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2. Iran Shuts Its Taps

In the second scenario, Iran stops exporting oil. This could be in response to a strike on its nuclear facilities, a retaliation against the West for supporting Israel, or internal disruption in Iran. In any case, Iran takes its 2.7 million barrels of oil exports off the market.
World oil prices soar, probably to above $100/barrel temporarily but settling near $95/barrel. Near the end of next year, oil prices begin to decline, presumably as Iran returns to world markets, and fall back to $66/barrel by the end of 2008. Scenario 2's impact on the U.S. is substantial, with a near-recession starting in the fourth quarter and continuing through mid-2007. Higher oil prices take 1.8% off the level of real GDP by the third quarter of next year and add 3.3% to the level of the CPI a year later. The impact on the Eurozone economies is smaller than the U.S. response, with real GDP cut by a maximum of 1.0% and the CPI up 2.0%. The Japanese price effect is similar to Europe's, but GDP is cut 1.2% because of the greater reliance on oil and on imports.

3. The Gulf Goes Dry

In this scenario, Iran closes the Strait of Hormuz to oil tankers. Oil prices spike sharply. World oil supplies would be cut by about 20%. World SPRs are tapped extensively, but even so, oil prices rise to $250/barrel. The world economy moves into recession, on the order of the 1980-1982 downturn. The U.S. is the hardest hit of the major economies, with real GDP dropping 5.2% below the baseline in late 2007, implying a major recession, and the unemployment rate reaching 7%. Consumer price inflation hits 10% next year as oil prices soar.

The impact on Europe is smaller, but because the Continent started with weaker growth, the recession is just as big. Japan has a recession of similar size. Both in terms of the price effect and the supply impact, the models are being pushed well outside their historical range, and the dislocations could be even more painful than this projection implies. This is by no means a worst-case scenario but closer to a best case given the closure of the Strait. We think (and certainly hope) this is an unlikely scenario.

4. The U.S. Gets Cut Off

The fourth scenario involves an oil embargo against the U.S. begun by Iran but then accepted by the other Arab nations, perhaps because the threat of closing Hormuz brings them into line. Without cooperation from other oil-exporting nations, the impact would be minor because the U.S. gets only about 17% of its oil from the Middle East. We assume, however, that Venezuela goes along, thus increasing pressure on the U.S.

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