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.
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 found that:
- Petroleum prices fell by 15 percent after implementation of the recommendations.
- The U.S. economy recovered approximately 970,000 jobs in the first year and recovered $112 billion of output in the first year.
The results of this second game are described in detail in the following sections:
- Situation and Strategic Environment
- The Crisis Scenario
- Conduct of the Game
- Outcome Trends
- Global Economic Effects
- Lessons Learned and Conclusion
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
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
Why This Exercise?
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
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
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
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.
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
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
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.
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
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
The Road to Crisis
- Al-Qaeda takes 300 pupils hostage at the Ras Tanura Middle School. The next morning the hostage-takers begin executing students.
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 over-pressure.)
explosives-laden plane attacks the Saudi Aramco headquarters,
destroying the Intenet facilities there and killing portions of the
- Indonesia-based Jemaah Islamiyah begins speedboat attacks on oil tankers crossing the Strait of Malacca.
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.
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
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.
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
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.
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 actions.
Player responses were organized into three subcategories:
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
- Economic. These responses have a dominant economic component, such as modifying production quotas, price controls, or rationing.
- Military. Actions include those that directly involve a nation's military assets, or intelligence assets normally under military control.
Table 1 summarizes the actions taken. Click to view Table 1
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.
India and Japan mentioned possible domestic social or political
tensions created by energy scarcities and rapid price increases.
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
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.
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.
combined effect of responses by the U.S. and other participating
countries helps to counter some of the effects of the attack.
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.
disposable income recovers within two years after the attack--compared
to continued lowered inflation-adjusted income two years after the
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.
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
- 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.
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
- 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.
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.
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
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
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 their
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 Insight.
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.
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.
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:
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.
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.
model was solved and results obtained with and without the national
responses. The forecast was used to generate the summary results
James Jay Carafano, William W. Beach et al
., "If Iran Provokes an Energy Crisis: Modeling the Problem in a War Game," Heritage Foundation Center for Data Analysis Report
No. 07-03, July 25, 2007, at http://www.heritage.org/Research/EnergyandEnvironment/cda07-03.cfm.
 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.
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 prices.
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 16, 2008).
See 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