Ed Hirs argues that should Iran implement a partial blockade of the Strait of Hormuz, cutting crude supplies to the market by 10 per cent, oil prices would rise by 250 per cent.  Reuters/Fars News file photo.

Iran can boost oil prices to $200 just by partially blocking the Strait of Hormuz

By Ed Hirs

This article was published by Forbes Magazine on July 25, 2018.

The latest saber rattling from and about Iran gives new resonance to talk of $200 oil. Iran can do it with just a partial blockade of the Strait of Hormuz.

Reuters recently detailed past Iranian military operations that could interrupt the oil supplies passing through the Strait of Hormuz: 18 million barrels of oil per day, or about 20 per cent of the world’s supply. How do we get to $200+ per barrel? An economic analysis is required.

Crude Oil Imports and National Security’ estimates -0.04 for the price elasticity of demand for crude oil. That is, if quantity supplied to the market is cut by 10 per cent, the price of oil will increase by 250 per cent. With oil currently at $70 per barrel, a disruption in shipping in the Strait of Hormuz would lead to a $175 a barrel price increase, for a total of $245 per barrel, as shown in the graph.

oil prices

Econ 10 diagram of impact of partial blockade, 9 million barrels per day. Graphic by Ed Hirs.

President Trump is correct that the United States has paid a lot of money for the defense of oil interests in the Middle East.

The Cost of War Project at Brown University now estimates the costs of wars since 9/11 at $5.6 trillion. To this needs to be added the military casualties of 6,961 dead and 52,682 wounded.

President Eisenhower avoided the trap that has ensnared three consecutive U.S. administrations. He rejected the pleas from Britain, France and Israel to enter the Suez Crisis in 1956.

Understanding that conflicts in the Middle East were about who owned the oil and largess from its production, the pragmatic President Eisenhower realized that consuming nations would buy the oil without regard to who sold it to them.

He also realized that strategic dependence on cheap oil from the Middle East would undermine U.S. national security and the U.S. military’s ability to project supply lines during the Cold War.

President Eisenhower imposed an oil import quota in 1959 to limit U.S. dependence on foreign crude. The price of oil in the United States was roughly double the world price, and OPEC was formed in response.  The U.S. oil industry was stable and robust.

This policy remained in place until his vice president, then President Nixon, removed the import restrictions.

The irony today is that the United States has initiated a tariffs regime in the name of national security for U.S. steel and aluminum industries but has excluded the oil industry from similar protection.  Why?

This policy today would benefit our national security by lessening our dependence on OPEC. Higher domestic oil prices will encourage more employment and encourage a faster transition to alternative fuels (see ‘Crude Oil Imports and National Security’ above).

Tariffs or import restrictions can eliminate the exposure to wild downward price swings and protect us from foe and friend.

In 2014, Saudi Arabia increased production to drive down price costing U.S. shale plays 250,000 direct jobs, 300+ bankruptcies, $250-plus billion in lost capital, billions in lost GDP and billions in lost local, state and federal taxes.

While the U.S. surge in domestic production is good, domestic refineries have not found it profitable to shift to the lighter crudes from the shale plays, and the industry exports much of it.

In the event of an Iranian blockade or war in the Strait of Hormuz, it is likely that Congress would again ban exports, but U.S. refiners may not be able to quickly adjust.

Releases from the Strategic Petroleum Reserve could possibly help in the short run, but it has never been tested at even 10 per cent of draw down capacity.  Consumers would face shortages and higher prices.

President Eisenhower showed us a way forward.

Ed Hirs

University of Houston photo.

Ed Hirs teaches energy economics courses to undergraduate and graduate students within the department of economics at the University of Houston. He is also appointed as an inaugural University of Houston Energy Fellow. 

In addition to his teaching, Hirs is Managing Director for Hillhouse Resources, LLC, an independent E&P company developing onshore conventional oil and gas discoveries on the Texas Gulf Coast.  Previously, Ed was CFO of DJ Resources, Inc., an early leader in the Niobrara Shale.