Barring an unexpected last-minute deal to relax European Union sanctions, Europe's Protection and Indemnity (P&I) clubs will be unable to insure vessels carrying Iranian crude from July 1, an unforeseen but ultimately critical side effect of EU sanctions to punish Iran for its nuclear program.

In an extreme scenario, exports from OPEC's second-largest supplier -- already curtailed by separate U.S. sanctions and an EU import ban -- could grind to a halt next month as overseas oil companies cannot afford to take the risk of multibillion-dollar liabilities arising from an uninsured incident.

Such an outcome seems unlikely. In Japan, which now buys about a fifth of Iran's exports, legislators are expected to approve unprecedented government guarantees to insure shipments later this month.

But no other country has announced similar arrangements, and buyers in South Korea and India say they will have to stop loading any new cargoes from July without a solution.

Despite the risks, however, oil markets appear blase: Since April, Brent crude prices have slumped more than 20 percent to trade below $100 a barrel for the first time since early 2011; in a straw poll by Reuters, none of the five analysts who provided forecasts for Iranian exports expected more than a modest dip in sales in July and the rest of the year.

"Insurance issues may affect exports on top of volumetric targets, resulting in lower-than-expected Iranian exports, but as time passes market participants may find ways to deal with sanctions and exports may increase," Seth Kleinman at Citi said.

For the moment, traders are betting that reduced demand resulting from Europe's debt crisis, near-record Saudi oil production and a boom in North American output are more than sufficient to offset the estimated drop of 1 million barrels per day (bpd) in Iran's exports since last year.

Group of Eight nations have also made clear they could release emergency oil reserves quickly if supplies are endangered.

In effect, market sentiment on Iran has swung from one extreme to the other. The fears earlier this year of an immediate Israeli military attack on Iran have been replaced by what some analysts warn is dangerous complacency.

"Our view is that a large part of the lower Iran exports is already priced in," said Hans van Cleef, energy economist at ABN AMRO, who declined to provide a forecast. "The price effect on July 1st will therefore be very limited."

More broadly, dimmer prospects for a resolution to high-level nuclear talks and growing risks of instability stemming from Syria's turmoil may be underestimated.

"I think it's a lot more volatile than the market recognizes," Barclays analyst Helima Croft said.

JAPAN INSURANCE

Citi expects exports to drop by 200,000 bpd compared to May, and then remain at around 1.25 million bpd for the rest of the year -- about half what Iran was exporting last year, before tougher sanctions.

On average, the analysts see Iran's exports slipping by only 216,000 bpd in July, and marginally thereafter. That implies a total loss of exports at close to the 1.5 million bpd level that analysts at Barclays warned could provide "significant upside to prices", particularly with summer demand rising.

The P&I block initially appeared to be an unanticipated side effect of Europe's sanctions, which included a more direct ban on imports of Iranian crude and a host of other measures meant to convince Tehran to quit its nuclear ambitions.

The West suspects Iran of trying to make atomic weapons, but Tehran says its nuclear program is for power generation.

However, insurance quickly become a central issue with wider implications. While U.S. sanctions have successfully convinced most Asian nations to cut Iranian purchases by a tenth or more, the lack of P&I coverage threatens to halt exports completely -- a development that not even Washington seems to want.

Major importers had lobbied the EU to relax the ban or delay the sanctions, but the EU has been resolute: "We have a clear position starting with the oil ban on the first of July," Energy Commissioner Guenther Oettinger said last week.

Most are also seeking sovereign support, with few results outside of Japan.

Earlier this year Chinese shipowners prevailed on Beijing for coverage, but there has been no evidence that such steps are forthcoming. An Indian official said last week that New Delhi was struggling to resolve the problem. Industry sources said earlier that the country's mostly state-owned refiners would be forced to halt imports without a solution.

"Oil traders see Iran's buyers creating workable substitutes for EU maritime insurance through sovereign guarantees," said Mark Dubowitz, head of the non-profit group Foundation for Defense of Democracies, which advocates tough sanctions on Iran.

OWN FLEET?

NITC, the Islamic republic's biggest private tanker operator, has sought to reassure customers that it can keep shipments moving with $1 billion of insurance coverage on its own fleet, largely from privately owned Kish P&I.

If deployed in full, NITC's fleet of 39 vessels would theoretically be enough to carry a maximum of around 62 million barrels of oil, data from its website showed. Assuming a 35-day round trip to China, the fleet could theoretically ship 1.8 million bpd, more than Iran's current exports.

But brokers say as many as three-quarters of its 25 supertankers may already be occupied by storing surplus production at sea, while its smaller vessels would be ill-suited to longer-haul shipments. That would make it difficult to sustain current exports using only NITC vessels.

Ultimately, for some analysts the question is less about the immediate impact of sanctions than about the degree to which some countries may yet evade them.

Nic Brown at Natixis says China -- the only major importer not to have secured an exemption to U.S. sanctions -- may buy more than 500,000 bpd of crude in July.

"We suspect that Chinese importers have negotiated attractive terms to take more oil from Iran," he said.

(Reporting by Jonathan Leff in New York and Naveen Arul and Nallur Sethuraman in Bangalore; Additional reporting by Timothy Gardner in Washington; Editing by Dale Hudson)

• A Permanent Economic Emergency