Let me kill off once and for all the Iranian oil bourse story
Crazy scenarios involving Iran's purported attempts to create an oil bourse to start selling oil in euros make the rounds regularly, and even get recommended with alacrity on DKos.
These things WILL NOT HAPPEN, and we have, as a supposedly reality-based community, to focus on real issues and not imaginary ones.
So let me explain why an Iranian oil bourse will not work for the foreseeable future. I hope that this diary can be used as a handy reference when this crops up again in the future.
Here are some basic facts about what a "bourse" is:
- it's a place for sellers and buyers for a given product to meet. So, as a seller, you want a place where buyers come and, as a buyer, you want a place where sellers come. It's a meeting point.
A meeting point is a form of conventional information, and one that is highly stable once established. People come to the market because they know that others will be there as well, and these are there for the same reason.
Once players have agreed to come to one place, it is simpler to come to that place than to try and organise a new place, which everybody must agree to and which all occasional players need to be informed of. Just like DKos is now THE main meeting place for the progressives, the existing oil bourses have an massive advantage over any new one in that they already exist. London has remained the main trading place for a surprising number of commodities despite the British Empire being long gone and the US having replaced it as the largest economy - simply because the infrastructure was there, and the people with the competences to play there were still around.
Windows is unassailable on desktops despite being obviously inferior in quality to some alternatives, simply because there is a real advantage for everybody to use a common standard, even if it imperfect. A bourse is a standard on where and how to trade.
There is no compelling reason to move from London or New-York to Iran to trade oil. Iran only has 5% of world production and is in no position to impose anything. Network effects paly massively against a switch.
- it's a place that allows a price to be set for the transaction. That means that you want many buyers if you're a seller, and many sellers, if you are a buyer. It provides liquidity.
This is linked to the above point: liquidity exists when you have a deep market, i.e. many buyers and many sellers. That comes from having a place where everybody comes, and a place that everybody trusts because it works. "Don't fix it if it ain't broke" applies here. Again, this is a compelling argument against Iran. Iran can potentially act as a seller, but would will ensure that there are buyers on that particular market?
- the other item related to price is that a bourse needs to provide a single price to act as a universal reference for everybody - a market standard, both in terms of the quality of the product, and the currency it is expressed in. This allows for historical data to be expressed consistently, and for market players to have useful references and background to do their trades.
For oil, that currency is and has always been dollar, as a widely stable, universally accepted monetary unit. There is no market and no liquidity in any other currency. It is at least conceivable that the euro could be used as it is similarly stable and acceptable to all, but it has no history as an oil trading currency, and thus market players would naturally convert any price in euro into a price in dollars to see what it means (try switching from degrees Celsius to Farhenheit or from centimeters to inches to know why this matters). Again, there would need to be an overwhelming reason to force all market players to make the switch (and to do it all at the same time), which Iran does not provide.
- a bourse is a place that provides security for the transactions. Buyers know that they will get their purchase delivered, and sellers know that they will get paid in a timely fashion. It provides clearing mechanisms.
Do you expect other producers to rely on Iran to ensure timely payment of their sales? Do you intent to rely on Iran, an untested bourse, to be responsible for delivery by other parties?
- it's a place that provides rules and enforcement of these rules for the proper functioning of the market, i.e all the above: who can participate, how prices are formed, how the clearing is organised, and how disputes are settled. It needs to be a neutral arbiter, uninvolved in the actual trading.
Again, this plays against Iran, who is too small a player to impose rules to all, but too big to be seen as a neutral player by other sellers. And do you really want to take the risk that the religious authorities in the background or any other Iranian politician come and start meddling with the ongoing trades?
- as rules will ultimately be set by public authorities overseeing the bourse, and disputes will ultimately be decided by courts of that place, it needs a consistent regulatory and legal framework.
There's a reason why most commodity bourses are in Western countries. They provide the rule of law, a predictable set of rules, and a capacity to enforce these rules in an effective and market-neutral way. and they have a long track record of doing so. Iran? Not so much.
- in today's world, a bourse is essentially a big IT operation, with systems able to provide complete market information to all participants in real times, treat operations as they are decided, and provide an unambiguous audit trail to all interested parties to a transaction.
Again, that requires a lot of specialised competences on the ground: programmers, developpers, consultants to install them, the specialist hardware providers, etc... all people that need some (or a lot) of understanding of what's going on in the market. That's highly specialised knowledge, which is, naturally concentrated in the few places that carry bourses, i.e. a few large cities in the West. Iran will be hard pressed to attract such people to Tehran or thereabouts.
- finally, the oil bourse is only a small part of the trading that goes on around oil. Most of what takes place are financial transactions: spot sales, forward sales, swaps, various hedging instruments, short term financing, long term financings. All these transactions rely on the underlying oil market, and significantly expand it. If you take out the oil market, or change its rules, standards, references, clearing mechanisms and enforcers, you kill the associated financial markets, which are vital to the world economy and underpin a large chunk of our industrial activity and energy needs.
Do you really expect the financial markets to move to Tehran, which has neither the infrastructure, the competences, the legal framework or the stability to host them? Even a switch to the euro would need a massive reorganisation of the financial markets, which are exclusively geared to dollar transactions. This only amplifies the arguments made above about the sole oil market with respect to liquidity, standards and the like. And the legal and regulatory questions are even more important. Do you really want billions of euros of daily financial flows to be ultimately controlled by the Iranian Central Bank? It would basically take the outright destruction of the existing markets to provide any incentive to try to rebuild them differently, and Tehran would not be their first pick to do it...
So, say that Iran decides to sell its oil in euros. Fine. Both the Iranians and their clients will determine the price for the transaction in dollars, on one of the established markets, and will trade these dollars for euros for the actual payment operation. It will give banks active on the forex markets a little bit of income, but will change nothing to how oil is traded.
If they open a bourse, who will come? The answer is, no one, unless it is nothing more than the new place to buy oil from them and the transaction, whether in euros or in any other currency, will be negotiated in dollars, using existing market standards expressed in dollars, because there is no way that anybody will be able to express and clear the transaction in any other way.
So please, let's stop the fantasies, or the conspiracy theories about a switch to euros or a new bourse. If any transaction, whether by Saddam, the Iranians or anyone else is expressed in euros, it is purely cosmetic. The underlying market is in dollars, and will remain that way.
Those who poste these stories or push them are badly undermining their credibility and engaging in silly scaremongering.
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