Western trade sanctions against Iran are strangling its oil exports even before they go into effect, a U.S. advisory body has found, amid warnings that any shortages will only push up crude prices and strain a weak global economy.
With crude prices trading around 10-month highs and limited spare production capacity worldwide, the United States may offer Iran's biggest customers waivers from the oil sanctions, which take effect June 28.
Iran is the world's fifth largest oil exporter and the second-biggest producer in OPEC after Saudi Arabia.
It's biggest customers, including China, Japan and India have become tangled up in U.S.-led sanctions aimed at curbing Iran's nuclear ambitions, but which have also revived fears of a global recession.
High crude prices present a major challenge for politicians seeking re-election, including for U.S. President Barack Obama, who may face a backlash from voters paying a U.S. gasoline price that is climbing towards record levels of $4 a gallon.
Obama, however, can grant waivers if doing so would be deemed in the nation's interest.
"With oil inventories and spare OPEC production capacity running low, consumers don't have much buffer against additional disruptions in supply," said Trevor Houser, a partner at Rhodium Group and a former State Department adviser.
"That means the needle the administration has to thread to pressure Iran without raising oil prices has gotten even smaller."
The Energy Information Administration (EIA), an independent arm of the U.S. Department of Energy, said on Wednesday that Western insurers were declining to cover the trade risk on some Iranian oil shipments.
On June 28, Washington will slap sanctions on foreign banks facilitating Iran's oil trade, making doing business with Tehran all the more difficult.
On Wednesday, news emerged that the U.S. government recently forced Dubai-based Noor Islamic Bank to stop channeling Iranian oil money, cutting off another of Iran's links to the international banking system.
The world's biggest electronic bank clearing system, SWIFT, is also preparing to block Iran's central bank from using its network to transfer funds.
In a sign of Iran's difficulties, traders said Tehran was trying to sell about 200,000 tonnes of crude oil from a supertanker floating off Singapore.
They also said a vessel heading towards China was carrying more oil than the usual term-contract supplies.
Asian nations buy almost half of Iran's oil exports, but the U.S. sanctions have forced them to either reduce the amount they buy or look for alternative suppliers.
Iran is India's second-biggest oil supplier after Saudi Arabia, and New Delhi revealed on Wednesday it had sought up to 80,000 barrels per day extra oil from Iraq in 2012/13, days after placing a similar request with top exporter Saudi Arabia.
The EIA report, which looked at global oil output and prices over the last two months since Obama signed the sanctions into law, said oil supplies have become increasingly tight, largely due to the looming embargo and string of production outages in Yemen, Syria, South Sudan, and the North Sea.
The report said global spare crude production capacity was "quite modest" by historical standards, and estimated a global supply gap of 1.6 million barrels per day if Iranian oil was completely taken out of the picture.
Iran has threatened to retaliate against the sanctions by closing the Strait of Hormuz, a waterway which carries nearly 20 percent of the global oil trade.
Fears of Israel Strike
Iran insists its nuclear program is for peaceful purposes but the West's mistrust runs deep. Western diplomats say the U.N. nuclear watchdog was concerned over "activities" that might be taking place at Iran's Parchin military facility.
It was unclear what kind of activities the International Atomic Energy Agency (IAEA) suspected. Diplomats said the agency was monitoring the site via satellite images.
With Israel hinting it could launch a pre-emptive strike on an Iranian nuclear facility, a pro-Iranian militant group, Hezbollah, warned such an attack would set the Middle East ablaze and possibly drag the United States into the conflict.
"America knows that if there is a war on Iran, this means that the whole region will be set alight, with no limit to the fires," Hezbollah deputy Sheikh Naim Qassem told Reuters.
The United States and Israel have not ruled out a military strike on Iran to halt its nuclear program.
Rising petrol prices are a hot issue ahead of the U.S. presidential elections in November. Republicans are trying to tap voter anger to criticize Obama and his Democratic party's energy policy.
Fortunately for oil consumers, Saudi Arabia, home to the world's biggest spare oil cushion, has also boosted production in the last two months.
The kingdom produced an average of 9.7 million bpd over the last two months, the EIA said, about 100,000 bpd less than figures in a Reuters survey on Wednesday. The EIA figure is up about 600,000 bpd from the same period last year.
(Additional reporting by Rachelle Younglai and Ayesha Rascoe)