During the 1973 Arab Oil Embargo, crude oil prices quadrupled from roughly $3 to over $12 per barrel. This oil price shock was based on a net disruption in the global supply of crude oil that amounted to less than 4% during approximately three months.
To put this into today’s context, a global oil supply disruption of the sort that caused the 1973 oil crisis – along with an extraordinarily deep recession and an exceptionally severe equity bear market in the US – would amount to a disruption of a little over 4 million barrels per day for several months.
Today, with a major regional war on the verge of exploding in the Middle East, the stage is decisively being set for an oil supply disruption that could be significantly greater than the one that occurred in 1973. This severe potential disruption in global oil supplies is all occurring against the backdrop of low levels of commercial inventories, a depleted Strategic Petroleum Reserve, and a heavily unbalanced futures market.
In this article, I will describe how a major market-defining oil price shock could occur and why.
The Strait of Hormuz: A Global Economic Chokepoint
Every year, roughly 20% of total global oil supplies pass through the Strait of Hormuz – this amounts to over 20 million barrels per day. Geographically, the straight is roughly 20 miles wide at its narrowest point, but the shipping lanes are only two miles wide.
Because of the narrowness of the shipping lanes and the peculiar geography of this waterway, Iran can easily shut the Strait of Hormuz for many months through mining, sinking of ships (physical blockage), rocket launches, and drone strikes on ship traffic. This means that the disruption to global oil supplies that Iran could cause is significantly greater than the one that caused global oil prices to quadruple in 1973-1974.
Indeed, in practice, the only thing that Iran would have to do in order to shut down virtually all oil traffic through the Strait of Hormuz would be to announce that it would sink any ship that attempts to cross the Strait. No commercial insurer would insure any vessel under those circumstances and virtually no shipping company would risk their vessels and crews by attempting passage under the shadow of such a threat.
Based on recent experiences in the Red Sea, in which the Iran-backed Houthis (with far less military resources than Iran possesses) have managed to shut down roughly 75% of all traffic through the vital passageways of the Suez Canal and the Bab-el-Mandeb Strait, there is very little doubt that Iran can effectively block almost all commercial traffic from transiting through the Strait of Hormuz.
A concerted effort by Iran to block commercial transit through the Strait of Hormuz could only be partially compensated with mitigation measures such as using over-land routes and pipelines.
As a result, various estimates (including a U.S. GAO estimate in 2006) suggest that a shutdown of the Strait of Hormuz could cause a tripling or quadrupling of global oil prices, implying an oil price that could exceed $300.
Why Would Iran Shut the Strait of Hormuz?
If an all-out war were to break out between Iran and Israel, the best (and perhaps only) means of survival for the regime that currently governs the Islamic Republic of Iran might be to the black passage of all oil traffic through the Strait of Hormuz. This is why:
In an all-out war against Israel, Iran would not only be fighting against Israel but against the United States, which is firmly committed to Israel’s defense. In an all-out military confrontation against Israel, the US, and other allies, Iran would be decisively and disastrously defeated. Such a defeat would endanger the very existence of the current Islamic regime.
Faced with such a potentially existential military defeat, the only viable leverage that the Islamic Republic regime has to try to ensure its survival is to perform an act of “blackmail” on the global economy. Iran’s leaders would declare:
“Cease all hostilities against Iran or we will shut down the Strait of Hormuz.”
In such a scenario, in the face of oil prices above $200, spiraling inflation, and the triggering of deep economic recessions around the world, there would be enormous international pressure to bring an end to Israeli (and allied) military action against Iran.
As the Houthis have proven in the Red Sea, there is no way to quickly restore safe passage through a narrow commercial waterway in the face of a determined and powerful enemy. Indeed, reopening the Strait of Hormuz by force – if it could be done at all – would probably require a massive multinational land invasion of Iran that could only succeed after many months.
Given that there will be no international appetite for such a prolonged and disruptive military conflict, the Iranian regime can be confident that international diplomatic (and even potentially military) pressures to end Israeli (and US) attacks on Iran will be enormous.
Iran does not need to fire a single shot at Israel in order to defend itself. By cutting off the Strait of Hormuz, Iran can blackmail the entire world into pressuring Israel to end its conflict with Iran. This is almost certain to be Iran’s strategy in the event of an all-out war with Israel.
Indeed, it is a strategy that they have been meticulously preparing for militarily for well over a decade, and it has been publicly discussed many times by political and military leaders in Iran over the years, including in the past few months.
If The Risk of an Oil Shock is So Great, Why are Oil Prices Falling?
Oil prices have been falling since the news on October 14th that Israel has decided to accede to Biden Administration requests to not target Iran's oil facilities – at least not before the US presidential elections. However, this is a very shortsighted reaction from market participants. Israel may accede to US requests to perform only “limited” attacks on Iran prior to US presidential elections.
But, make no mistake: The endgame for Israel is permanent destruction of Iran’s nuclear capabilities and an attempted toppling of the Iranian Islamic regime. While Israel will “play ball” with the US by limiting attacks on Iran before the US presidential election, they will not compromise on their two key strategic objectives, which they consider to be existential in nature.
As discussed in detail in the video at the bottom of this article, we believe that Israel’s current leadership has decided that Israel’s very survival depends on A) Preventing Iran from acquiring a nuclear weapon; B) crushing “the head of the octopus” (Iran) that has been attacking Israel on multiple fronts through its proxies in Gaza, Lebanon, Syria, Iraq, Yemen and elsewhere in the region
Given Israel’s “existential” strategic objectives, as understood by the nation’s current leadership, investors should not become distracted by short-term developments in oil markets. Investors should not lose sight of the “end game,” (from Israel’s strategic standpoint) which essentially entails an all-out war between Iran and Israel.
Most importantly, investors should not lose sight of the fact that his end game (all-out war between Israel and Iran) will most likely lead to a closure of the Strait of Hormuz by Iran in a strategic act of desperation. Furthermore, strategic desperation could very well lead Iran to execute other acts aimed at disrupting international oil supplies – which Iran is fully capable of executing – which will not be discussed in this article.
Conclusion
In this article, I have shown that global oil supplies are extremely vulnerable to a possible war in the Middle East. The Strait of Hormuz constitutes a global economic “chokepoint” and Iran’s leadership has the wherewithal and the will to blackmail the global economy if they feel that they are fighting for their survival.
Given our view that an all-out war between Israel and Iran is likely (given Israel’s strategic objectives as outlined) a major oil price shock in 2024-2025 is not only possible but likely.
We expect an oil price shock to send global oil prices toward $200 per barrel – and potentially above $300 per barrel if Iran closes traffic through the Strait of Hormuz for several months.
The consequence of a disruption of oil traffic through the Strait of Hormuz would be raging global inflation, a deep global economic recession, and a very severe decline in global bond and equity prices.