Gasoline prices in the United States have increased by over 50% since President Donald Trump launched the disastrous Iran war—belying Trump’s insistence that massive U.S. domestic oil production renders the country “totally independent” from Persian Gulf oil and the effects of the Strait of Hormuz closure.
The U.S. is the world’s leading oil producer—and a net petroleum exporter—but U.S. consumers are just as exposed to the Iran war oil price shock as everyone else, thanks to the global nature of the oil market. The Yale economist William Nordhaus has famously compared the global oil market to a giant bathtub with many spigots and many drains, representing petroleum-producing countries and petroleum-consuming countries, respectively. Prices are determined not by which molecules flow into which drains but by the total level of petroleum available in the bathtub. If the oil level rises, prices decrease for everyone drawing supply from the tub. But if the oil level falls—as it has with Iran’s Strait of Hormuz closure effectively “turning off” many Persian Gulf spigots—prices increase for everyone across the market, even those that consumed no Persian Gulf oil at all.
In the context of the global market, then, oil “independence” is an illusion. The U.S. can “drill, baby, drill” all it wants, but as long as it remains connected to the global market, the price-moderating effects of any increased U.S. production would just diffuse across all users of the tub. More pressingly, the U.S. cannot quickly ratchet up output—nor can any other countries except for Saudi Arabia and the UAE, whose spare capacity is located on the wrong side of the Strait of Hormuz. The lead times for new development range from several months to years, even for relatively quick-responding U.S. shale oil producers, who held off on greenlighting new production for the first two months of the Hormuz closure in part because Trump so persuasively talked down markets to keep prices artificially low.
According to the International Energy Agency (IEA), Iran’s suppression of oil traffic through the Strait of Hormuz has removed over 10 million barrels per day, or roughly 10% of total global supply, from the world market—the largest supply disruption ever recorded.
Author
