Strait of Hormuz Scenario Analysis

Methodology

This analysis uses a computable general equilibrium (CGE) model—essentially a mathematical simulation of the global economy that tracks how a shock in one place (say, Iranian oil going offline) ripples through every sector and trading relationship worldwide. The model is calibrated to 2021 OECD input-output data covering 52 sectors and 46 countries/regions, with energy sectors disaggregated into crude oil, natural gas, petroleum products, and coal separately. When we apply a shock—a sanctions regime, a production disruption, a tariff change—the model finds a new equilibrium: new prices, new trade flows, new output levels across every sector and country simultaneously. It captures substitution effects (buyers switching suppliers), price transmission through supply chains, and macroeconomic feedbacks that simpler models miss.

Scenarios

We modeled four Hormuz-specific scenarios plus one standalone reference case:

S1—Iran Offline, Strait Open. Iranian crude production drops 60% due to tightened sanctions enforcement or internal disruption, while Gulf Arab flows continue with a brief transit risk premium. This is the most probable near-term disruption scenario.

S2—All Flows Free (Sanctions Lifted). A JCPOA-style deal restores full Iranian access to Western markets. Models the upside case: what happens when sanctioned Iranian crude re-enters the legitimate market and buyers like Japan, Korea, and the EU resume direct purchasing.

S3—Full Strait Closure. Iran and Saudi Arabia go offline simultaneously—crude output drops 80% and 70% respectively, with prohibitive trade barriers on all Gulf energy exports. This is the 1973-scale tail risk scenario.

S4—Venezuela Offset Strategy. Tests whether Venezuelan/Western Hemisphere production ramp-up (US shale, Brazil, Canada) can offset tightened Gulf constraints while Iran faces stricter enforcement—the “$60/bbl” thesis.

Iran Unsanctioned (Reference). Sanctions lifted on Iranian crude without broader Hormuz disruption—a pure trade normalization scenario for comparison with S2.

Comparative Results

GDP Impact

GDP effects are concentrated in the directly shocked producers. Even the full strait closure (S3) does not register as a GDP event for the US or China—the global economy adjusts through price and trade-flow reallocation. This does not mean the disruption is painless; the welfare numbers below tell a different story.

Welfare Impact (Equivalent Variation, $B)

Welfare captures the full consumer and producer surplus effects that GDP misses. Key findings:

• S1: China is the biggest loser among importers (-$17.5T EV)—it loses its primary discounted crude source and must substitute at higher cost. The US actually gains (+$1T) as its producers capture higher margins.
• S3: Saudi Arabia's welfare loss (-$345T EV) dwarfs all others—a full production collapse destroys its primary revenue source. The US and ROW gain as alternative suppliers capture massive market share at elevated prices.
• S2: Sanctions relief is a net positive for Iran (+$9.3T) and ROW (+$4.5T), but modestly negative for the US (-$469B) as American producers lose competitive advantage.

Energy Sector Output Changes

Crude Oil Price Changes

Note: Price changes are relative to each region's domestic composite. Iran's price spike in S1/S3 reflects domestic scarcity (supply collapse with captive demand). The negative US/China prices in S3 reflect that these producers are now relatively abundant suppliers compared to the pre-shock world—they gain pricing power in export markets even as global benchmarks rise.

Exchange Rate Effects

S3 produces dramatic exchange rate movements: Saudi Arabia's +196% reflects a massive terms-of-trade shock (its export revenue collapses), while China's -27% reflects its increased need for alternative, more expensive crude sources.

Scenario Narratives

S1—Iran Offline: The Base Case Disruption

Iran absorbs nearly all the pain. Its crude output collapses 82%, domestic crude prices spike 160%, and its currency depreciates 29%. Saudi Arabia and the US pick up export market share but the shock barely registers in their GDP. China is the most affected major importer—it loses its primary discounted crude source (welfare loss ~$17.5T equivalent) and must substitute at higher cost. US producers benefit modestly from price effects and increased export volumes.

S2—Sanctions Lifted: Iran Returns to Market

Iranian crude output jumps 42% as sanctions barriers fall. The biggest losers are ROW crude producers (-16% output) who get displaced by Iranian re-entry, and modestly the US (-1.3% crude output, -$469B welfare). Iran gains $9.3T in welfare. Interestingly, China's welfare is roughly flat—it currently buys Iranian crude at a sanctions discount, so normalization means paying market price for what was previously cheap.

S3—Full Strait Closure: The Tail Risk

This is the catastrophic scenario. Iran and Saudi Arabia's crude output drops 98% and 71% respectively. Saudi welfare loss is enormous (-$345T EV). But the global GDP impact is still small—the model shows the world economy adjusts through trade diversion to US, ROW, and Chinese producers who ramp output significantly. US crude output rises 5.5%, ROW +23%. The US and ROW both gain in welfare terms (+$10.6T and +$10.5T respectively) as their producers capture the displaced market at premium prices.

Important caveat: This 5-region configuration only captures Iran and Saudi Arabia as explicit Gulf producers. UAE, Qatar, Iraq, and Kuwait are absorbed into ROW. A full S3 with all Gulf producers modeled individually would show larger global effects.

S4—Venezuela Offset: The Western Hemisphere Hedge

A mild scenario by design. ROW crude production rises 6.8% (representing Venezuelan/Latin American ramp-up), and the US gains modestly. Iran is squeezed (-10% crude output, -$1.7T welfare) by tighter sanctions enforcement. The key finding: Western Hemisphere supply can partially offset Gulf disruption, but the effect is incremental rather than transformative.

What This Tells You—and What It Doesn't

What the model captures well:

• Relative price adjustments and trade diversion across suppliers
• Which countries gain or lose export market share when a producer goes offline
• Second-order supply chain effects (e.g., petrochemical feedstock costs rising in China)
• Macroeconomic magnitude—whether a disruption is a rounding error or a GDP event

What the model does not capture:

• Short-run price spikes. This is a medium-run equilibrium model. It shows where prices settle after markets adjust, not the $150/bbl spot spike in week one. Real-world overshooting will be worse than these numbers suggest in the short term, and likely milder in the long term.
• Strategic petroleum reserve drawdowns. SPR releases are policy responses that would dampen price effects.
• Financial market contagion. Credit risk, shipping insurance spikes, and speculative positioning are outside the model.
• OPEC+ coordination dynamics. Saudi spare capacity utilization is modeled as a market response, not a strategic decision. In reality, Riyadh chooses how much to ramp.
• Inventory and storage effects. The model has no time dimension for stock drawdowns.

Current run limitation: Results shown are for a 5-region configuration (USA, China, Iran, Saudi Arabia, Rest of World). Country-specific impacts for Japan, Korea, India, and EU members are absorbed into the Rest of World aggregate. Expanding to 8–10 explicit regions will provide granular importer-level results.

Next Steps

• Expand to 8–10 region resolution (Japan, India, Korea, EU as individual actors) for granular importer-level impacts
• Sector deep-dive on petrochemicals and refined products downstream effects
• Sensitivity analysis on elasticity assumptions (how easily can refineries switch crude sources?)
• Time-phased scenario variants (gradual disruption vs. sudden shock)

Model outputs represent equilibrium adjustments conditional on the stated shock assumptions and should not be interpreted as point forecasts. Welfare figures are in model units (billions, calibrated to 2021 OECD data) and represent equivalent variation—the income change that would make each country indifferent between the baseline and shocked world.