MUST READ: IF IRAN PROVOKES AN ENERGY CRISIS: MODELING THE PROBLEM IN A WAR GAME

If Iran Provokes an Energy Crisis: Modeling the Problem in a War Game
by James Jay Carafano, Ph.D. and William W. Beach
Center for Data Analysis Report #07-03
and
Ariel Cohen, Ph.D., Lisa Curtis, Tracy L. Foertsch, Ph.D., Alison Acosta Fraser, Ben Lieberman, and James Phillips

From December 2006 to March 2007, Heritage Foundation scholars conducted a computer simula­tion and gaming exercise that examined the likely economic and policy consequences of a major oil disruption in the Persian Gulf. The exercise utilized a realistic scenario, state-of-the-art macroeconomic modeling, and a knowledgeable team of subject-matter experts from government, business, aca­demia, and research institutes from around Wash­ington, D.C.

This project was a proof-of-principle investiga­tion that combined computer modeling and gaming to capture how U.S. decisions during a crisis might affect how global energy markets and the U.S. econ­omy adjust to sudden and significant disruptions of oil supplies. In this scenario, the United States responded to a crisis precipitated by an attempted Iranian blockade of the Strait of Hormuz.

The game began with a series of economic results based on a scenario in which Iran began blockading the Strait of Hormuz in January 2007. The assump­tion was that Iran may succeed in fully blockading the strait for up to one week, but after that, some oil shipping would slowly resume.

The Heritage Foundation economics team, sup­ported by analysts at Global Insight, then modeled the blockade's likely economic effects on world oil prices and the U.S. economy. They found that under worst-case circumstances:

• The price of West Texas Intermediate (WTI) crude[1] would peak in the third quarter of 2007 at $150 per barrel, an increase of $85 per barrel;
• Real (inflation-adjusted) gross domestic prod­uct (GDP) would fall by over $161 billion in the fourth quarter of 2007;
• Private non-farm employment would decline by over 1 million jobs by the middle of 2008; and
• Real disposable personal income would be more than $260 billion lower by the fourth quarter of 2007.

With this set of economic forecasts, the game par­ticipants devised policy responses to mitigate the oil price shock and subsequent economic harm. They recommended a number of policy moves, which are described later in this report. The economics team ran new economic simulations based on these pol­icy responses and found that:

• The price of WTI crude would peak in the first quarter of 2007 at $75 per barrel, an increase of less than $12 per barrel;
• Real GDP would remain at roughly non-crisis levels during 2007;
• Employment would expand by 109,000 in 2007; and
• Real disposable personal income would grow at non-crisis rates during 2007.
  

The project demonstrated the feasibility of mod­eling the economic consequences of crisis decision making and responses during an oil price shock induced by a hostile foreign government. At the same time, the game emphasizes how much more work is needed to explore how various combina­tions of political, military, diplomatic, and eco­nomic initiatives might affect the course of a global energy crisis. The Heritage Foundation plans to ex­pand and refine its simulation and modeling tools to evaluate international responses, environmental consequences, and private-sector and public re­sponses to other foreign policy challenges.

The results of the game also suggest that an offi­cial response to an actual crisis based on an Iran blockade of the strait might be effective. The experts who played the roles of the U.S. government offi­cials opted for a focused but restrained use of mili­tary power oriented toward objectives that directly addressed vital national interests and that were clear, relevant, and obtainable. This use of force demonstrated the U.S. determination to uphold freedom of navigation in the Strait of Hormuz. The American response did much to calm global markets and reassure American consumers.

In addition, the experts chose to take a minimalist approach to interfering in U.S. domestic markets. They focused primarily on liberalizing domestic energy policies and rolling back regulatory restric­tions. They also strove to propose policy changes that would minimize fears over shortages beyond the immediate crisis. In this exercise, the combina­tion of a determined but limited military response and minimal government intervention ameliorated the economic consequences of the crisis.

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Pertinent Links:

1) If Iran Provokes an Energy Crisis: Modeling the Problem in a War Game