Oil, Guns, and Iran

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Meanwhile, the U.S. and the U.N. are also putting more pressure on Iran over its nuclear program. This past weekend the U.N. Security Council passed a resolution imposing sanctions on the country. And President George W. Bush has linked sectarian violence in Iraq with Iran and indicated he doesn't rule out any option to ensure Iran doesn't develop nuclear weapons. Analysts say the price volatility will continue as long as tensions remain high.

How Bad Can It Get?

The worst-case scenario? For the oil markets, it would be an all-out war between the U. S. and Iran, which would send prices soaring. That certainly is unlikely. But traders are thinking through every possibility these days. At issue in this scenario is not just Iran, but the key strategic gateway to the Middle East's oil supply: the Strait of Hormuz. If there's a blockage of the strait, oil from not only Iran, but also Kuwait, Iraq, and Saudi Arabia could be disrupted—potentially cutting off more than 20 million barrels of oil a day. In that case, prices could surge to $80 and only relent when demand "comes to a screeching halt," says Gheit.

Even if a full conflict doesn't break out, there's a lot of gray area between war and peace that could send oil prices higher, at least temporarily. "There are a variety of things the countries could do short of shooting at each other," says Gal Luft, co-director of the Institute for the Analysis of Global Security in Washington. Luft says for example that a rogue element within the Iranian navy could plant a bomb in the Strait of Hormuz, causing temporary panic in the market. "It could be a case of political posturing—sending a signal to the West that there would be serious consequences to the world economy if you think of using force against Iran," says Luft.

Even if tensions with Iran resolve themselves tomorrow, that won't eliminate the volatility in the oil markets of the day. "It's all very jumpy," says Luft. "Traders are responding to any rumor. But I believe this crisis will resolve, in spite of the muscle-flexing. I don't think Iran, the U.S., or the U.K. want to drive this thing over a cliff."

Herbst is a reporter for BusinessWeek.com in New York.