Right now the greatest threat to America's economic recovery and tofurther market gains is the situation in the Persian Gulf. Absentthis danger of higher crude and gasoline prices, investors canreasonably anticipate a durable, if plodding, economic recovery andmodest relief from European debt fears now that the EuropeanCentral Bank has adopted an easier monetary policy. It is, then,the potential economic fallout from higher oil prices, not tomention the shock of a military confrontation, that poses thebiggest risk. If probabilities still favor some easing of tensionsand so continued economic and market gains, the danger issignificant enough to warrant serious attention.

|

It understates the current situation in the Persian Gulf—grosslyso—to describe it as tense. Whatever quibbles emerge among thedifferent intelligence sources, the basic contours are clearenough: Iran is on the verge of getting a nuclear weapon. It hasalready demonstrated rocket technology capable of delivering thatweapon, by some estimates, as far as the United States butcertainly as far as Europe and, of course, Israel. Tehran hasstonewalled all efforts by the United States, the United Nationsand the international community more loosely defined to discoverwhere its program stands or what its intentions are. A sanctionsregime, cobbled together by the United States and major Europeannations, seems to have hurt Iran, despite opposition from Russiaand China. No doubt that pain has prompted the government in Tehranto invite renewed negotiations, though Iran's past behavior leaveslittle reason to expect success. Military action from the UnitedStates, Israel, both of them or even, peremptorily, from Iran,remains a real threat.

|

Even now, well short of those extremes, the current level oftension and the threat it constitutes to ongoing oil flows havepushed up petroleum prices significantly. Since last fall, when thelatest problems with Iran began to mount, the price of a barrel ofoil (West Texas Intermediate) has risen more than 40%, from about$78 to about $110. The price of gasoline has risen almost as much,by 30%, from a national before-tax average of $2.40 a gallon to$3.12. Since according to the Labor Department, fuel of all kindsconstitutes about 9.8% of the average American's budget, this oilprice rise has already siphoned more than $280 billion, or about2.5%, from households' other consumption options. That more thaneats up, as the media widely indicated, the value of the payrolltax-cut extension Congress just recently passed and the Presidentsigned.

|

And these recent strains pale next to what could happen shouldtensions in the Gulf intensify. Even something far short of anoutright military exchange could raise oil prices toward their 2008highs of over $140 a barrel. Iran need only threaten to closetheStrait of Hormuz, and tanker traffic would stop. Regardless ofassurances by the U.S. Navy, insurers would forbid its use, even ifshippers and oil companies were willing to take the risk, whichthey surely would not be. The oil price could stay at that high,too, for as long as such a threat remained in place. If actualshooting were to start, few suggest that the operation would runits course quickly, as attacks would lead to retaliations and thenretaliations to the retaliations. In such an environment, stillmore extreme and lasting oil price hikes would become a significantpossibility after the first exchange of fire.

|

An increase to the 2008 highs would constitute an additional 30%rise in the price of crude, which, especially if it persists, wouldbring wholesale, that is before tax, gasoline prices to over $4.25a gallon. With taxes, the price at the pump could exceed $5 in someparts of the country. Such a jump would redirect another $440billion from other household spending, enough to erase almost anentire year's consumption growth, if it lasted long enough. Openhostilities could, of course, raise prices even farther, almostassuredly stalling the U.S. economic recovery or creating outrightrecession, again if they were to last long enough.

|

With the situation highly unstable, all of this, of course,remains conjecture. The hope—the expectation—is that the powersinvolved can reach a resolution without resorting to militaryaction or even a standoff that prompts insurers to close downshipping. After all, for all the tension to date, oil flows havecontinued uninterrupted. Should such a resolution develop, crudeoil and gasoline prices would certainly drop from today's highs.Though they would not likely recapture the lows of late last year,a wholesale gasoline price of $2.50 a gallon is plausible, or $3.30to $3.50 at retail in high-tax regions. Even if today's level oftension were to sustain current prices indefinitely, it would causelittle more harm than it already has. But until some resolution isreached, risks for much higher prices remain significant. Whateverthe present probabilities, the instabilities demand that investorsstay on their guard and that they make plans for portfolioadjustments, should matters deteriorate.

|

Milton Ezrati is senior economist and market strategist forLord Abbett & Co. and an affiliate of the Center for the Studyof Human Capital and Economic Growth at the State University of NewYork at Buffalo. See more of his articles about the economyhere.

|

Complete your profile to continue reading and get FREE access to Treasury & Risk, part of your ALM digital membership.

  • Critical Treasury & Risk information including in-depth analysis of treasury and finance best practices, case studies with corporate innovators, informative newsletters, educational webcasts and videos, and resources from industry leaders.
  • Exclusive discounts on ALM and Treasury & Risk events.
  • Access to other award-winning ALM websites including PropertyCasualty360.com and Law.com.
NOT FOR REPRINT

© 2024 ALM Global, LLC, All Rights Reserved. Request academic re-use from www.copyright.com. All other uses, submit a request to [email protected]. For more information visit Asset & Logo Licensing.