Unless you're a geography enthusiast or have ties to the region, there's a better-than-average chance that you've never heard of the Strait of Hormuz. A strait is a small channel of water that connects to larger bodies; in this case, the Persian Gulf and the Gulf of Oman which connects to the Arabian Sea. Iran sits to the north of the strait and the United Arab Emirates to the south.
However, this small body of water has a large impact on world economies. It's the only waterway open to the oil rich countries of the Persian Gulf and with an average of 14 tankers holding 15.5 million barrels of oil passing through the strait each day, it's vitally important for the world's oil supply. Twenty percent of the world's oil passed through the Strait in 2011.
The United States, along with other nations, have grown increasingly concerned that the Iranian nuclear program isn't as non-military as they claim. Iran's refusal to cooperate with United Nations mandates has forced nations to impose trade sanctions against them. On New Year's Eve, these sanctions were further tightened making it increasingly difficult for Iran to sell their oil.
China, one of Iran's biggest customers, has cut their purchases by more than half and EU countries have recently agreed to similar actions. These sanctions have caused the value of Iran's currency to plummet more than 40% and the even tighter sanctions will make the pressure on their economy even worse.
(For more on how trade restrictions and their subsequent effects on an economy, read The Power Of Economic Sanctions.)
In response to these sanctions, Iran has warned that if they can't sell their oil, other nations won't either. They've threatened to block the Strait of Hormuz, preventing oil from reaching the markets. The U.S. as well as the U.K. have pledged to take military action if Iran attempts to block the waterway.
The Effects at the Pump
If Iran attempts a blockade of the Strait of Hormuz, energy analysts believe that oil prices could rise as much as $50 per barrel in only few days, making prices at the pump well above $4 per gallon. Any long-term standoff could have severe economic effects to cash-strapped consumers forced to pay higher prices.
The likelihood of Iran following through on their threat is slim. Iran sends 2 million barrels of oil through the strait each day and any further disruption of their shipments would be catastrophic to their already weakened economy, according to Energy Department analysts. Second, Iran knows that economies all over the world would unite to keep the strait open in order to keep oil prices low. Moreover, Iran's Navy would be no match for the combined militaries of the world.
What may be most devastating is a slow escalation of the conflict causing oil prices to slowly move higher, as they have since the tension began. As insurance companies raise premiums for the tankers, oil companies pay higher wages for crews willing to take the extra risk and the market responds to the political tensions, Iran could accomplish its goals without an actual blockade. (For one insight into the causes of price fluctuations in what you pay at the pump, read What Determines Gas Prices.)
The Bottom Line
The oil market is very sensitive to events like these. Analysts believe that an actual blockade likely won't play out, but tensions may cause pump prices to rise in the short term.