Striking Iran? Implications for the Global Oil Market

A couple of commentators remarked on U.S. energy policy in my earlier post on the likelihood of Iran's assured destruction as a result of a catastrophic nuclear detonation by Tehran. In the event of retaliatory nuclear action, would U.S. access to Iranian oil be curtailed? How would world petroleum markets be affected by such a strike?

This Heritage Foundation analysis provides a glimpse into some potential consequences of U.S.-Iranian military hostilities:

If diplomacy fails, Iran’s pursuit of nuclear weap­ons will leave the U.S. and its allies with few choices, similar to the options that President John Kennedy faced 40 years ago during the Cuban mis­sile crisis.

On one hand, the U.S. and its allies could choose the military option, deciding that a nuclear-armed Iran that sponsors global terrorist organizations like Hezbollah, Hamas, and Palestinian Islamic Jihad is incompatible with the post-9/11 world.

Yet, the economic consequences of a military strike on Iran’s nuclear facilities to the world energy market would likely be significant, if not disas­trous. Immediately following military action, uncertainty about Iran’s ability to sustain oil pro­duction at the current level of 4.05 mbd could drive oil prices above $80 per barrel. If Iran retal­iated and escalated by shutting down the Strait of Hormuz, which would merely require placing anti-ship mines in the strait, the temporary loss of more that 15 million barrels of oil to the interna­tional market could drive oil prices above $83 per barrel, the historic height of the 1970s (adjusted for inflation).

On the other hand, Iran’s aspirations in the region are far-reaching. Allowing Iran to join the nuclear club introduces the possibility of Iranian interference throughout the Middle East, especially given Iran’s location near so many of the world’s largest oil fields. The large Iranian military, amply supplied by Russia and China, would be in a position to dominate the Persian Gulf under a nuclear umbrella, with U.S. ground forces pinned down in Iraq.

Currently, Iran enjoys the support of some Shi’a in Iraq, especially Muqtada Sadr’s Mahdi Army, and in the Shi’ite-populated Ash Shar­qiyah (Eastern) Province of Saudi Arabia. This appeal could facilitate the takeover of some of the largest oil fields in the world. In a worst case scenario, a nuclear Iran could threaten the United Arab Emirates and Kuwait. If this were to happen, the Islamic republic could quickly secure a sizable part of the world’s oil supply, bringing the nuclear-armed militant Shi’ite Muslim state close to a virtual monopoly over the world’s energy market.

The general consensus is that the U.S. needs to reduce is dependence on Middle East oil.

To that end, the current edition of Business Week has a promising article debunking "peak oil theory," a view that argues that world petroleum supply is about tapped out. The story notes that new reserve discoveries -- deep down in the ocean depths of the Gulf of Mexico -- mean that the U.S. has the potential to exploit substantial new supplies of crude, which might alleviate pressure on world markets:

You can tune out all the scare talk about Peak Oil for a while -- probably a long while. Peak Oil is the theory, on the verge of becoming conventional wisdom, that the world's petroleum supply is topping out and will not be able to meet global demand soaring along with the economies of China and India. But a successful test in a mammoth field deep beneath the Gulf of Mexico, announced on Sept. 5 by Chevron, Devon Energy, and Norway's Statoil, should help put that scary scenario on hold for decades.

One huge oil reserve, even if it could rival the 1968 discovery of Prudhoe Bay and increase U.S. reserves by up to 50%, will not turn around the world's tight energy markets, of course. It won't even bring the U.S. close to energy independence when oil and gas get into full-fledged production four or five years from now.

But the capability to find and recover petroleum at extreme depths, temperatures, and pressures, as demonstrated by the Chevron team, may indeed tip the balance of supply and demand in the long term. There will be a new frenzy of drilling at these depths in the Gulf of Mexico, where about a dozen promising exploration wells have already been drilled.Other parts of the world that once appeared beyond the pale may also come into play. Areas believed to have oil deposits extremely deep beneath the ocean floor, which could now become commercially recoverable, include the North Sea off the coast of Britain, the Nile River Delta off the coast of Egypt, and possibly coastal Brazil, says Andrew Latham, a vice-president at energy consultancy Wood Mackenzie in Edinburgh, Scotland. Other analysts say West Africa could harbor lots of ultra-deep deposits. The areas have produced oil before but never from these depths.

The record-setting Chevron well, called Jack 2, which is 175 miles off the Louisiana coast, is more than five miles deep, including more than a mile of ocean depth. Modern 3-D seismic gear enabled the team to know where to drill to have a chance to make their $100 million-plus bet that oil would flow from such a deep formation. The drilling was the work of an advanced deep-sea rig -- Transocean Inc.'s Cajun Express -- one of 13 the company has launched since 1998 capable of drilling to depths of 35,000 feet, about double what the previous generation could do. Earlier drilling had established promising reserves in an area of the Gulf 300 miles long and 80 miles wide, but the Chevron project found a flow rate of more than 6,000 bbl. a day of light, sweet crude. The discovery confirmed the area's commercial viability, strengthening hopes that as much as 15 billion barrels of oil could be recovered in the vicinity.

Note also that in an earlier post on the changing nature of global petroleum markets, I cited sources indicating the potential to extract as much as 800 billion barrels of oil in Canada's shale oil regions. The world is not running out of oil, and should more domestic political pressures for North American production be forthcoming, the U.S. may have the means to reduce its dependency on foreign oil.