Tim O'Brien | Jan 20, 2012

If you’re hurting at the pump at the moment, prepare yourself for some real pain. Real pain? Try $2.00 a litre – that’ll hurt.

And, right now, short of a miracle, or an unlikely outbreak of good sense in that silly angry little place that passes for a parliament in Iran, it’s an increasingly likely prospect.

The issue behind the issue – Iran’s nuclear research program and the West’s efforts to force it to abandon uranium enrichment – has festered on and off for the better part of a decade. (This particular trail of bad blood, among many such trails, can be tracked all the way back to 1981 when Israeli jets bombed a reactor in neighboring Iraq.)

Unfortunately for motorists, and for a world economy struggling to avoid slipping back into recession, the shadow-boxing and sabre-rattling between Iran, the US, its European allies and now – also entering the fray – China, took a dangerous turn in the closing days of 2011, and has since become more dangerous.

For you and I, it threatens to turn the trip to the pump into the stuff of nightmares.

The escalation to the issue began with Iran’s threat, delivered by its Vice-President Mohammad Reza Rahimi on December 27, to block shipments of oil through the Strait of Hormuz if the US and Europe impose stricter economic sanctions.

Ham-fisted US and European diplomacy since, and the killing – perhaps by Israeli agents – of an Iranian scientist involved in its nuclear program (and there have been four murdered to date), have inflamed tensions and, importantly, made it harder politically for Iranian leaders to accede to US demands.

Yesterday, January 19, as reported by Bloomberg, Iran’s ambassador to the United Nations, Mohammad Khazaee, reiterated the threat to block the Strait as “an option” if “Iran is threatened seriously and somebody wants to tighten the noose”.

Can Iran blockade the Strait? Maybe yes, maybe no; but one single tanker hitting one single Iranian mine will plunge global oil markets into crisis.

To get a perspective on the issue, and the impact on pump prices of a serious escalation of tensions, consider that in the first few months of the Libyan conflict, the global barrel price for oil jumped from US$99 to peak at US$120.91 in April 28 of last year.

Libya, although a producer of ‘clean’ low-sulphur crude oil, contributed then just two percent to global oil production.

Yet, such is the irrational twitchiness in global oil markets, the threat of interruption to supply while the Libyan people got rid of the execrable Gaddafi drove the barrel price up by 21 percent.

Iran holds the second-largest oil reserves in the world and, before this outbreak of nonsense, was the fifth largest oil exporter (accounting for around five percent of global oil production).

But interruption to that supply is not where the danger lies.

Saudi Arabia, in a spectacular gaffe that raised temperatures even higher across the Persian Gulf, said that it could increase production to offset the loss of Iranian oil should the US and Europe tighten restrictions further.

In fact, Saudi Arabia can quite easily cover any loss from Iran. So the loss – temporary or otherwise – of Iran’s production is not the crucial factor.

It’s the Strait of Hormuz, a narrow strip of water between Iran and Oman, that is the issue. It’s a highway for supertankers. If the US and Europe press ahead with tougher sanctions, there is little to suggest that Iran won’t act on its threat.

The Strait is, at its narrowest point, just 32 kilometres wide. The US Government describes it as the “world's most important oil chokepoint”.

If you were to look for a point of vulnerability that could most quickly put a tourniquet on oil supplies to the West, and to the developing economies of China and India, this is the place you’d apply it.

In 2011, the daily oil ‘flow’ through the Strait was almost 17 million barrels. Over a year, that amounts to around 35 percent of all seaborne traded oil, and almost 20 percent of oil traded worldwide. (Source: US Government)

Most analysts conclude that Iran’s Revolutionary Guard does not have the military capacity to close the Strait and keep it closed. But any blockade, however brief, will cause serious disruptions.

And what will that do to the barrel price of oil? Benchmark crude, over much of January has been trading between US$98 per barrel to around US$103 per barrel.

Any escalation of tensions between the US and Iran, and any attempt at blockade, would push the barrel price to heights far outstripping the $20 rise seen when Libya descended into civil war.

Recent history suggests that barrel prices could surge beyond US$150 – a 50 percent increase – and even double.

That would have you and I, despite the high Aussie dollar having provided a buffer of sorts to the upward movement in barrel prices over the past three years, paying more than $2.00 a litre for 95RON.

Elsewhere, such rises in the barrel price of oil would be catastrophic for a world economy teetering on a return to recession and still reeling from a sovereign debt crisis (and with little idea of how to solve it).

And that’s why China, although not supporting the imposition of tougher restrictions, yesterday added its voice to the international chorus for Iran to abandon its nuclear program.

Given the events of the past week, there is little likelihood it will.

When it comes to Middle East policy, bull-headedness, stupidity and short-term political expedience has never been in short supply - neither in Washington nor in Europe.

Unfortunately, for both motorists and ordinary people wearying of pointless tensions, it is magnificently matched by bull-headedness and stupidity in Tehran, Riyadh and Tel Aviv.

Tim O’Brien
TMR Managing Editor & Industry Analyst