Escalating geopolitical tensions, triggered primarily by the threat of US sanctions on Venezuela and Iran that can potentially crimp supplies in an already tightening market, have propelled crude markets higher to test $80 a barrel for Brent, near three-year highs. The emerging situation points to the possibility of a further rise in oil prices.

Venezuela is already going through a political and currency crisis that has caused oil production to drop to a decade low of about 1.4 million barrels a day. The US sanctions are sure to further curb the country’s oil output. Without doubt, falling production in Venezuela has contributed to tightening of the global crude oil market. Despite availability of spare capacity elsewhere, other producers have not so far ramped up production.

Even as the market began to digest the news, the US has hardened its stand against Iran, raising the risk of supply outages from one more important source. The US has threatened Iran with ‘strongest sanctions in history’.

It appears that in the latest threat to Iran, the US may not have taken Europe and China into confidence. As a result, oil supplies from Iran may find buying support from large importers. It is observed that Iran is leaning on the European Union to make euro-denominated purchases of Iranian oil as a way to avoid US sanctions. However, it would be only a matter of time before the US will start to put intense pressure on European companies that do business with Iran.

So, the situation is nebulous and fraught with possibilities. No wonder, speculative capital has quickly moved into the market, exacerbating the price action triggered by geopolitical concerns. The one possibility of relief from falling supplies is if the OPEC decides to ramp up production. A meeting of the oil cartel scheduled next month will be watched with great interest.

While the supply side risks disruptions, the demand for oil is robust on the back of strong economic growth. The positive relationship between global economic growth and oil consumption is of course well recognised. Indeed, oil is known as a growth-commodity.

What will be the impact if oil prices continue to remain at the current elevated levels or even rise further? Given the tightening market fundamentals, if the current level of prices continues for a length of time, say a quarter, or rise further, it will start to impact demand. Consumption growth will begin to slow.

It can potentially trigger inflation in emerging markets such as India that are substantially dependent on oil imports to meet domestic fuel needs. As a universal intermediate, oil has a role in almost every economic activity and oil prices impact inflation.

India is currently suffering a double whammy – rising oil prices and depreciating rupee. If this potent combination continues for a few months, the days of benign inflation will be well behind us. Growth will be at risk.

That argues for a reduction in the onerous taxes on downstream products of crude including petroleum and diesel. The sooner the government does it the better, politically.

When crude prices were $30 a barrel two years ago, New Delhi did not allow the consumers to benefit from low international rates with the argument that oil revenue was needed to fund welfare programs. In retrospect it appears to have been a naïve decision to generate revenue from a volatile commodity such as crude oil. Consumers sacrificed the benefit when prices were low but are now forced to shell out more when prices are rising. Politically this can prove to be disastrous.

The writer is a policy commentator and commodity market specialist. Views are personal

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