If Israel Strikes Iran: What Happens to Oil Prices?

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To a surprising degree, financial analysts are now beginning to price the cost to the world economy of an Israeli strike on Iranian nuclear facilities.

Far from the political arena, these economists and analysts are taking a common-sense approach to a potential Israeli strike and asking just how much it will affect the price of global oil.

Greg Sharenow, a portfolio manager at PIMCO, the global investment company, has recently penned a report outlining the four potential scenarios for global oil prices after an Israeli attack.

The following summary appeared Tuesday in the Financial Post.

First scenario: This is the most optimistic. In this scenario, oil initially spikes to US$130-$140 per barrel after Israel attacks Iran, and then settles around US$120-US$125. This would occur if the International Energy Agency steps in and fills any shortfalls in the oil supply. Mr. Sharenow adds, however, that markets need to price in an attack before one occurs for this scenario to play out.

Second scenario: This one is slightly more grim. In it, Iranian exports are cut off for one month following an Israeli attack. This would result in prices reaching previous all-time highs of US$145 a barrel — and potentially even higher. In this scenario, the IEA and Saudi Arabia step in to fill help fill the gap, but uncertainty over capacity still drives oil prices higher. PIMCO eventually sees oil prices settling to US$130-135 a barrel after a few months.

Third scenario: This envisions a serious shock to the Iranian oil supply. Exports are lost for half a year, causing global oil prices to spike to US$150 for six months, with notable spikes above that level. Once the Iranian supply comes back online, PIMCO expects oil to settle back to US$110 or lower, depending on global demand.

Fourth scenario: This is the “Doomsday” scenario. Oil prices soar as Iran responds to the attack militarily. Oil production is not only effected in Iran, but also throughout the region as the ability to move oil through the Straits of Hormuz is affected. PIMCO doesn’t forecast where oil prices will be in this scenario. “Forecasting prices in the prior scenarios is dangerous enough,” Mr. Sharenow said. “So, we won’t even begin to forecast a cap or target price in this final Doomsday scenario. Needless to say, even the modest Scenario 1 is enough to collapse global economic growth.”

Sharenow concludes that an Israeli attack would have either "subtle or profound" effects on the price of oil worldwide. In other words, there is the possibility that an Israeli strike would not grossly affect the price of global oil.

The Obama adminstration is now saying that an attack on Iran's nuclear facilities would be a disaster for the world economy. If Sharenow is right, the White House may have to reconsider its thinking.

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