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Why are crude oil prices going up? (Relevant for GS Prelims, GS Mains Paper III; Economics)

What is the trigger?

Brent, the international benchmark for oil prices, crossed $80 a barrel this week, touching the highest level since November 2014. The current price is almost three times the cost in early 2016 when it was $29 a barrel. The trend may continue in the coming weeks and months, according to most reporting on oil. Rising oil prices could cause significant inflation, dampen economic growth and alter geopolitics in multiple ways this year.

The major trigger that sent crude prices north was U.S. President Donald Trump’s decision to withdraw the country from the Iran nuclear deal on May 8. A second factor that is setting crude prices on fire is political and economic instability in Venezuela, another major petroleum exporting country.

Further aggravating the situation, the Trump administration is threatening Venezuela with new sanctions that could come as early as next week. India imports significant quantities of oil from Venezuela and Iran.

How will it affect us?

The full impact of re-imposition of sanctions on Iran will take effect only in six months. The Trump administration has provided a six-month wind-down period for energy-related sanctions against Iran. Sectors such as financial and banking, underwriting services, insurance, shipping and shipbuilding and port operation had got relief from the sanctions under the Iran nuclear deal in 2016, all of which influence oil trade. All these sanctions will kick in again.

European countries, Russia and China, who are part of the Iran deal, have said they will not participate in American sanctions. It is unclear how far European companies could withstand American pressure and continue trade with Iran.

French oil company Total has announced that it will halt a natural gas development project in Iran unless it receives a waiver from the U.S. government. China will continue to buy from Iran and so will India, even if in reduced quantities. Market analysts differ on how much of Iran’s current export of around 2.2 million barrels per day would be off the global market in the coming days.

Some say half of it will be unavailable as American sanctions take effect. In 2012, when sanctions were imposed last time, Iran’s exports had fallen by half. The Trump administration appears to be in no mood to give any waiver to European companies, and the oil market is betting on America’s ability and will to enforce the sanctions.

What are other factors?

Oil prices are also driven up by coordinated action by Russia and Saudi Arabia to keep supply on a tight leash. But the curbs on production by these countries had not anticipated the dramatic fall in production in Venezuela. The heightened instability in West Asia in the form of Saudi Arabia-Iran rivalry and the looming possibility of new military conflicts add to this.

What happens next?

Instability in oil prices could help America’s strategic rivals Russia and China. Russia could benefit from higher prices in the international market. China could get better deals in buying crude cheap from Iran as it could insulate the trade from secondary American sanctions.

Higher oil prices could have mixed impact domestically in America. As the summer driving season is about to start, the daily increase in petrol prices and accompanying inflation could ruin Mr. Trump’s political posturing. At the same time, higher global prices have accelerated domestic drilling and shale gas production in America, boosting Mr. Trump’s politics. Plummeting prices had rendered shale gas extraction unviable in America, and it is coming back to life.

Without directly addressing the gasoline prices, Mr. Trump posted on Twitter on Thursday:

“America is blessed with extraordinary energy abundance, including more than 250 years’ worth of beautiful clean coal. We have ended the war on coal, and will continue to work to promote American energy dominance!”

(Adapted from the Hindu)

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