Explained: Life without Iranian oil

Mains Paper 2 : India & Its Neighborhood - Relations |

Note4Students

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


News

Background

  • 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.

Diversification efforts

  • 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.

II. Rupee:

  • 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.

III. Inflation:

  • 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.

Geopolitical Impact

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.
Oil and Gas Sector – HELP, Open Acreage Policy, etc.
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