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The Real Oil Shock

An Iran with nuclear weapons is the true threat to the world economy.

Jan 16, 2012, Vol. 17, No. 17 • By MICHAEL MAKOVSKY AND LAWRENCE GOLDSTEIN
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The CBI sanctions law does provide the Obama administration greater leverage in its discussions with other countries, but probably not enough. Other countries know that the Obama administration is loath to implement the sanctions fully, not only because it is concerned about oil prices but also because severing relationships with foreign banks that hold U.S. bonds could disrupt the U.S. financial system. 

To convince Asian buyers to reduce or cease their purchases of Iranian crude, the administration will need to arm itself with more than the CBI law and Saudi oil. Senior Obama officials will need to make it abundantly clear that the only alternative to sanctions is a U.S. or Israeli military strike on Iranian nuclear facilities. In other words, the choice offered should be: Reduce/cease purchase of Iranian oil to pressure Iran enough so that its nuclear threat can be resolved peacefully, or face the real risk of having the oil supply from Iran and the Persian Gulf disrupted for some time following military action. 

Instead, the administration has gone out of its way in public to express its opposition to an Israeli military strike and condition the American public—as well as Iran, China, and others—not to expect a U.S. strike. Despite repeated assertions that they are keeping “all options on the table,” Defense Secretary Leon Panetta has followed the practice of his predecessor Robert Gates in highlighting the risks of a military strike. Twice recently, Panetta emphasized a strike’s “unintended consequences.” He listed five categories of them in a speech on December 2, including high oil prices, which the Washington Post criticized in an editorial entitled “The Wrong Signals to Iran.” Panetta and Obama have since strengthened their rhetoric, but the damage was done. Indeed, the administration has not made any credible preparations, at least overt ones, such as military exercises and deployments, for a strike. 

Thus, as long as the administration continues to derogate publicly a military option against Iran, CBI sanctions are unlikely to be adequate. By publicly eschewing a military option by Israel or the United States, the administration has undercut the chance for CBI sanctions to work and inadvertently made war more, not less, likely. 

This is certainly the case regarding an Israeli attack. Israeli officials have suggested that CBI sanctions are the last chance to prevent peacefully a nuclear Iran. An Israeli attack would indeed lead to a spike in oil prices, the duration and extent of which would depend upon the nature and intensity of the Iranian response. Iran could retaliate against Israel with missiles and have its Lebanese terrorist proxy Hezbollah rain down many of its 50,000 rockets upon central and northern Israel, including Tel Aviv. Still, Iran might be constrained from expanding its target area lest it invite an American response. An Israel-Iran conflict could last a few days or a few weeks, during which tankers could avoid loading oil from Iran or southern Iraq. Oil prices would certainly spike during such a conflict, and that rise could be sustained afterwards if there were damage to Iran’s oil facilities. 

If the United States attacked Iran’s nuclear infrastructure, the attack would likely be more sustained and more intense than an Israeli strike, and the theater of conflict would cover a larger area, leading to a higher and longer spike in oil prices. A U.S. attack would also likely inflict a lot more damage on Iran. The United States could employ its vast air and naval assets to fire missiles and drop bombs that would cripple not only Iran’s nuclear infrastructure but also its defensive and offensive military capabilities. Iran could react ferociously, knowing it had less to lose than if responding to an Israeli strike alone. It could try to disrupt the flow of oil from the Strait of Hormuz—using mines, gunboats, missiles, and so on—to prevent its enemy neighbors from exporting oil and to raise the cost of the military action and increase international pressure on the United States to cease its actions. The Iranians could also attack the oil facilities of Saudi Arabia and other neighbors that were supporting the U.S. strike. The duration and extent of that impact could depend on the magnitude, if any, of the damage to energy facilities of the Persian Gulf countries, particularly Saudi Arabia. The United States and other major consuming countries could mitigate the rise in oil prices by releasing their strategic reserves, but the spike in oil prices would still be significant. 

However great the impact on oil prices of military action to address the Iranian threat, it could be relatively minimal and short-lived compared with the sustained period of higher prices that would result from Iran passing the nuclear threshold. This would create longer-term economic damage to the United States. 

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