Conflict Contained. The current fighting subsides without spreading to Syria or Iran. Oil prices subside to $70/barrel by year-end.

Iran Shuts Its Taps. The conflict spreads to Iran, perhaps because of air strikes by Israel or the U.S. on nuclear or other facilities. Iran stops exporting oil. However, the Strait of Hormuz, through which most Persian Gulf oil flows, remains open, and Arab states continue to export.

The Gulf Goes Dry. As in Scenario 2, except that Iran partially closes the Strait of Hormuz. Most Persian Gulf oil shipments are shut down for a period of six months before the vital shipping lane reopens.

The U.S. Gets Cut Off. The Persian Gulf countries join in a selective embargo of the U.S., refusing to export

Gulf Oil Still Dominates World Supplies

The Persian Gulf remains the most important global center for oil production. Although the world uses less oil as a share of total energy production (36% today compared with 44% in 1971),declining production shares in the U.S. and Western Europe have offset the increases from Russia and other regions. The Middle East continues to account for 31% of world oil production, about the same share as in 1980. About 17% of U.S. imports come from the Persian Gulf, with most of the remainder coming from Canada, Mexico, and Venezuela. Iran exports about 2.7 million barrels/day of oil, which is about 3% of world oil production. However, most of the Middle Eastern oil goes through the Strait of Hormuz, a bottleneck between Iran and Oman.

The strait is 21 miles across at its narrowest point, and the shipping channel is only two miles wide, with a two-mile buffer zone on each side of the channel. This strait is the primary outlet for Kuwait, Saudi Arabia, Iran, and much of the Emirates' oil production. If Iran stops exporting oil, OPEC might be able to make up 1 million barrels, but its production is already near maximum. The world and U.S. strategic petroleum reserves (SPRs) can be drawn upon, but that would leave countries completely vulnerable if the conflict spreads further. Estimates for the U.S. from various economic models, including Global Insight and the World Bank, suggest that over the short term, a 100% increase in oil prices reduces oil demand by only about 3%. In addition, the models show that higher prices weaken growth and that a 1% drop in U.S. growth reduces U.S. oil consumption by about 1%.

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* David Wyss is Chief Economist with Standard & Poor's, New York.