Head Line: Explained: Life without Iranian oil
1) Mains Paper II: Effect of policies and politics of developed and developing countries on India’s interests, Indian diaspora.
- Mains Paper III: Infrastructure: Energy, Ports, Roads, Airports, Railways etc.
- The price of Brent crude, the global oil benchmark, rose as much as 3.3% to $74.31 a barrel on Monday, the highest intraday level in almost six months, immediately after the US announced its decision to end the Iran oil waiver.
- India has said the country is “sufficiently prepared” to deal with the impact of the US decision to curtail the temporary exemption from sanctions on the purchase of Iranian oil, and that “a robust plan” has been put in place for adequate supply of crude to refineries.
- This came a day after Indian benchmark indices slid by around 1.3%, as investors rushed to sell shares on concerns that rising oil prices could stoke inflation and dent the already weak consumption story.
Iran and India’s oil basket:
- India, the world’s third-biggest oil consumer, meets more than 80% of its crude oil requirements and around 40% of its natural gas needs through imports.
- Domestic oil and natural gas production has been declining for the last few years, even as the energy needs of the economy have grown.
- India is Iran’s top oil buyer after China. In 2018-19, it imported 23.5 million tonnes from Iran; in the previous year, almost 10% of its total 220.4 million tonnes of crude imports was from Iran.
- In 2018-19 (first 11 months), of India’s total $128.7 billion import of Petroleum, Oil & Lubricants (POL), Iran accounted for 9%, according to Centre for Monitoring Indian Economy (CMIE) data compiled by rating agency CARE.
- Iran was the fourth largest supplier of oil to India in 2018-19, and other suppliers may not provide the same benefits in the form of price and credit facilities.
- The US move comes at a time when the price of the Indian crude basket — an average of the Dubai, Oman and Brent crude benchmarks — has been rising, and the country is in the middle of Lok Sabha elections.
- Indian refiners have almost halved their Iranian oil purchases since November, when the sanctions came into effect.
- At the time, the US had granted waivers, known as Significant Reduction Exceptions (SRE), for six months until May 2 to eight countries — India, China, Japan, South Korea, Taiwan, Turkey, Italy and Greece.
- According to market players, Indian refiners are increasing their planned purchases from the Organisation of the Petroleum Exporting Countries (OPEC), Mexico, and even the US to make up for the loss of Iranian oil.
- As part of the diversification, India imported crude from the US for the first time two years ago. Since October 2017, four PSUs have placed orders for 11.85 million barrels, worth approximately $730 million at current market prices.
- The first US crude consignment reached Paradip on October 2, 2017.
- Indian companies have also contracted 8 million metric tonnes per annum (MMTPA) of liquified natural gas (LNG) and ethane condensate from the US.
- The first long term LNG cargo from the US was received on March 30, 2018.
Also, Indian oil companies had until February 2018 acquired stakes in 27 countries including Australia, Brazil, Canada, Colombia, Indonesia, Iraq, Kazakhstan, Libya, Mozambique, Nigeria, Russia, and the UAE.
- Recently, an Indian consortium comprising OVL, IOC and Bharat Petroresources Ltd (a BPCL company), picked up 10% in the Lower Zakhum offshore oil field in UAE, and IOCL acquired 17% in Oman’s Makhaizna oilfield.
Terms of supply:
- The big concern is that the substitute crude suppliers — Saudi Arabia, Kuwait, Iraq, Nigeria and the US — do not offer the attractive options that Iran does, including 60-day credit, and free insurance and shipping.
- The challenge is to secure an alternative supplier at competitive terms in an already tightening global situation.
- The projected drop in Iranian exports could further squeeze supply in a tight market — given the US has also sanctioned Venezuela, and the OPEC and allied producers including Russia have voluntarily cut output, which has pushed up oil prices more than 35% this year, according to Reuters data.
Potential impact on India:
Analysts point to key metrics that could be impacted by the current situation:
Current account deficit (CAD):
- Higher crude oil prices will widen the trade deficit and current account deficit, given that the value of imports goes up with crude oil, and that the quantity imported tends to be sticky in general.
- According to CARE, a permanent increase in crude oil prices by 10% under ceteris paribus conditions could translate into the current account deficit increasing by 0.4-0.5% of GDP.
- Given that each dollar increase in the price of oil raises India’s annual import bill by over Rs 10,500 crore, any spike in global crude prices could have a bigger impact on India’s deficit numbers in the absence of the Iranian cushion.
- The currency could be impacted if the trade and current account deficits were to widen. An increase in the import bill will tend to put pressure on the rupee.
- The coefficient of correlation between the absolute value of exchange rate and Brent between April 1, 2019 and April 22, 2019 was high at 0.62, the data show.
- There could be significant impact on inflation, given how crude oil prices move and the extent to which the government allows the pass-through to the consumer.
- Analysts do not expect a full pass-through until the elections are over.
- The crude oil price could be an important consideration when the Monetary Policy Committee meets for its bi-monthly meeting in June.
- There could be a two pronged impact on government finances — both on the revenue side and on the expenditure side.
- On the revenue side, higher oil prices mean more revenue for the states as tax is ad valorem; for the Centre, though, it may not materially impact the fiscal math as the duty rates are fixed.
- In FY18, the government earned Rs 5.53 lakh crore, of which Rs 2.85 lakh crore was direct revenue as tax from oil products.
- In the case of states, it was Rs 2.08 lakh crore. Other incomes streams included tax payment by OMCs, dividend and profits.
- The expenditure impact would primarily be on account of fuel subsidy outlays.
- According to CARE data, subsidy provided on LPG was Rs 32,989 crore and kerosene was Rs 4,489 crore for FY20.
- Depending on how the prices move in the coming months, there could be pressure on those heads as well.
Strait of Hormuz: world’s most critical oil choke point:
- After the US said it would prevent five of Iran’s biggest customers — including India — from buying its oil, Tehran threatened to close the Strait of Hormuz, a neck of water between its southern coast and the northern tip of the sultanate of Oman, and the lane through which a third of the world’s seaborne oil passes every day.
- It is a threat that Iran has made earlier, too — and this strategic area has seen several flashpoints erupt in Tehran’s fraught relationship with the West over the years.
State of play:
- Iran cannot legally close the waterway unilaterally because part of it is in Oman’s territorial waters.
- However, ships pass through Iranian waters, which Iran’s Islamic Revolutionary Guards Navy controls
- Annual war games by Iran involve missile tests.
- The Guards have warned that the security of the US and US interests are in Iranian hands
- The US fifth fleet in Bahrain protects commercial shipping in the area. The US has said closing the Hormuz Strait would amount to crossing a “red line”.
- Massive stakes give Iran leverage, but closing the Hormuz Strait will amount to an escalation with unknown fallout — this is one reason Iran has, in 40 years of hostility with the West, never yet acted on its threats to close the Strait.
- International energy markets are critically dependent on reliable transport.
- Over 60% of the world’s petroleum and other liquids production moves on maritime routes.
- The seven choke points in the map above are critical nodes of the world’s energy security grid.
- Blocking them can lead to huge increases in energy costs and world energy prices.
Choke points are also the places where tankers are most vulnerable to pirates, terrorist attacks, political unrest, war, and shipping accidents.