
policy objectives. Also, both producing concessions and supply contracts
often are parts of longer term arrangements involving follow-on
transactions such as maintenance contracts. For this reason too an inability
to supply oil-related services because of sanctions may have greater effects
on U.S. firms than are immediately apparent.
Market for U.S. Suppliers of Oil Field Goods & Services
In figure 2A, U.S. suppliers are assumed either to comprise a significant
portion of the world market or to offer somewhat differentiated technol-ogy,
and hence the loss of a country's market does have some effect. This
is shown in two stages in the figure. For convenience, the demand by
country A for oilfield goods and services is shown as part of U.S. demand
only (i.e., country A initially buys its services only from U.S. firms). The
denial of country A's market to U.S. suppliers then initially shifts the U.S.
demand from Dus to Dus' while the demand for the rest of the world's
suppliers shifts outward, from Drw to Drw' (shown in figure 2B). However, higher prices in the foreign suppliers' market and lower prices in the U.S.
suppliers' motivates other buyers to switch to U.S. suppliers, shifting the
demand part of the way back, to Dus" and Drw". In this new equilibrium, there are efficiency losses in both the U.S. and foreign suppliers' markets,
and U.S. suppliers lose producer surplus while for-eign suppliers gain
such surplus. Country A must pay somewhat higher prices for equipment
while other countries pay more or less depending on the mix of foreign
and U.S. supplies they purchase. If country A's market is only a small
portion of the world market, the direct impact on U.S. suppliers may be
quite limited. However, as mentioned above, a seller whose government
conditions its country's firms' supply of goods and services to foreign
policy objectives bears a higher expected cost than one whose government
does not. Thus, the loss to U.S. suppliers may be greater than what is
reflected only in the loss of the targeted country's market.
Market for Rest of World Suppliers of Oil Field Goods & Services
How big an effect do unilateral sanctions have on U.S. suppliers of oil field goods and services? Unfortunately, there is no well-documented information, but one industry source puts the total loss of market to U.S. suppliers in Iran and Libya alone at $600 million (Bowles).
How much effect might all this have on worldwide oil production (and hence on price)? That depends on the size of the sanctioned country's output and the ease with which non-U.S. firms' services can be substituted there. In a country such as Iran, for example, daily production is about 3.5 million barrels per day. Hence, even if U.S. sanctions on supply to and investment in Iran's oil industry have constrained its production by no more than 3 percent, the effect on production there is approximately 100,000 barrels per day, probably enough to have a small effect on the world price of oil.
A final observation regarding unilateral oil sanctions. U.S. policymakers
sometimes have been frustrated by the inability of unilateral sanctions to
achieve their policy objectives. This has led to efforts to compel firms in
other countries to comply with U.S. sanctions through the use of secondary
boycotts. The Iran/Libya Act of 1996 forbids any foreign oil firm from
transacting in U.S. markets if it invests $40 million or more in either of
those countries, with the amount dropping to $20 million in 1997. Such a
secondary boycott imposes costs on the U.S. economy as well as on the
firms involved, and has angered several foreign governments, who view it
as impinging on their sovereignty. Somewhat ironically, the attempt by
the U.S. to modify the behavior of a targeted regime through this means
has led other governments to seek means to modify the behavior of the
U.S.!
B. Multilateral Sanctions
We now turn to an assessment of multilateral oil sanctions. Under a
multilaterally-imposed total boycott, the targeted country is faced with a
single buyer which refuses to take any of the country's product at any
price. Thus, there are no exports though the country maintains a domestic
market. The effects are shown in figure 3.
Initially world oil market equilibrium occurs at point E, with quantity Qw
and price Pw. Sanctions remove supply QB-QA from the market, rotating
world oil supply as shown by SW. The world oil price rises to Pw', while the quantity transacted falls to Qw'. Note however that as country A's market has become isolated, oil previously shipped to world markets is consumed ther (denoted by QA-QA) and the internal price falls to PA'. There is an efficiency loss in the world market as demand is curtailed and higher cost supplies utilized, and there is an income transfer to all non-sanctioned producers of amount PWPwCD.
How large might such an income transfer be? Suppose that, in a world
market of some 70 million barrels per day, multilateral sanctions impose a
net production loss, after adjustment by others, of one million barrels per
day (possibly roughly what today's Iraq sanctions might be accom-plishing).
Then with a world price for oil of about $20 per barrel, and a
worldwide intermediate term price elasticity of demand for crude oil of
say .3, the impact on price would be about $1 per barrel, and the annual
impact on worldwide producer income about $25 billion.
U.S. producers would receive a little under one-eighth of this, and some of
it would accrue to producers in countries towards which the U.S. is
friendly, (e.g., Great Britain, Norway, Saudi Arabia) but some too would
accrue to countries that the U.S. is not friendly towards and in some cases
against which it has also targeted oil sanctions. As an illustration of the
latter, Iran would receive about 5 percent of the total worldwide increase
in producer income and Libya about 1.5 percent. Thus, between the two
countries such sanctions would mean an extra $1-2 billion in income per
year from the higher price of oil.
Consumers would pay more. U.S. consumers comprise about one quarter
of world oil demand, so in the example they would bear something over
$6 billion in higher costs of oil. Consumers in countries friendly to the U.S.
(e.g., Japan and the Western European industrialized countries) would
bear a large fraction of the remainder.
The impact in the sanctioned country also is of interest. Assume for illus-tration that it exports a million barrels per day less than otherwise. At $20
per barrel, this would reduce production income there by $20 million per
day or by about $7 billion per year. Clearly this would reduce imports and
hence consumer welfare in that country. On the other hand, some of the
foregone oil export is transferred to the domestic market, and consumers
in that market will gain consumer surplus. If consumption in the country
is small relative to production and exports this will not much make up for
the loss of export income, but if it is substantial relative to such production
energy consumers in the exporting country may be largely compensated
for their loss of consumption of imported goods implied by the lost income
from oil exports.
Multilateral Sanctions on Country A Exports
CDE - Efficiency Loss
CDPWPW
QAQB - Exports of Country A which are kept from World Market
QAQA - Oil diverted from world to Country A Domestic Market