Aircraft carrier USS George H.W. Bush transits the Strait of Hormuz

The Bipartisan Policy Center (BPC) hosted an event on October 10 to launch its study on the economic ramifications of Iran obtaining nuclear weapons capability. The thrust of the report is that while a military strike to halt Iran’s nuclear weapons program would be costly, inaction also has its costs.

The report takes a look at a region that produces about 18% of the world’s daily oil production, most of which passes through the Strait of Hormuz. Entitled, “The Price of Inaction” the BPC study devised five plausible scenarios that would unfold after Iran obtained a nuclear weapon. The study then assigned probabilities to each scenario and assessed the economic impacts of them – mainly through the effects on oil prices.

The five scenarios include: 1) an emboldened nuclear Iran incites unrest in Saudi Arabia to drive up oil prices; 2) Iran sabotages or destroys Saudi oil facilities to drive up oil prices; 3) Sanctions lapse because preventing Iran from obtaining a nuclear weapon becomes a moot point; 4) Iran and Saudi Arabia engage in a nuclear exchange (assuming Saudi Arabia pursues a nuclear weapon in response to Iran’s capability); and 5) Iran and Israel engage in nuclear exchange.

The analysts assigned probabilities to each scenario, along with the estimated effects on oil prices. Then, through an economic model, they predicted the “risk premium,” which the markets would presumably take into account immediately after Iran obtained a nuclear capability.

The conclusion of the report is that if Iran obtains a nuclear weapon, oil prices could increase 10%-25%, or about $11-$27 per barrel of oil, given today’s prices. Over the subsequent three years, tensions may rise even further, elevating the risk premium to 30%-50%, or $30-$55 per barrel of oil.  This translates to about an extra $1.40 per gallon of gas at the pump.

It is important to note: these price spikes would happen when Iran merely obtains a nuclear weapon. Prices would go up because of the greater risk potential. Should one of the above scenarios actually happen, prices could spike even higher.

However, there are two important caveats. One, the scenario in which sanctions lapse would lead to lower oil prices. In effect, the world learns to live with a nuclear Iran, sanctions are lifted, and more Iranian oil is sent to the world market, which lowers prices. Second, there are so many factors that decide the global oil price; it is extremely difficult to predict what will happen given certain events.

Leaving the non-proliferation and military questions aside, the report has some striking findings for energy security. As Dr. Daniel Ahn, the Chief Commodities Economist at CitiBank, emphasized, the United States remains extraordinarily vulnerable to oil supply disruptions. Despite the significant reduction in reliance on foreign oil, which dropped from around 60% in 2005 down to 42% this year, oil price spikes can still inflict significant harm on the U.S. economy. If oil prices go up by 30% (which BPC predicts is possible under a nuclear-armed Iran), the U.S. economy would shed more than one million jobs and GDP could drop by more than 1%.

This hits on an important point. Even if the U.S. were to become self-sufficient in oil production, which some analysts are predicting over the next ten years or so, our economy would still be severely impacted by events around the world. Conflict between Israel and Iran, or unrest in Saudi Arabia, will cause gasoline prices at the pump to go up in rural America. This is important to remember when we debate energy policy.