Because Iran has previously demonstrated its willingness to close the key trade route through the Strait of Hormuz, some media outlets are speculating that oil prices could soar to $100 a barrel or higher. They argue that this could cause a recession in the United States, which would spread across the global economy.
These fears are misplaced. Yes, the price of Brent Crude, the global benchmark, has climbed sharply to around $75 to $78 a barrel. But from the standpoint of economic activity, that is not a particularly troubling price. Several times in the past five years, Brent has traded above $90 a barrel without causing a recession in the U.S. or globally. World markets can weather oil prices in the $70s.
Fears of $100 oil are understandable. About 20% of global oil supply transits the Strait of Hormuz. The strait is narrow, and conceivably, Iran could try to close it. Some analysts warn that a prolonged closure could remove 8 to 10 million barrels a day from trade routes — a shock that, in theory, could push prices past $100.
But that scenario is highly unlikely. Iran’s economy is in tatters. Iran needs to export its oil through the strait to obtain the hard currency necessary for critical imports. If Iran tries to close the strait, it will be committing economic suicide. The Iranian regime wants to survive. In addition, much of Iran’s navy has been destroyed since the recent conflict began, making it much more difficult for the country to enforce any blockade.
But even if Iran tried to limit exports through the Strait of Hormuz, Saudi Arabia and other oil-exporting countries could use alternative oil pipelines to supply world oil markets. These pipelines could, in theory, carry up to an additional 5 million barrels per day. Even if some crude is prevented from reaching global markets, the net shortfall is unlikely to be so persistent that Brent would surge to $100 and stay there.
Global oil markets are well supplied. Global oil supply very recently exceeded demand by up to 3.7 million barrels a day. Moreover, both the U.S. and China, the two largest oil-consuming countries, have large strategic reserves of oil. These reserves provide a significant buffer against additional price hikes.
Finally, unlike oil shocks of the last century, when Iran and other Islamic countries brought the U.S. economy to its knees, today America holds the crown asset of global oil markets: the shale oil deposits of West Texas and East New Mexico. These deposits hold potential reserves of up to 230 billion barrels of oil. With global oil prices near $80 a barrel, U.S. shale producers can, very profitably, drill new wells and increase production in a matter of weeks.
TEXAS BAR SHOOTING SUSPECT WORE ‘PROPERTY OF ALLAH’ CLOTHING WITH IRANIAN FLAG
Producers are economically sophisticated. They use oil futures markets to hedge risk and lock in high prices. Today, they can sell forward current production and be certain that the new production can be sold at prices well above $70 a barrel. Importantly, production costs for new wells in the Permian Basin are below $65 a barrel.
Today, global oil prices reflect fear of worst-case scenarios. In a few days, logic and facts will replace fear, and oil prices will retreat, modestly at first and then perhaps precipitously.
James Rogan is a former U.S. foreign service officer who later worked in law and finance for 30 years. Today, he writes a daily note on markets, economics, politics, and social issues.
