Could the world handle an Iranian oil crisis?

at 01:59 PM ET, 02/01/2012

Lately, oil markets have been jittery over fears that Europe’s new embargo on Iran could spark tensions in the Persian Gulf. So how would the world cope with an Iranian oil crisis, if it came to that? A new paper explores our options — and none of them are pleasant.


An Iranian Army soldier stands guard on a military speed boat in the Strait of Hormuz in December. (ALI MOHAMMADI/AFP)
In theory, the E.U.’s embargo on Iranian oil imports, set for July, is supposed to cut into Iran’s finances without cranking up the price of crude too high. “The idea here,” says Robert McNally, president of the Rapidan group, “is that if Iran’s other customers, like China and India, see that Iran is prohibited from selling 20 percent of its crude to Europe, those countries now have leverage to bargain down the price” of the leftover oil. So the sanctions depend on China and India flouting the embargo, but forcing Iran to take a loss. Europe and the United States hope this will all go smoothly. One big worry, though, is that Iran responds by lashing out — say, by trying to block the Strait of Hormuz, where 35 percent of the world’s seaborne oil passes through. That’s a big “if.” But it would make life excruciating for everyone.

As McNally details in a new report (pdf) for the Council on Foreign Relations, a serious and prolonged disruption of the Strait of Hormuz would dwarf the oil crises of the 1970s — there’s just so much more oil at stake here:

In the truly apocalyptic scenario, McNally estimates, a complete cut-off of the 17 million barrels of oil that pass through the straits each day could cause the price of oil to rise as high as 320 percent — which would “likely tip the global economy into recession.” Now, it’s unlikely the U.S. would allow that to happen. But even lesser disruptions (if, say, Iran started harassing ships or decided to cut off some of its exports) could push the oil price up $20 or $40 or more — the sort of spike that could really put the brakes on economic growth.

So how would the world handle an Iran-related oil shock? McNally considers a couple of options, none of them perfect:

1) Ask Saudi Arabia to save the day. In the event of modest turmoil, Saudi Arabia and OPEC could try to make up any shortfall in oil with their own spare capacity. Unfortunately, the evidence suggests that OPEC just doesn’t have nearly enough spare oil anymore. According to McNally, oil analysts think OPEC needs at least 4.5 million barrels per day in reserve to stabilize prices (and this is for relatively modest crises). At best, OPEC will have about 3.9 million barrels per day of spare capacity by summer — and even that’s likely an inflated figure, as many analysts suspect that Saudi Arabia is overstating its extra capacity.

2) Reroute some of the oil around the straits. McNally notes that it’s possible to divert a small portion of the Middle East’s oil around the Strait of Hormuz. Saudi Arabia has extra pipeline capacity to channel about 1 million barrels per day over to the Red Sea, and the United Arab Emirates is hoping to have a new pipeline done by the summer that could transport 1.5 million barrels per day (although the pipeline’s already been plagued by delays). That might help a bit, though it would be of limited use in a major showdown.

3) Countries immediately start cutting back on oil use. In 2005, the International Energy Agency released a report (pdf) titled “Saving Oil in a Hurry” which detailed all sorts of ways that wealthy countries like the United States could cut down on oil in rapid order — by altering speed limits, promoting telecommuting, boosting car-pooling. But even if these measures were instituted quickly, it would only save about 1 million barrels of oil per day — nowhere near eenough to offset a major disruption of 17 million barrels per day through the Strait of Hormuz.

4) Countries start releasing emergency oil stockpiles. The 28 IEA countries have plenty of oil stockpiled away for emergencies — in places like the U.S. Strategic Petroleum Reserve. Official estimates suggest that these countries could quickly release the 14.4 million barrels of oil per day necessary to offset a major blockage in the Strait of Hormuz — for about a month. But, McNally tells me, that’s just the theory. “This would be several orders of magnitude larger than anything that’s ever been released,” he says. “We just don’t know if the logistics—the storage facilities and the pipes and bureaucracy—could move that quickly.” McNally’s survey of oil market analysts suggests that even if the IEA released its strategic reserves, prolonged chaos in the Strait could still raise the price of crude about $39 per barrel.

In the end, the world could probably handle a minor disruption (say, if Iran intentionally throttled back on production). Any major conflict in the Strait of Hormuz, though, would be very difficult to absorb. The world is too hooked on oil and there’s not enough spare crude around to avoid serious pain. So that leaves the military option: “The most effective and credible way to limit and shorten the oil price spike,” McNally concludes, “will be for the military to quickly and convincingly reopen the Strait to tanker traffic.”

 
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