Tehran, Iran David Rosenberg / The Med – Can Europe – or for that matter, the world — live without Iranian oil?

That’s the question as the continent’s leaders gear up to impose an embargo on oil from the Islamic Republic.

While Iran accounts for less than 5 percent of the world’s petroleum production, for many key economies the Islamic Republic’s oil is critical to keeping vehicles and factories running and homes heated. It supplies 11 percent of China and India’s needs and 10 percent of Japan’s. Overall, Europe is far less reliant on Iranian oil, but Greece, Italy and Spain, three of Europe’s weakest economies, depend heavily on Iranian crude.

Nevertheless, analysts are pretty close to a consensus that an embargo can be successfully imposed without creating energy bottlenecks or causing prices to spike.

“The shortfall could be made up with increased production from Saudi Arabia, and Saudi Arabia would be happy to do that because of the tensions between Saudi Arabia and Iran. There aren’t two countries — apart from Iran and Israel — that hate each more,” Julian Jessop, chief global economist at London-based Capital Economics, told The Media Line.

But just as important a factor in the supply-and-demand calculation is the likelihood that European demand for petroleum will go down this year as its debt crisis spins into a generalized economic slowdown, said Jessop. “Europe might need less oil than last year because of the recession,” he said.

As U.S. Treasury Secretary Timothy Geithner was making the rounds in Asia to drum up support for sanctions, the Organization for Economic Cooperation Development reported that its composite leading indicators, which point to changes in the direction of the economy, continued pointing to a slowdown in activity in most member countries, notably China and the eurozone.

Oil prices have been rising amid what many observers say are fears that a sharpening war of words between the U.S. and Iran may cross the line into military or other action that would hit oil supplies coming from Iran and/or its Gulf neighbors. But a Goldman Sachs report on Thursday discounted Iran fears and attributed higher oil prices to improved economic prospects in the U.S. and China.

“The market remains focused on the improving economic outlook rather than on the risk that the Iranian tension escalates into a severe supply shortage,” David Greely, head of energy research, said in a note.

The sanctions campaign is gaining momentum amid concerns by Western powers that that Iran is moving closer to acquiring nuclear weapons. Although Tehran maintains that its program is for peaceful purposes, it announced this week that it started to enrich uranium at its Fordo production facility to a level of 20 percent.

On Thursday, Japan became the latest country to line up behind U.S.-led sanctions campaign, saying it would cut imports of Iranian oil. The European Union is scheduled to consider a ban on Iranian crude imports when the bloc’s foreign ministers meet on Jan. 23. U.S. President Barack Obama signed into law at the end of last year measures that block foreign lenders doing business with Iran’s central bank from accessing the U.S. financial system.

Beijing this week turned down a plea by Geithner to cut back, but China has reduced crude purchases from Iran for January and February in a dispute over contract pricing terms. Last year, China purchased close to a quarter of Iran’s oil exports. While analysts say China is interested in getting a better price from Iran, the tactics will cut purchases by about 40 percent for the two months.

The Paris-based International Energy Association estimates that Saudi Arabia has the capacity to produce as much as 12.5 million barrels per day (bpd), about 2.5 million more than it is producing now. That is about equal Iranian export levels, which are approximately 2.6 million bpd.

Moreover, Saudi Arabia’s spare capacity mimics the kind of oil Iran produces, heavy sour crude, so a transition for importers from one supplier to another will not entail any upheavals, analysts said.

The Saudis stepped in to replace an oil shortfall earlier this year when revolution in Libya cut off the North African country’s exports. Riyadh is fearful of Iranian nuclear and military ambitions, and officials have signaled they will do their part in the campaign to stop Tehran.

But Paul Stevens, a senior research fellow for energy at Chatham House, warned that the Saudis may disappoint.

“They have ability to replace it [Iranian oil], but there is question in my mind if they would be willing to replace it,” Stevens told The Media Line. “They will be concerned about upsetting the Iranians. They are deeply suspicious of the U.S. following the way U.S. government ditched Mubarak. I must add that I have some sympathy with that.”

Riyadh was deeply upset when Washington urged Egyptian President Husni Mubarak to leave office after mass protests erupted against his rule nearly a year ago. Like Saudi Arabia’s ruling Al-Saud family, Mubarak had been a key U.S. ally.

A Reuters report on Wednesday cited unnamed Gulf sources as saying that Saudi Arabia is nearing its comfortable operational production limits at 10 million bpd and might struggle to do much to make up for shortages that arise from new sanctions on Iran. But most analysts said the IEA estimate is likely to be correct.

Without Saudi help, the world would be hard-pressed to find enough oil to replace Iran’s, said Stevens. The United Arab Emirates has space capacity of about 200,000 bpd and Kuwait has some as well. After quickly recovering to 150,000 bpd, Libyan production growth has leveled off as its struggles to fix war-related damage.

“In a way, it’s the Saudis or nothing,” he said.

In any case, Europe’s ban on Iranian oil is likely to come into force slowly because Italy, Spain and Greece cannot afford another blow to their already troubled economies. Reuters cited EU diplomats as saying a consensus was emerging that the sanctions would come into force after six months and the petrochemical product ban after three — similar to provisions in U.S. legislation.

“I think the transition would be smooth,” said Capital Economics’ Jessop. “We’ve been talking about sanctions for a long time and there has been time for parties to prepare. They could also in the short-term draw on strategic reserves. The idea that the world will be different from a day before is a bit naive.”

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