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Are oil prices set to rise further?

According to simple demand-supply theory, when the demand for a product is low and supply is high, the price of that product should fall and vice versa. However that is not the case with oil. The demand for oil is weak and supply is stable, then too oil prices are increasing. Brent crude, the global benchmark closed at US$ 110.5 a barrel on Monday. The reason for this is the geopolitical tensions prevailing around the world.

There are plenty of short-term factors affecting the oil price. Tensions over Iran's nuclear ambitions, rising militant activity in Nigeria and worries over suicide bomb attacks in Saudi Arabia. The US has imposed sanctions against Iran's central bank and it is highly likely that Japan and South Korea will reduce their imports of Iranian oil. The EU has also agreed to an embargo on oil imports from Iran. However, an EU embargo on Iranian oil imports will likely be delayed for 6 months so that countries including Greece, Italy and Spain can find alternative supplies. The embargo would force European refiners, which imported about 0.5 m barrels a day of Iranian oil last year, to look for other suppliers.

Although Saudi Arabia has promised to meet any demand for extra output, replacing Iranian oil will be a difficult task. In response to sanctions imposed by the western countries, Iran has threatened to block the narrow Strait of Hormuz at the mouth of the Gulf and the route for a fifth of the world's oil. Iran has rattled world markets with repeated warnings it could block the hook-shaped waterway, which could spark a conflict in the Gulf.

Given the current turmoil in the Middle East, the loss of Libyan and Yemeni oil and the recent supply disruptions in North Africa, especially Nigeria, there is enough ammunition for speculators to push oil prices higher. Thus oil prices should continue to move with great volatility in coming months as long as geopolitical tensions persist.