Editorial Board

An Oil Strategy in Case Iran Closes Strait of Hormuz: View

Let’s just say Iran makes good on its recent threats to shut down the Strait of Hormuz. And let’s say that with one-fifth of the world’s oil supply bottled up, the price of a barrel of oil then almost doubles, as some analysts predict, to more than $200.

What can the world do to bring prices down before a still-woozy global economy gets pushed back into recession?

Pipelines that circumvent the strait could carry to market at least 7 million of the 17 million barrels of tanker-borne oil that passes through the strait each day. The U.S. could, for the third time since the Gulf War in 1991, release oil from its 700 million-barrel Strategic Petroleum Reserve; other members of the International Energy Agency (set up after the 1973-74 oil crisis) could also tap the 90-day supply stocks that they are required to maintain.

The IEA has already prepared a plan to release as many as 14 million barrels a day in the event of a Gulf closure, according to a Reuters report. Saudi Arabia, long the self-appointed swing man of the Organization of Petroleum Exporting Countries, has a spare production capacity -- on paper, at least -- of about 3 million barrels per day; everyone else is producing almost flat out.

The U.S. now gets only about 9 percent of the oil it consumes from the Persian Gulf. Countries such as China, India, Japan and South Korea, however, rely on Gulf exports, particularly from Iran, to power their economies. In the European Union, debt-ridden Greece gets 14 percent of its oil imports from Iran, Italy 13 percent and Spain almost 10 percent. And because oil is a global commodity, as far as oil prices are concerned, what happens in the Persian Gulf does not stay in the Persian Gulf.

For all Iran’s missile-rattling, however, there is little reason to think it will carry through on its bluster. To block the Gulf would verge on economic suicide: Petroleum products account for 20 percent of Iran’s gross domestic product, 80 percent of exports and 70 percent of its government revenue. Any attempt to close the Gulf could also provoke a war with the U.S. and vaporize what diplomatic support and leverage Iran gets from countries (and clients) such as China.

Iran may not intend ultimately to close the strait, but its threats to do so can still instigate tremendous economic uncertainty with very real consequences, especially in a hyper-connected world wired with complex speculative instruments. The challenge is similar to dealing with terrorist groups such as al-Qaeda, which command our attention and resources through their potential no less than their actions. In either case, the goal is to balance the risks that such threats present with the costs of protecting against them.

More pipelines would be a good start. Unfortunately, the United Arab Emirates just announced that the opening of a 1.8 million barrel-per-day pipeline that circumvents the strait will be put off until May. The use of drag-reduction agents -- an estimated $600 million investment -- could increase the capacity of Saudi Arabia’s existing two pipelines that reach the Red Sea to as many as 11 million barrels per day. And if the Kingdom wants to bolster its reputation as a “stable, reliable” supplier of oil, it could invest the several billion dollars needed to build another pipeline -- a prospect that may be less painful if oil prices remain high. The current turmoil is another reason why Iraq needs to repair its pipeline to Turkey. At home, we support the building of the Keystone XL pipeline that will bring oil from Canada’s tar sands to market.

The IEA’s plan to release oil from emergency stocks will only work if China, India and other non-IEA countries agree not to hoard. That would require an unprecedented degree of policy coordination. One way to reduce future shocks, especially in Asia, may be more positioning of exports in regional storage depots and greater use of floating stocks. Governments may also want to dust off the IEA’s 2005 blueprint for cutting the amount of fuel consumed by cars, trucks and buses. If the crisis continues, the market’s response could also be an important first test of the Commodity Futures Trading Commission’s soon-to-be-imposed limits on trading by speculators.

Over the last few years, the U.S. has reduced its dependence on oil imports in general and from the Middle East in particular. Yet, almost four decades after the first oil shocks, the economy remains deeply vulnerable to the threat of a cutoff of oil from the Persian Gulf -- a state of affairs that calls into question the commitment of, by some estimates, trillions of dollars to keep the Gulf stable and the Strait of Hormuz open. Factor that “externality” into the price of a barrel of oil, and alternative fuels begin to look like a bargain by comparison --at least until someone figures out how to take away the sun, wind, rivers and tides.

    To contact the senior editor responsible for Bloomberg View’s editorials: David Shipley at davidshipley@bloomberg.net .

    Before it's here, it's on the Bloomberg Terminal.