Single point of failure
The Strait of Hormuz is a chokepoint for oil, but the US economy is built on an even bigger flaw
The US and Israel started a war with Iran. Iran responded by closing the Strait of Hormuz.
About 20% of the world’s oil passes through this waterway, as does 20% of natural gas, and a similarly high amount of fertilizer.
For a very simple model for what could happen to prices, we could imagine what happens if world oil supply goes down 20%. If the elasticity of oil demand is around 0.2, prices triple to about $200 per barrel.
If elasticity is 0.1, prices go up 9 times to about $600. It’s hard to know the right numbers — elasticity for gasoline is even lower than that, in the short term (around 0.05), but if an oil shock lasted for long enough, people would eventually react more.
If oil tripled, US gas might go from $3 to $6 per gallon.
We can also look at previous oil shocks:
That image is already out of date, we’re up about 34% now, on par with other events like the war in Ukraine, but below the 60% from the first gulf war.
But we shouldn’t expect the same increase — this event could remove up to 5 times as much production as those other oil shocks.
I posted some stock recommendations on Twitter. Oil companies outside of the region are the obvious beneficiaries. But chemical companies, natural gas shippers, fertilizer companies will also benefit from the lack of competition. These trends could, of course, reverse quickly if the war were to end quickly.
No end in sight
The quickest fix would come from the US giving up and going home. Trump could probably just tell his supporters that he’d won, and they wouldn’t be smart enough to know the difference.
A slower end might come from Iran losing the war. That might take months, and it might take real risks for the US navy or ground troops. This is an asymmetric warfare situation, where Iran can do a lot of damage with aerial and naval drones, mines, and small boats. It’s much harder for the US to successfully find and bomb every small boat in Iran, or every drone launch point.
The US has tried a number of things to fix the problem.
We’ve tried lying and pretending the war is over — Trump announced the war was “very complete, pretty much” and oil prices went down. Then he held a press conference saying we’d keep bombing and oil prices went up.
We’ve also tried lying and pretending the strait is open. The administration tweeted out that tankers were moving with US Navy escorts:
Then, after oil prices dropped, he promptly deleted the tweet and admitted it wasn’t true. Oil went back up.
You’d have to guess that someone in the Trump admin also did some insider trading, alongside all this.
People on Twitter have also tried lying and pretending that ships are going through, but with their transmitters turned off.
Nope, it’s empty, and the small amount of remaining traffic is probably headed from Iran to China.
Saudi Arabia has tried diverting the oil. They have an east-west pipeline that can handle about 7 million barrels per day:
But it leads to a port that can only handle maybe 1.5 million barrels, and that oil ends up in the red sea, where ships can get threatened by the Houthis if ships try to leave through the south.
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Iran could also just blow up that pipeline. It looks like an easy target — how do you guard hundreds of miles of above ground pipe?
So, there’s no end in sight, and even if the strait were to suddenly reopen, shut down production often takes a month to restart, and the region’s infrastructure is increasingly being blown up.
Gulf states have a different failure point
For the world economy, commodities like oil and fertilizer are key. For people in the middle east, there’s a different point of failure.
90% of Kuwait’s drinking water comes from desalination plants. In Oman, 86%. In Saudi Arabia, 70%. In Israel, 50%. In the UAE, 42%.
It looks like these aren’t single points of failure, there are multiple plants. But targeting enough of this infrastructure is a simple way to cripple a country:
This wouldn’t have as big an effect on the world economy, but it would make for a bigger humanitarian crisis.
Iran is much less dependent than its neighbors, with most water coming from rivers. Nonetheless, it looks like the US and Israel started playing this game first, striking a desalination plant in Iran and triggering retaliation.
The US stock market doesn’t really care, so far
Over the last week, stock markets haven’t change much overall. Two groups of stocks have done well. One is the group that I just mentioned: oil companies and others which will benefit from the Hormuz closure. The other is AI infrastructure, stocks like NVidia, Micron (MU), and Broadcom (AVGO):
Those AI stocks were already doing well. I can imagine people thinking that, even with some short term disruption, these industries will keep doing well in the future.
The world is building AI at an incredible pace, with over 600 billion dollars planned for AI infrastructure spending this year. That money gets spent on chips and other data center components. Here’s where it went last year:
The plan is simple — we’ll take advanced chips, build them into datacenters, run large language models, and use this to automate intelligent thinking. Some jobs will be replaced, some jobs may be created. Either way, we’ll grow our economy to new heights.
We’ll also use this edge in AI to dominate in geopolitics. We’ll use our lead to win any competition with China. We’ll win so much that you’ll get tired of winning.
And we will do this all by manufacturing 90% of those advanced chips on an island just off the coast of China:
AI’s single point of failure is Taiwan
Unlike oil, where only 20% of global supply can be choked off in the middle east, the AI buildout is 90% dependent on chips made in Taiwan.
I can’t help but wonder what Xi Jinping is thinking, while watching the fiasco in the middle east. He sees that the US navy is afraid to get close to the Iranian coast because of missiles and drones, and he knows that China has better anti-ship missiles. He sees that the US has just expended a large stock of guided bombs and missiles. He sees that 2 aircraft carriers are tied down by this job. He sees that the US is moving military assets out of Asia — the US has 8 THAAD missile defense batteries in the world, but Iran blew up the radar for a few of those, so the US is now moving radar away from Korea to use against Iran. He sees that foreign invasions have been legitimized by Russia in Ukraine and then the US in Iran.
It’s often said that China is not prepared to invade Taiwan, and won’t be ready until 2027 at the earliest. While they might be better prepared in the future, they might also face new risks, like weapons and missiles developed by Taiwan and America, maybe swarms of drones operated by superior AI.
The two weather windows for an amphibious invasion of Taiwan happen each year in April and October. That’s when the weather and waves are best for vessels to cross the strait between China and Taiwan.
3 weeks from now, while Trump is still trying to figure out how to bomb Iran into submission, wouldn’t that be the perfect time to invade?
I’m not predicting this will happen — if you offered me 50% odds I’d have to bet against it. But surely the odds aren’t so low, it’s not some less than 1% chance.
There are more likely outcomes. My best guess is that Trump will give up and declare victory after a bit more economic pain. The next most likely scenario is that the war grinds on, while the world economy struggles to adapt. The third most likely is that Iran gives up. But there is a possible black swan event which could be much worse than any of those scenarios.
