The Hindu Business Line : Oil uncertainty hits markets

THINGS are gradually getting worse. There has been spate of terrorist attacks in Saudi Arabia, the world's biggest oil producer and also custodian of the largest reserves.

The violence in Iraq is unabating, where the Americans seem to have bitten off more than they can chew. The mood in the country is clearly against the occupation, which, after Saddam's fall, promised a better life but has miserably failed to deliver, with the result that the average Iraqi is today worse off in every sense than he was under Saddam.

It is the price being paid by the US for its arrogance and ignoring the well-meaning advice of the UN.

Of particular concern is the sharp rise in crude prices in recent weeks and months. At over $40 a barrel, oil is at the highest ever seen.

It is not only the fear of supply disruptions that have caused the price rise. Soaring demand has played no mean role, especially with big economies such as China and India growing fast and an increase in the car population in these countries as well as smaller ones such as Thailand.

The problem is that all oilfields, barring Saudi Arabia's, and refineries are already producing to near full capacity.

The recent Saudi assurance of increasing production may not translate into softer prices, given the shortage of refining capacity, possible increases in shipping rates and the ever-present fear of terrorist activity.

These are already reflected in record gasoline prices in the US. With processing capacity unable to keep pace with crude output, we could see an increase in the prices of downstream products.

The signs obviously point to higher inflation down the road. It is pricing power with a vengeance to crude producers - not exactly the kind sought by Mr Alan Greenspan, the US Federal Reserve Chairman.

Down the road, rising downstream product prices obviously have the potential to crimp global economic growth.

Central banks face a dilemma. If they raise interest rates, they run the risk of further slowing down or pushing into recession the already slowing economies. On the other hand, an accommodative monetary policy could worsen inflation significantly.

Mr Alan Greenspan and his crew will have a slew of data as well as the behaviour of oil markets to ponder on before they meet on June 29-30. Chances are that the figures on the US economy will not be all that strong, but oil will be. The prospect of a rate rise is a toss-up.

Meanwhile, we could do worse than deploy our bulging forex reserves in building up a strategic Petroleum Reserve like the US to cope with supply emergencies. We are extraordinarily vulnerable to any interruption in crude imports.

Action on this front brooks no delay. Mr Mani Shankar Aiyar, are you listening?

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