How war with Iran would cause $7 gas

This post comes from Rick Newman at partner site U.S. News & World Report.

If gas prices are still close to $4 per gallon when Election Day rolls around, President Barack Obama will face tough political odds. But Obama -- or his successor -- could end up with a far worse problem than that in the not-too-distant future.

Forecasting firm IHS Global Insight has run a detailed scenario on how a war with Iran would affect oil prices and the global economy, with disconcerting takeaways for anybody sensitive to oil and gas prices -- including politicians.

The forecast says that if a military campaign over Iran's nuclear program prompted Tehran to lay mines in an attempt to shut down the Strait of Hormuz, Brent crude prices could soar from current levels of about $125 per barrel to a peak of roughly $240. Gas prices would rise by the same magnitude -- pushing them above $7 per gallon.

In the model, oil and gas prices probably wouldn't stay at those levels for long. Any major disruption of oil markets by Iran would likely bring a rapid and overwhelming response by the U.S. military, including attacks by ships and aircraft already stationed around the Persian Gulf. IHS predicts U.S. forces would probably be able to reopen the Strait of Hormuz, the world's most important oil chokepoint, in four weeks or less. But it would still take months for oil prices to settle back down to normal levels, while consumers and businesses grappled with collateral damage to their finances.

Most economists estimate that the threat of confrontation with Iran has already pushed oil prices up by about $20 per barrel. In the United States, gas prices have risen by nearly 55 cents per gallon so far this year to a national average of $3.88. In addition to hurting consumers, that impacts investors, speculators and business leaders, who are all intently focused on oil prices and where they might be heading. (Post continues below.)

In its scenario, IHS assumed that Iran will use mines, missiles and small-boat swarming tactics to shut down the Strait of Hormuz, through which about 20% of the world's traded oil flows every day. That could come in response to a U.S. or Israeli pre-emptive attack on Iran's nuclear facilities, but Iran could also make such an aggressive move on its own.

"Iran's leaders have done things that we expect rational leaders to avoid doing," Farid Abolfathi of IHS told clients in a recent presentation. "They might miscalculate or misjudge their chances of success."

Even though the model predicts U.S. forces could probably reopen the strait fairly quickly, it might still take a while to completely defeat Iran. Mines are notoriously tricky to clear and some could lurk undetected, threatening tankers for months. Iranian submarines and small attack boats could hide amid a large fleet of civilian fishing vessels in dozens of villages and island harbors, mounting follow-up attacks on tankers and U.S. ships.

The forecast also says that if oil were to rise to more than $200 a barrel, it could induce panicky consumer behavior, such as drivers topping off their gas tanks regularly out of fear that gasoline might run out. Lines at gas stations reminiscent of the 1970s could reappear. Pump prices would rise in line with oil prices, and stock markets could easily fall by 10% or 20%, possibly spurring a new recession.

IHS goes on to predict there would also be urgent efforts to relieve the supply crunch, such as a generous release of oil from emergency reserves in the United States and Europe. Saudi Arabia would be pressured to tap all the spare capacity it has and export as much as possible via pipelines that run to the Red Sea. Many nations would institute rationing schemes and strict conservation measures.

Those actions, combined with the rollback of the Iranian military, would bring oil prices down to an average of about $160 per barrel for three months or so, then back to around $120, IHS believes. So the whole affair might rattle markets for six months or so, and perhaps end with something like a return to the status quo.

If it were to happen, the timing could upend U.S. politics. A war with Iran in the fall, leading up to the elections, would intensify the financial pain soaring gas prices have on the typical American family, with gas costing a household an extra $100 per month or more. But a surge of patriotism might offset that, electorally speaking, helping Obama more than it hurts him.

IHS assume that its scenario takes place at the beginning of 2013, which would saddle the U.S. president with one more tough and complex problem at the same time that momentous decisions about tax cuts (or hikes) need to be made, and big cuts in federal spending are due to kick in. Wriggling out of a recession under that blend of economic pressures would be an impressive Houdini act for whoever is president in 2013.

There's one other scenario, of course: Some kind of diplomatic resolution that avoids a military confrontation and pushes oil prices down instead of up. That would mean politics as usual, which is ugly enough. But the politicians, at least, would have one less thing to argue about.

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