From UPSC perspective, the following things are important :
Prelims level : Not Much
Mains level : Heated US-Iran relation and its impact of India and the World
- 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.
- India has “a robust plan” that has been put in place for adequate supply of crude to refineries.
- In the past several months India has worked hard to significantly diversify its energy sources in preparation for this situation.
- But its ties with Iran are significant and historic, and New Delhi will work hard to maintain some links.
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.
- 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.
- 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 gemeral elections.
Amidst US sanctions
- Indian refiners have almost halved their Iranian oil purchases since Nov 18, when the sanctions came into effect.
- At the time, the US had granted waivers 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 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.
- The first US crude consignment reached Paradip on October 2, 2017.
- 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 picked up 10% in the Lower Zakhum offshore oil field in UAE, and IOCL acquired 17% in Oman’s Makhaizna oilfield.
No comparison for Iranian Oil
- 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 OPEC and allied producers including Russia have voluntarily cut output, which has pushed up oil prices more than 35% earlier this year.
- The projected drop in Iranian exports could further squeeze supply in a tight market.
Potential impact on India
Analysts point to key metrics that could be impacted by the current situation:
I. Current account deficit:
- Higher crude oil prices will widen the trade deficit and current account deficit, given that the value of imports goes up with crude oil.
- 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.
IV. Fiscal impact:
- 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.
- According to CARE data, subsidy provided on LPG was Rs 32,989 crore and kerosene was Rs 4,489 crore for FY20.
- The expenditure impact would primarily be on account of fuel subsidy outlays.
I. 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.
- The strait is 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.
II. 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 (recently named terror organization by US).
- 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”
III. A test of Hostility
- 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.
IV. Choking trade routes
- 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.