Iran sanctions send Brent oil above $120 a barrel - what's next for oil prices?

By Chris Tedder, Forex.com Research Analyst

Tehran has halted all exports of oil to the UK and France, pre-empting an EU embargo scheduled to take effect in July. Also, investors are becoming increasing optimistic that Greece will receive its second bail-out in time to repay EUR14.5bn in bond redemptions on March 20, and China has recently cut the ratio that dictates how much capital domestic banks are required to hold, in a move to designed to stimulate demand.

The decision by Iran to halt exports to the UK and France is likely more symbolic than anything else, given both countries have taken action to limit imports of oil from Iran. Officials in Tehran appear to be sending a message to the West that they will not be bullied into giving up their nuclear program, as Iranian officials are also threatening ban all oil exports to the entire EU.

Nevertheless, the impact of such a ban could have a limited impact on the price of oil. Other oil producers, especially OPEC's largest oil exporter Saudi Arabia, could likely cover any supply shortages. Furthermore, Iran would likely be the hardest hit if it suddenly cuts its exports of oil to the EU, given that Tehran will struggle to find a buyer for the 500,000 barrels a day that European nations purchased last year. The only nations that can cover demand of that size are India and China, but these nations will likely ask for a discount before they agree to buy more oil which would eat into Iran's main source of revenue.

Yet, this doesn't mean oil prices will escape unharmed. This latest round of high-stakes brinkmanship surrounding Iran's nuclear program is increasing tensions regarding a possible US or Israeli strike on Iranian nuclear sites, which could drive oil prices even higher. However, the UK and the US have recently been attempting to poor cold water on the situation by backing the current diplomatic and economic sanctions imposed on Iran, with the chairman of the US Joint Chiefs of Staff and the British Foreign Minister publicly announcing their opposition to any military action. Nonetheless, there is always the lingering fear Israel or another country will take action despite what the West thinks.

Global economy will be main factor for oil prices

Assuming war does not happen, the global economic situation will likely be a main driver of the price of oil going forward. Clearly investors are nervous about the situation in Europe and in particular the possibility of a disorderly Greek default, which threatens to drag the world further into a global economic slowdown. Given there is so much at stake it seems unlikely officials in Europe will allow this to happen. Instead, it is more likely that there is no default or the rest of Europe creates a firewall to protect itself if Athens falls of a cliff. However, the lingering problems in Europe could weigh on the price of oil in the long-term.

Overall, if Iran continues with the mentality that they are not going to take these sanctions lying down then it may start to take more direct action to affect oil prices. For instance, Tehran has been threatening to close the Strait of Hormuz, which we don't think is likely, but we do think Iran could slowdown the flow of oil through the Strait by increasing inspections. Also, the threat of violence in the region could cause the price of oil to increase in the near-term; however in the longer-term we are concerned about situation in Europe hampering demand for oil and in turn pushing its price down.