The world is facing what could be the largest energy shock in history. We aren’t there yet.
The U.S. and Israel have heavily damaged Iran’s military capacity. Iran no longer has a meaningful air force, anti-aircraft defenses or blue-water navy. This would appear to be a clear military loss for Iran.
But these losses change the Iranian strategy into one of stark survival, both in the immediate and long term. These conditions give Iran few, yet powerful, options.
About 20% of the world’s petroleum flows through the Strait of Hormuz. Iran cannot fully close it, but it has already shown it can disrupt shipping, and the threat is not going away.
How effective these tactics prove to be will depend on how well U.S. forces can neutralize Iranian assets and establish control of the strait’s approaches, which is neither a quick nor comfortable proposition.
What is certain: Ship traffic will fall and transport costs will rise, with ripple effects across other commodities — including aluminum and the fertilizer feedstocks that gulf producers supply to farmers worldwide.
Thus, prices for almost everything will rise significantly.
The math is straightforward: If 20% of the world’s oil stops moving, prices don’t rise just 20%. Because oil demand is urgent and alternatives are few, the effect is multiplied.
Economists estimate a 20% supply cut could push oil to somewhere between $200 and $400 a barrel. For context, the worst of the 1970s crisis peaked at roughly $140 a barrel in today’s dollars.
For drivers, even the low end of that range means gasoline above $8 a gallon, which is twice what Americans are paying today and well above any price on record.
It is hard to imagine what sort of political panic that price range will cause, though I’d imagine folks reading President Donald Trump’s social media accounts might now have a taste of it.
It is not hard to envision the economic damage. Oil at $200 would cause a deep global recession lasting until well after prices moderate. In 1979 and 1980, inflation spiked to more than 14% and remained stunningly high for three years, helping to force us into two back-to-back recessions and double-digit unemployment.
The worst case in this scenario is simply that even a few hours of heavy missile and drone targeting could damage oil production infrastructure so heavily that it takes many months, or even years, to resume production and shipment at current levels.
There are good reasons to hope the worst case will not materialize.
Iran wants to sell oil. It needs the revenue to rebuild its military. Iran could allow its own vessels to pass through the strait, and many countries appear happy to pay for the privilege of moving theirs. Iran may be content to limit transit to roughly 10% of normal flow, striking a deal with Israel and the U.S. that leaves this coerced toll system in place. That would be an Iranian victory of some consequence.
But make no mistake about what the best case looks like: gasoline above $6 a gallon; concurrent spikes in diesel, natural gas, heating oil and fertilizer of 30% to 50%; and inflation in the 6% to 8% range for an extended period.
The best-case scenario is still a recession.
Sadly, even that may be too optimistic. It is very difficult to envision a military or political end to this war that re-establishes pre-conflict oil flow within the coming year. For Iran, a painful, destabilizing global recession is the best insurance against future attacks. Oil flow hitting even half of prewar levels is hard to imagine. In the coming months, oil above $150 a barrel seems the most likely outcome.
The U.S. will suffer less than most. We are oil exporters, so we face price spikes rather than shortages. We are far less oil-dependent than we were in the 1970s, or even 2008. More Americans work from home, and high diesel prices will push schools and businesses further online.
But higher prices will still bite — consumer spending on everything from vacation travel to homes and automobiles will contract, and borrowing costs will rise.
All of this comes at a time when the U.S. economy was already teetering on the cusp of a recession.
The U.S. economy was already weak because Trump was doing to American households and businesses precisely what Iran is now doing to the world — limiting the free trade of goods. So, if you like tariffs and think they were ever going to make America more prosperous, you should really love the coming oil price shock.
Michael J. Hicks is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University.
This article originally appeared on Lafayette Journal & Courier: Hicks: Oil supply shocks have the same economic effects as tariffs
Reporting by Michael Hicks, Muncie Star Press / Lafayette Journal & Courier
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