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Crude oil prices could sink by as much as $30 a barrel if China decides to buy Iranian crude oil in retaliation to the latest U.S. tariff measures, according to Bank of America Merrill Lynch.

CNBC Aug 5 2019

If true, this seems to imply that the US sanctions are costing consumers an extra $30 per barrel (since removing the sanctions would have the same effect on prices). This adds up to about $1Trillion per year globally. Of course, this is good for producers.

High oil prices are painful to some countries, and higher prices slow economic growth.

Yet, there does not seem to be much concern about the price issue. Why is this? Sometimes people get very upset over smaller price changes.

A rule of thumb from the 1980s: In the short term, a 1 percentage point shortfall in world oil supplies causes a 7 percentage point increase in oil prices. In economics jargon, the price elasticity of oil demand is 1/7.

During the summer of 2019, oil prices ranged between 50 and 60 dollars per barrel, which is between $ 1.20 and $ 1.45 per gallon of crude oil.

Iran is capable of producing 4.5 million barrels per day of oil. During the spring of 2019, the U.S. managed to reduce Iran's oil exports to less than half a million barrels per day. Total world oil production is about 83 million barrels per day.

Thus, the short-term worst case change in oil prices caused by preventing Iran from exporting oil is (4 million barrels per day) / (80 million barrels per day) * 7 * $ 55 / barrel = (5 %) * 7 * $ 55 / barrel = (35 %) * $ 55 / barrel = $ 20 per barrel.

But it has already been five months since the U.S. managed to prevent Iran from selling most of its oil, and the price of oil is now in the 50 - 60 $/barrel range. Over the 12 months from September 2018 through August 2019, the price has ranged from 45 - 75 $/barrel. The peak was in October 2018; the low was in January 2019. Interestingly, the price rose from 45 $/barrel to 65 $/barrel during January - May 2019, which is consistent with my 20 $/barrel estimate of the worst-case effect of cutting off Iranian oil exports.

This is because the North American oil industry (frackers and tar-sand melters) can profitably produce oil in the 40 - 60 $/barrel range. With a lag of a few months to a couple years, North American oil production tends to adjust to keep prices in this range. If the prices are below this range, some frackers go broke, and stop producing; this has the longer lag. If prices are above this range, Albertans melt the tar sands faster.

So over the medium term (several months to a couple years), the market adjusts around an equilibrium price.

Peter Zeihan has given a series of speeches over the last decade about how improving fracking technology changes the strategic calculus of the international oil trade. This Youtube link goes to one of his 2018 presentations.