23/01/2012 06:54 GMT

Iran Tensions Push Oil Prices Past $110 As Europe Plans Sanctions

Oil prices rose above $110 per barrel on Monday morning amid an ongoing dispute over Iran's nuclear programme, with Tehran threatening to close the Strait of Hormuz in response to Western sanctions.

The passage of a flotilla of Western warships through the straits marks a further escalation in tensions between Iran and the US and the EU.

European leaders met on Monday morning to discuss a possible embargo on Iranian oil exports.

The benchmark Brent Crude contract breached $110 per barrel in trading on Monday morning in London, before slipping back slightly to around $109.50.

Oil prices have been kept in check by fears that demand may be about to decline. The continuation of the eurozone crisis and the real possibility that the world economy could be on the verge of sliding back into a recession suggest that industrial production, and hence demand for oil products, could fall.

Iran is the second largest exporter within the Organisation of Petroleum Exporting Countries (OPEC) and a major supplier of European and Asian markets. As much as 20% of the world's oil passes through the Straits of Hormuz.

The country has continued to push on with its nuclear ambitions despite international pressure to stop and open up its research facilities to observers. Western sanctions are designed to cut off the supplies of capital to the country, which is largely reliant on oil exports to finance itself.

Teymur Huseynov, head of global energy consulting at forecasting firm Exclusive Analysis, told the Huffington Post UK that the effect of sanctions on Iran might be diluted by the country's relationship with China. Chinese refiners may take up some of the slack in Iranian production if the price is right.

"I personally think that depending on the price that Chinese refiners can get from Iran, which can be very attractive, the Chinese would be quite willing to buy. We have to remember that China has actually increased its purchase of Iranian crude in 2011," Huseynov said.

"Whether this happens is not purely driven by political factors. It's primarily driven by economic factors and calculations of cost. After all, the ultimate decision makers in this situation are the refineries, and what they care about is their margins. They don't give a damn about what the Americans are saying or what even the Chinese political establishment is saying to them."

However, shutting off the Straits of Hormuz would represent a serious escalation, and a decision that could not be taken lightly.

"You have to look at the cost/benefit analysis on the Iranian side. Yes, they would threaten Western oil interests, but they would shoot themselves in the foot as well. They depend on their oil exports," Gary Li, head of current intelligence at Exclusive Analysis said.

"We do believe the intention in certain elements in the Iranian government is there, they would go through with this kind of action if they felt the regime is under threat or if they are being attacked by the Israelis."

Militarily, Iran is capable of closing the strait using sea mines, Lee explained. Were they to do so, the action would be hard to undo. Any de-mining operation would be vulnerable to attack by Iranian small boats and from the shore.

"They have quite primitive sea mines, but they have a lot of them, and the straits are very narrow," he said. "You would be looking at quite a complicated military operation in order to break through this kind of Iranian lockdown."