Crude prices increased $1.13, spiking to a three-month high to touch $65.05 a barrel in midday trading Tuesday on the New York Mercantile Exchange. In London, March Brent crude on the ICE Futures exchange rose 99 cents to $64.17 a barrel.

A high-risk premium had already been built into oil prices with the situation in Iraq. Whether it goes higher is the function of rhetoric on Iran, analysts say. There is going to be no Western-led attack on Iran in the short-term and there is unlikely to be U.N. Security Council referral with a prearranged set of sanctions, they say. Instead, analysts believe, the pressure on Iran is likely to be ratcheted up step by step.

Tuesday's price increase was, in part, due to the standoff between Iran and the international community on its uranium enrichment program. Last week, Iran removed U.N. seals on its nuclear facilities and said it would resume enrichment, a process that can be used for peaceful purposes as well as making nuclear weapons.

The United States and the European Union-3 -- Britain, France and Germany -- vowed to refer Iran to the U.N. Security Council. Iran, one of the world's top oil producers, said there would be consequences with oil supply.

"We have the necessary tools to defend our rights," President Mahmoud Ahmadinejad said at a news conference Saturday. "Those who use harsh language against Iran need Iran 10 times more than we need them."

The threat resulted in a surge in oil prices as a mild winter in the United States was offset by political instability and a threat of supply disruptions. If Iran's 2.4MM bpd of exports is curtailed, other suppliers lack the spare capacity to make up the shortfall.

"As the stages of diplomacy are acted out, Iran will take a defiant stance until the last moment, and then appear conciliatory," said New York-based Fimat's Energy Risk Management Group in a research paper Tuesday. "What this means for the oil market, is that, at the very least, volatility will remain extraordinarily high.

"Not only because there will be conflicting geopolitical statements from day-to-day but also because the market has become divorced from economic fundamentals."

Analysts said it is unclear whether the threat would be carried out, but noted every time such a threat was made, oil prices spiked, leading to more earnings for producing countries.

"The oil weapon is more talked about than used, but it rattles the markets" David Hobbs, managing director of Cambridge, Mass.-based CERA, told United Press International in a telephone interview. "And they get more money for their oil."

He also noted that Iran's complex leadership structure made it impossible to know if the president's comments had the full backing of the Islamic leadership.

"There is question mark on whether Ahmadinejad is talking with the full authority of all the various Iranian institutions," he said.

Experts say uncertainly in Nigeria has a more direct link on oil prices, which have touched $65 a barrel despite a 30 MM bbl surplus. Supply in the country, which exports around 2.2 million bpd, has been curtailed, and militants in Africa's largest producer and the world's eighth-largest exporter have threatened to increase attacks on the country's oil sector, its workers and their families from Feb. 1.

Royal Dutch Shell, the country's biggest foreign operator, evacuated staff and scaled output amid the increasing violence.

"While the amounts are not immediately critical, the frequency of the attacks and the apparent lack of any ability to control them puts the country's entire output at risk," Fimat warned.

But Hobbs, of CERA, said the full force of the Nigerian disruption was still unclear.

"Nigeria crept up when the U.S. markets were closed (for the Martin Luther King Jr. Day holiday on Monday). In the current situation, this still has the flavor of a local dispute," he said. "The dispute is more real if events get out of the control of the leaders, leading to a shutdown in the affected areas."

A disruption is supplies is likely to increase oil prices worldwide amid growing demand in Asia and the United States.

The International Energy Agency said global demand for oil increased by some 1.3 percent in 2005 and that figure was expected to grow by 2.2 percent in 2006 amid a demand rebound in the United States and China.

The IEA said that amid the threat to supply disruptions there was a limited ability to pump extra oil. Much of the spare capacity of 1.5 million barrels per day lies within the Organization of Petroleum Exporting Countries, but IEA warned about the cartel's ability to produce the extra oil.

"OPEC spare capacity remains tight," it said.

But with threats looming of a supply cutoff from two major oil producers, the markets are likely to be in for a tough road ahead.

"I'm not sure the market could cope with both these areas shutting down," Hobbs warned.

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