In June 2008, The Heritage Foundation invited energy scholars
and policy experts to participate in a computer simulation and
gaming exercise assessing the economic effects of a global
petroleum energy crisis. The exercise was similar to the previous
energy study conducted from 2006 to 2007, but larger in geographic
and economic scope.
The Heritage team simulated the effects on world oil supplies,
demand, and prices after a major terrorist attack on oil exports
from Saudi Arabia and resulting disruption of oil shipping lanes
between the Middle East and major Asian economies. Analysts at The
Heritage Foundation's Kathryn and Shelby Cullom Davis Institute for
International Studies developed the crisis scenario, while analysts
in Heritage's Center for Data Analysis (CDA) measured the effects
of these disruptions on the U.S. economy and found:
- The price of petroleum in the U.S. spiked very quickly from the
price of $127 per barrel on the day of the game to a high of $244
per barrel just days later.
- This price increase caused a rapid slowing of the U.S. economy,
seen in a drop in employment of approximately 1.5 million jobs in
the first year and an average drop in inflation-adjusted gross
domestic product (GDP) in the first year of $119 billion.
The scholars and policy experts recommended steps the U.S. and
other countries could take to mitigate such adverse economic
effects. CDA members analyzed these policy recommendations with the
same economic model used to make the initial impact estimates. They
- Petroleum prices fell by 15 percent after implementation of the
- The U.S. economy recovered approximately 970,000 jobs in the
first year and recovered $112 billion of output in the first
The results of this second game are described in detail in the
- Situation and Strategic Environment
- The Crisis Scenario
- Conduct of the Game
- Outcome Trends
- Global Economic Effects
- Lessons Learned and Conclusion
This project was a "proof-of-principle" investigation. It
combined computer modeling and gaming to capture the economic
impact of a sudden petroleum-supply disruption. By design, the
magnitude of the disruption was to be catastrophic--well beyond
what excess petroleum capacity and strategic petroleum reserves
could easily absorb.
The purpose of the gaming exercise was to provide input data for
an economic model to estimate net impacts of 1) the shock (the
terrorist actions) and 2) the policy responses. As such, the study
focused on the economic and diplomatic reactions of the player
nations, and the subsequent implications. Military reactions by
players were minimal. The exercise incorporated a plausible
scenario that caused an immediate petroleum-supply interdiction of
approximately 10 to 15 percent of global production, or 8 to 12
million barrels per day (mbd), with residual effects that would
disrupt approximately 4 mbd for several months.
The project demonstrated the feasibility of modeling the
economic consequences of crisis decision making and responses
during an oil-price shock induced by a terrorist attack. At the
same time, the game emphasizes that much more exploration is needed
of 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- and public-sector
responses to other foreign policy challenges.
Why This Exercise?
Demand for oil is no longer driven exclusively by developed
economies like the United States. China, India, other developing
countries, and energy producers themselves are transforming global
energy markets through their sheer size and pace of growth.
According to the Paris-based International Energy Agency (IEA),
between now and 2030, China and India will account for 70 percent
of the new global oil demand; their combined oil imports will
skyrocket from 5.4 mbd in 2006 to 20 mbd in 2030--overtaking the
current combined imports of Japan and the United States. Thus,
an evaluation of any potential responses to an energy crisis must
include exploration of the actions of major consumer nations,
energy producers, and geo-strategic powers as well as of sub-state
and transnational non-state actors that will shape the military and
diplomatic agendas, as well as energy policies. The goal of this
proof-of-principle exercise was to model a multi-player response to
an energy crisis.
Situation and Strategic Environment. Catastrophic
destruction of the Ras Tanura port and oil terminal in Saudi Arabia
would achieve a loss of more than 4 mbd for at least several
months, and as long as the terminal remains non-functioning. Two
principal choke points--the Strait of Hormuz at the mouth of the
Persian Gulf and the Strait of Malacca between Indonesia and
Malaysia--transport a combined 28 million barrels of petroleum per
day. Interdicting either of these choke points would cause a
short-term loss of global petroleum supply on the order of 8 to 12
mbd. Together, these events achieved the desired results for the
purpose of the exercise and study.
Represented in the game were the United States, the European
Union, China, Japan, India, Australia, and the Organization of
Petroleum Exporting Countries (OPEC). They were chosen both because
they represented major energy-producing and -consuming nations, and
because they are key geo-strategic players in responding to
regional events in the Middle East and South Asia. In particular,
each player is a significant energy consumer or producer, with the
exception of Australia, which was chosen due to its strategic
proximity to the Strait of Malacca. During the game, the players
were represented by teams of policy and academic experts. Each
national player was represented by a team of two to four
subject-matter experts. In some cases, the teams represented more
than one nation, such as OPEC or the European Union. To limit the
complexity of the exercise, several nations, including Russia,
Brazil, and Venezuela, were omitted.
The United States was among the most important of the players.
The United States receives most of its imported petroleum from
Canada, Mexico, and Venezuela, and less than 20 percent of U.S.
imports are from the Middle East. But as the world's largest
consumer of petroleum, the United States would be affected by any
loss of global supply that cannot be absorbed by the limited excess
capacity. Oil prices around the world are set by the globalized
markets. Any reduction in global supply will elevate prices for all
consumers, including those in the Western Hemisphere.
European nations import slightly more than 3 mbd from the Middle
East. Like the United States, they would be affected by any supply
interruption, since a reduction in global supply affects all
consumers as prices increase. This is especially true for the EU,
since its other major supplier is Russia (6 mbd), which has shown
no reluctance to raise prices for oil and natural gas exports when
given the opportunity.
Japan and China are heavily dependent on Middle Eastern oil,
specifically on petroleum transported by tanker through the Strait
of Malacca. China imports approximately 4 mbd, of which 2.2 mbd
traverse the Strait; while 4.2 mbd of Japan's imported 5.4 mbd
traverse the Strait. The energy vulnerability of Japan and China is
also mirrored by other developed nations in the Asia-Pacific
region, such as South Korea and Taiwan.
India imports nearly 2 mbd of the 2.5 mbd it consumes. Most of
this petroleum comes from the Middle East through the Strait of
Hormuz. India is also dependent on Mideast liquefied natural gas
(LNG) for electric energy generation to fuel its rapidly growing
economy. India has one of the largest economies in the world and
would be doubly affected by production degradation in the Persian
Gulf and by supply interdiction of the Strait of Hormuz.
Australia plays a unique role in the Asia-Pacific region. It is
the largest Western nation near the Strait of Malacca, it maintains
close diplomatic and economic ties to other developed nations in
the region, especially China, and it has been the previous target
of attacks by the Islamist terrorist group Jemaah Islamiyah.
Australia is very active in offshore exploration and production of
oil and natural gas, and has recently started importing small
amounts of crude oil due to a growing economy. Tankers that bypass
the Straits of Malacca and Sunda must travel by the island of Bali,
much closer to Australia.
OPEC remains an influential organization with a pivotal role in
the global economy. Members of OPEC provide approximately 41
percent of global oil production with key members located in the
Middle East, and much of its petroleum exports flowing through the
Strait of Hormuz. The most prominent member of OPEC is Saudi
Arabia--the largest exporter of crude oil and the historic provider
of global excess capacity, the production "cushion," that has kept
oil prices relatively stable for decades. Of the 86 mbd of global
production, 17 mbd (nearly 20 percent) flow through the Strait of
Hormuz from OPEC nations.
The Crisis. For this exercise, players were given a
supply-disruption scenario that was caused by a plausibly
successful coordinated terrorist attack conducted by the remnants
of al-Qaeda and an affiliated political group operating in Pacific
Asia, Jemaah Islamiyah. The intent of the attack is to cause an
immediate shock to the global petroleum transportation system, with
persistent effects that reduce petroleum throughput from producing
nations to consuming nations. The desired result of this
coordinated attack is to cause economic failure of oil-consuming
nations, fracture Western alliances, and cause economic and
political confrontation between Western nations and the Middle
Eastern Islamic states. This result is consistent with al-Qaeda's
previously established strategic goals.
The Road to Crisis
- Al-Qaeda takes 300 pupils hostage at the Ras Tanura Middle
School. The next morning the hostage-takers begin executing
- While Saudi security forces are distracted, al-Qaeda launches
simultaneous attacks on oil-processing and shipping facilities.
These are thermobaric explosive attacks on the Ras Tanura and Abu
Qaiq facilities, destroying parts of each. (Improvised thermobaric
weapons are containers of fine explosive particles or liquids that
burst open the container and disperse the contents in a cloud and
then ignite, creating a downward destructive wave of
- An explosives-laden plane attacks the Saudi Aramco
headquarters, destroying the Intenet facilities there and killing
portions of the company's leadership.
- Indonesia-based Jemaah Islamiyah begins speedboat attacks on
oil tankers crossing the Strait of Malacca.
- Jemaah Islamiyah places EM-52 mines in the Strait of Malacca
(near Singapore). The mines are coated with polymer to reduce the
likelihood of detection.
- All oil traffic through the Strait of Malacca is stopped
because insurers will not give coverage to hydrocarbon cargo.
- Al-Qaeda affiliates place mines in the Strait of Sunda to
further disrupt traffic.
The results of the coordinated attack were: 1) the catastrophic
destruction of the Ras Tanura terminal and subsequent reduction in
traffic through the Strait of Hormuz, and 2) the closure of the
Straits of Malacca and Sunda with traffic detouring more than 1,000
kilometers to reach the refineries and terminals of Southeast Asian
consumers. Transportation delays and costs increase across the
globe as producer and consumer nations implement increased security
measures in order to cope with the new types, sophistication, and
brutality of al-Qaeda- Jemaah Islamiyah attacks.
The following occurred as a result of the disruptions.
- Six million barrels per day of oil production has stopped.
- Fifteen million barrels per day can no longer be shipped
through the most direct routes.
- Saudi Aramco insists on being the only contractor for repairs
at the damaged facilities.
The U.S., U.K., Japan, India, China, and Australia deploy naval
and special forces operations to the Strait of Malacca to hunt down
sea-borne and land-based terrorist teams and to conduct de-mining
operations. This takes three months.
Conduct of the Exercise
After the players read and discussed the initial scenario and
its effects on their nation or organization, they separated into
break-out groups. In the first break-out, each team of nation
players further discussed and recorded its short-term actions.
Limited communication was allowed between nation players to
replicate diplomatic dialogue.
After the first break-out discussion, all teams of nation
players reconvened to brief each other on their respective actions.
Nation players were not required to reveal their diplomatic
dialogue. Once the actions were discussed by Heritage staff, the
teams returned to their break-out groups to determine long-term
Player responses were organized into three subcategories:
- Diplomatic. The actions of a nation player have a
dominant diplomatic component if, for example, they encourage
actions primarily by other nations or organizations. Encouraging
imposition of economic sanctions, for instance, is listed as a
diplomatic action in spite of its obvious economic effects and
possible military implications necessary for enforcement.
- Economic. These responses have a dominant economic
component, such as modifying production quotas, price controls, or
- Military. Actions include those that directly involve a
nation's military assets, or intelligence assets normally under
Table 1 summarizes the actions taken.
Click to view
In exploring how crisis decisions might be made in a
multi-player environment, the following practices and trends
emerged over the course of the game:
- Nation players tended to seek cooperation with other nation
players and took few unilateral actions to secure energy resources.
Not one nation player stated he would take military action to seize
or capture additional energy resources.
- Several non-U.S. players advocated engagement with Iran in
order to fill supply void.
- Only India and Japan mentioned possible domestic social or
political tensions created by energy scarcities and rapid price
- Most nation players sought actions to develop more diverse
sources of energy supply, also greater efficiency measures and
technology leaps. The exception was OPEC.
- Nations with pre-existing pipelines to developed supplies will
have a distinct competitive advantage over those who rely on
seaborne tankers to import energy. The United States and the
European Union have more secure energy supplies than do China,
Japan, or Asia. This may produce tensions among competing consumers
in the Asian region. It may also produce military alliances that
have energy security as their basis.
Global Economic Effects
The interruption of the energy supply results in a dramatic
increase in the world prices of petroleum. Absent any credible
national and multi-national policies, there will be major declines
in the economic output of the United States and other industrial
countries, as well as rapid impoverishment of developing economies.
Without enough energy to maintain current GDP levels, 592,000
workers lose their jobs at the outset and household income falls by
$309 billion in the quarter with the lowest income. These effects
were simulated using the Global Insight model. Heritage analysts
worked with energy specialists at Global Insight, a prominent
forecasting company, to determine what the reduced supply would
mean for the world price of crude oil. The analysts then set up a
simulation experiment to forecast the effects on some of the major
U.S. macroeconomic variables.
The U.S. and other countries' responses were then analyzed by
the Heritage team in terms of their likely economic impact. Oil
withdrawals from the Strategic Petroleum Reserves made up for part
of the lost world supply and mitigated the increase in the world
price of oil. The simulation experiment was then re-run with the
effects of these economic responses incorporated. The effectiveness
of the players' responses to the crisis are illustrated in Chart 1.
The graphs show both the devastating economic impact of the attacks
on the U.S. economy without any policy response, and the less
severe economic decline with a policy response.
The combined effect of responses by the U.S. and other
participating countries helps to counter some of the effects of the
- Job losses recover a year after the attack--compared to
continued significant job losses two years after the attack if the
U.S. and other countries do not respond.
- Inflation-adjusted GDP recovers within a year-- compared to
persistently lower output for two years after the attack.
- Inflation-adjusted disposable income recovers within two years
after the attack--compared to continued lowered inflation-adjusted
income two years after the attack.
The immediate and effective economic responses of the various
countries make it possible for them to accommodate much of the
short-term energy demands, while investment is mobilized for swift
recovery efforts in the meantime. The military deployments in
conjunction with all the investments made to rebuild damaged
infrastructure help contain job losses by mobilizing the labor
force for these reconstruction projects. Without these economic,
diplomatic, and military responses, an average of 406,000 jobs are
lost in the first year compared to an average of 164,000 jobs lost
with the response. These investments allow inflation-adjusted GDP
to grow, and finally real-income growth as investments start to pay
off in positive returns around two years after the attack.
The consequences of an energy disruption on a scale depicted in
this exercise were devastating and would no doubt have a profound
and lasting impact on the global economy. Without question, the
United States and its allies would have to exercise decisive and
effective leadership to deal with the crisis. The results of this
exercise illustrate the magnitude of the challenge:
- As governments and the private sector direct national resources
to deal with the second- and third-order effects, they will have
more success following the market than with a command economy. That
is, the more that nations rely on market principles to direct
resources, the faster the global economy will recover. But reliance
on market principles is unlikely. Expecting market-based responses
ignores most of recorded history, and is counterintuitive to human
nature. All nations will have domestic constituencies that advocate
greater centralized control of national assets for the sake of
national security. Contrary to the game's players, it will be
extraordinarily difficult for national leaders who advocate liberal
economic policies to survive their own internal politics. After the
crisis begins, it will be too late to educate the general
population about market principles. They must have this
understanding beforehand. Public information on handling energy
crises needs to be developed in advance and promptly implemented as
the crises erupt.
- While nations contemplate short-term and long-term economic and
diplomatic responses, military contingences, such as destroying the
most dangerous terrorist organizations' cells, deploying naval
assets to conduct mine-sweeping operations, and escorting tankers
through maritime choke points, need to be implemented.
- During a period of crisis, non-Mideast petroleum exporters,
such as Russia, Norway, Nigeria, Venezuela, and Brazil, could well
have greatly increased influence as consumer nations compete for
scarce energy supplies.
- Global economic disruptions would make many long-term actions
improbable, such as Japan's proposed regional strategic reserve in
northeast Asia, or India's proposed pipelines to connect to Central
Asian energy reserves through Pakistan.
- Nations will contend for breakthrough energy research and
development (R&D), but will have fewer national resources to
allocate to development given declining economies. Thus, looking to
a crisis to spur the drive for alternative energy sources appears
an impractical strategy. Alternative energy R&D needs to be
undertaken during peacetime and relative economic prosperity.
The Heritage game demonstrated the vulnerabilities of the global
system's capacity to produce and deliver oil supplies to a
concerted transnational terrorist threat. This exercise also
suggests that major producer and consumer nations and key
geo-strategic allies acting in concert with one another while
protecting their own national interests could ameliorate the
severity of long-term disruptions. Reliance on market forces and
coordinated security activities did much to help restore the
confidence of markets and consumers.
William W. Beach is
Director of the Center for Data Analysis at The Heritage
Foundation; James Jay
Carafano, Ph.D., is Assistant Director of the Kathryn and
Shelby Cullom Davis Institute for International Studies and Senior
Research Fellow for National Security and Homeland Security in the
Douglas and Sarah Allison Center for Foreign Policy Studies at The
Heritage Foundation; Ariel
Cohen, Ph.D., is Senior Research Fellow in Russian and Eurasian
Studies and International Energy Security in the Douglas and Sarah
Allison Center for Foreign Policy Studies; David W. Kreutzer, Ph.D.,
is Senior Policy Analyst for Energy Economics and Climate Change in
the Center for Data Analysis; Karen A. Campbell, Ph.D.,
is Policy Analyst in Macroeconomics in the Center for Data Analysis
at The Heritage Foundation; and Hopper Smith is a consultant to The
This energy simulation was built on the simulation of a previous
game, during which the impact of the U.S. response was estimated.
The technique used to introduce the effects of the oil price shock
and the contribution to domestic oil supply from the Strategic
Petroleum Reserve (SPR) can be found in the report by James
Carafano and William Beach. The procedure for the initial simulation on
which this current simulation is based was performed in three
steps. Each step produced a new state of the economy (from the
original baseline) in order to simulate the new economic reality
the U.S. economy would face if such a crisis occurred. Given this
new state, policy recommendations from the participants were
implemented and the impact of these recommendations on the "crisis
state" of the economy could thus be studied. Following is a
description of this process from the original report and
then the method used in the present study for incorporating the
policy recommendations from the rest of the world and assessing
Step 1. To simulate the effects of the oil price shock,
the Heritage Foundation economics team introduced the change in oil
prices and the contribution to domestic oil supply from the SPR
into the Global Insight model. They then directly changed three
separate oil prices in the model: the weighted average price of
imported crude, the weighted average price of domestic crude, and
the average price of West Texas Intermediate (WTI) crude. All three
were assumed to deviate from baseline levels by the same amount;
namely, the change in WTI crude oil prices forecast by Global
The contributions to the domestic oil supply from the SPR were
also calculated by Global Insight. They were converted to
quadrillion BTU before they were input into the GI model.
In Step 1, the team assumed that the Federal Reserve would
adjust the effective federal funds rate in response to changes in
the civilian unemployment rate and the rate of Consumer Price Index
(CPI) inflation. They next imposed the model's monetary reaction
function that mimics the actions of the Federal Reserve.XREF
Heritage economists excluded the GI model's exchange rate
variables, solved the model, and used this new forecast as the
starting point for Step 2.
Step 2. The team adjusted the response of real
non-residential investment in mines and wells on the advice of
economists at Global Insight. Global Insight recommended this move
because in the current version of the Global Insight model, this
variable is very responsive to oil price shocks. As a result of
these discussions, the team cut the mines and wells variable by
half from the baseline forecast. They then ran the model again with
these adjustments, and the new forecast was used as a starting
point for Step 3.
Step 3. Next, the team neutralized the relative price
effects of oil-related energy products and adjusted world GDP to be
consistent with these prices. U.S. trading partners would likely
face the same price changes as the U.S. and take similar hits to
their GDP from an oil price shock. Neutralizing the relative price
effects and adjusting world GDP helped to ensure that the final
simulation results reflect these shared effects.
The team neutralized the relative price effects by adjusting the
baseline. They made adjustments, first, by calculating the
deviation from baseline in the Global Insight model's variable for
the U.S. Producer Price Index excluding energy and, second, by
applying that deviation to the model's two variables for foreign
producer price indices.
They adjusted foreign GDP in the model by modifying key indices
of the real trade-weighted GDP of U.S. trading partners. The team
then solved the model and saved the forecast. This new forecast was
used to generate the summary results spreadsheets.
The policy prescriptions of all teams were analyzed for
quantifiable impacts on the U.S. economy. These impacts came from
two main areas: 1) policies that affect petroleum price and 2)
domestic policies that change U.S. government spending. The
economic impact of the world's response in conjunction with the
U.S. response on the U.S. economy was simulated using the Global
Insight 30-year macroeconomic model as follows:
a) Building on the previous simulation, the Heritage team
estimated the impact of the world's increased supply response on
the import price of oil by assuming a short-run vertical supply
curve and an elasticity of demand equal to 0.08. The effect of 3
million barrels per day released into the world market lowered the
import price of oil by 15 percent. The previous import price
(estimated from the reduction in supply from the attack) is also
reduced by 15 percent and made exogenous.
b) The United States military response has an economic impact
since higher military involvement will increase government
spending. This increased spending was estimated by the team to be
$30 billion per quarter for 10 quarters (until the end of 2010).
The national defense spending variable was increased by this amount
and made exogenous.
c) The model was solved and results obtained with and without
the national responses. The forecast was used to generate the
summary results reported above.
International Energy Agency, "World Energy
Outlook 2007: China and India Insights," 2007, p. 48.
Figures for individual and regional petroleum
production, transportation, and consumption taken from:
International Petroleum Encyclopedia 2007, Joseph Hilyard,
ed. (Tulsa, Okla.: PennWell Corporation, 2007). Table 7, World Oil
Trade Movements, on page 418 was particularly useful.
While these nations certainly have a
significant interest in the flow of global petroleum, they were not
in proximity to the Straits of Hormuz or Malacca. For the purpose
of the exercise, their reactions were assumed to be rational, and
that they would continue maximum petroleum production at elevated
2002 Bali bombing was conducted by Jemaah Islamiyah in support of
al-Qaeda's strategic goals. It targeted Australian tourists
vacationing in Indonesia, resulting in 202 civilian deaths. For
more information, see numerous articles by Dana Robert Dillon
including, "Bali Bombings: Self Inflicted Wounds?" Heritage
Foundation Press Commentary, October 18, 2002, at http://www.heritage.org/Press/Commentary/ed101802.cfm.
Also see "Bali Nightclub Bombing," GlobalSecurity.org, at http://www.globalsecurity.org/security/ops/bali.htm (October
the Appendix for the experiment methodology.
Carafano and Beach, "If Iran Provokes an Energy
Crisis: Modeling the Problem in a War Game."
methodologies, assumptions, conclusions, and opinions presented
here have not been endorsed by and do not necessarily reflect the
views of the owners of the Global Insight model or their employees.
Fortune 500 companies and numerous government agencies use
Global Insight's Short-Term Macroeconomic Model to forecast how
changes in the economy and public policy will likely affect major
economic indicators. Additional information on the simulation
methodology is available upon request.