Despite Low Probability, an Iranian Blockade Would Have Enormous Consequences for Global Economy

Jan. 9, 2012
MAPI report finds that Strait of Hormuz closure would have huge impact on price of oil.

Iran's threat to block the Strait of Hormuz, a 34-mile-wide channel located near the nation's southeastern corner (in retaliation for sanctions imposed by the United States and other countries related to nuclear weapons development) would have dramatic consequences if carried out, according to a new report from the Manufacturers Alliance for Productivity and Innovation (MAPI).

Sustained closure of the strait, while unlikely, would have a "huge impact" on the price of oil, argued Donald A. Norman, Ph.D., MAPI Economist.

In 2011, nearly 17 million barrels of oil per day (b/d), or 19% of the world's consumption (currently 89 million b/d), flowed through the Strait of Hormuz. The United States receives approximately 1.825 million b/d from Iraq, Kuwait, and Saudi Arabia -- representing 9.7% of U.S. petroleum production -- all of which flows through the strait.

"An increase in the price of oil would be reflected in the prices of petroleum products like gasoline and diesel fuel," Norman said. "Currently, the spot price of oil (West Texas Intermediate) is approximately $103 per barrel and the average price of gasoline in the U.S. is $3.32 per gallon. If the price of crude oil rose to the vicinity of $170 as a consequence of the blockade, gas prices could reach $5 per gallon."

Norman noted that any blockade would likely be temporary since oil revenues from exports account for approximately 80 percent of Irans government spending; it also imports 40% of the petroleum products it consumes.

Alternatively, the U.S. could tap its Strategic Petroleum Reserve (SPR), which now holds 696 million barrels of oil. To offset any loss from the Strait of Hormuz, Norman estimates the U.S. could draw down the SPR at a rate of 1.825 million b/d for 381 days -- almost 13 months -- and probably more since oil consumption would likely drop as a result of higher prices.

The threat posed by a potential blockade highlights the importance of a domestic energy policy. Two potential assets would be the approval for the construction of the Keystone XL pipeline that would initially bring 700,000 b/d of oil from Canadian Oil Sands into the United States, and opening areas thought to have substantial oil reserves for development.

Though improbable, the potential for a global economic crisis would be significant.

"In the unlikely event that the price of oil would spike to $180 per barrel, or even higher, and remained at such a level for more than three months, the U.S. economy (in addition to the economies of other industrialized countries) would experience a recession," Norman adds. "Given that the Eurozone economies are more fragile than they were one year ago because of the problems with sovereign debt in countries like Greece and Italy, such a spike in oil prices would likely throw the Eurozone into a deep recession, and a recession in the United States would follow."

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