Soaring Oil Prices Spell Trouble For Emerging Markets

By Jason Simpkins
Associate Editor

Middle East violence and inventory concerns sent oil prices rocketing to record levels above $92 a barrel Friday, spawning recession concerns in the United States and heightening inflationary worries in India and Asia, particularly in China.

It’s now virtually certain that oil prices will eclipse the psychologically important $100 a barrel level, just as Money Morning predicted this summer.

At a time when the global financial markets are wrestling with a swirling credit crisis – a problem that would normally be pressuring the central banks of the world to reduce interest rates to maintain liquidity – rising energy prices fuel inflation and put the opposite pressure on global central banks. Those conflicting forces are especially troublesome news for the U.S. market, which is hanging its hopes on a Federal Reserve rate cut this week. The situation is also bad for China, where rapid inflation has infiltrated its blistering economies.

The National Development and Reform Commission, China’s top agency for economic planning, just announced the country’s rate of inflation was 6.2% in September — it was 6.5% in August, a ten-year high.  The Bank of China has already raised its benchmark interest rate five times this year and instructed lenders to set aside larger reserves eight times.

According to China’s central bank chief, Zhou Xiaochuan, “the high oil price has resulted in a surge of cash at oil-producing countries, and as a result, this large amount of funds is flowing around the world looking for investment opportunities. China’s excess liquidity is partly linked to a surge of cash in the world, which is partly contributed by oil producing countries.”

China’s central bank says it expects inflation to exceed the government’s 3% target. The inflation rate for the first nine months of the year was 4.1%.

The official state-run Xinhua News Agency reported Friday that the chief economist of China’s statistics agency expects consumer price inflation to come in at 4.5% this year. This after official data showed that the consumer price index rose to 6.2% in September, indicating prices soared throughout the month. The central bank forecasts full-year CPI growth of 4.6%.

Oil price was at the top of the docket when China’s high-ranking energy officials sat down with their counterparts from the Organization of Petroleum Exporting Countries (OPEC) for the first time in two years. The last meeting was in 2005 when OPEC requested an audience to discuss China’s swelling demand.

Demand is hardly the biggest concern for China and OPEC, however. What the two entities find more troubling is that oil prices have climbed by $25 a barrel since their last meeting, without supply having been seriously affected.

“The oil price is too high,” one unnamed Chinese official told Reuters. “But we don’t see any shortages.”

OPEC heard the complaint loud and clear. It plans to increase production by 500,000 barrels a day starting in November. This should help ease any supply concerns, but fear and speculative investing are the main catalysts of oil’s rocketing prices.

“The real reason for prices being so high is not the shortage of crude oil. Fundamentally there is no problem,” Javad Yarjani head of OPEC affairs at Iran’s Oil Ministry told Reuters. “There is a fear factor [and] discussions of a political nature which are pushing up prices. We have to go back to the basics of the oil market, which is demand-supply, investments, flow of technology.”

The fear factor stems from Kurdish rebels having launched several attacks on the southern border of Turkey, practically daring Turkish forces to launch a counter offensive into Iraq. Rebels in Darfur attacked a Chinese-backed oil field on Thursday. And the United States just hammered Iran with a fresh round of economic sanctions, the toughest in 25 years.

These events – coupled with a U.S. dollar that’s plummeted to three-decade lows and investors trying to bid up oil’s price in an effort to cash in – and runaway record oil prices are all but assured no matter how much OPEC increases output.

Regardless of the cause, however, high oil prices could magnify inflationary risks for the global economy. China and other developing nations will continue to struggle with inflation, while giving U.S. Federal Reserve Chairman Ben S. Bernanke something else to worry about back home in the States.

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