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Slippery Situation

For now, the risk of rising oil prices due to US-Iran tensions may have receded, but India needs to do more for its energy security.

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The new year started on a nervy note for Indian policymakers. On January 3 US forces killed Iranian General Soleimani in Iraq. Iran vowed revenge and this sent international crude oil prices hurtling north overnight. On January 8, Iran retaliated by attacking US forces in Iraq. On the morning (6:39 a.m.) of January 9, Brent crude futures -- the global benchmark for crude oil -- rose 55 cents, or 0.8 per cent, to $65.99 a barrel after tumbling 4.1 per cent a day before. Brent crude oil cooled off after jumping to $71.75 per barrel, its highest level recorded since mid-September 2019. JP Morgan maintained its forecast for Brent to average $64.50 a barrel this year. 

But even before January 3, the day General Soleimani was killed in a drone attack in Baghdad, the oil marketing companies in India had increased the prices of petrol and diesel, as well as those of jet fuel or aviation turbine fuel. 

Analysts began shouting from newsrooms and television studios that any protracted period of high oil prices due to escalation of geopolitical tensions between the US and Iran could impact corporate earnings of several sectors, including auto, oil marketing companies (OMCs), chemicals, paints, plastics, packaging materials and some of the FMCG companies.

“Higher oil prices act as a tax on the Indian consumer with a $1 per barrel increase in crude price resulting in a Rs 0.5-0.6 per litre increase in diesel and gasoline prices. Also a $10 per barrel change in crude oil prices results in a 30 basis points spike in inflation, which will reduce the chances of further rate cuts from RBI and impact the rate sensitive sectors,” said a senior analyst. 

Another analyst said that a jump in crude oil prices will lead to a hike in ATF fuel costs, which constitute nearly 40 per cent of an airline’s operating costs. “Tyre stocks will also be affected as crude and crude oil derivatives, especially synthetic rubber, form nearly 35 per cent of their raw material costs,” he said. 

Impact on India

On January 7, petrol prices increased by 5 paise a litre while diesel prices were hiked by 11 paise a litre. Therefore, within the first seven days of 2020, petrol prices shot up by 60 paise, diesel by 83 paise. Aviation Turbine Fuel price had been hiked by 2.6 per cent on New Year. Meanwhile, non-subsidised (liquefied petroleum gas) LPG or cooking gas prices were also increased by Rs 19 and Rs 19.5 in Delhi and Mumbai, respectively, marking the fifth straight monthly hike in LPG prices. Since August, LPG prices have been increased by Rs 140 per cylinder, thereby burning a hole in common man’s pocket.

Industry experts and reputed economists such as Nuriel Roubini (who predicted the 2008 global recession) argue that in case of a full-scale war in the region, oil prices could go through the roof at least in the short term to more than $100 per barrel. It is likely we will witness a global recession in that extreme scenario. 

But for India, the third largest crude oil importer after China and Japan, the impact could be much more adverse given that two thirds of its crude oil imports come from the Middle East. India imports about 4.5 million barrels of crude oil per day which is 83 per cent of its demand. For every $10 increase in crude price beyond the current base assumption of $70, the GDP could be impacted by about 1 per cent. In other words, crude pricing of $80 would mean a drop of 1 per cent in GDP and at $100 level the GDP could be pulled down by 3 per cent. 

“Such a situation will pose a grave threat to India’s growth story and some of the key sectors that would take a direct hit from this crude price escalation are manufacturing, agriculture, aviation and infrastructure projects. For an economy already struggling with rising unemployment and an alarming increase in NPAs this crisis could only end up adding ‘fuel to the fire,’” says oil expert Hari K. Polavarapu. 

Impact on Airlines

On January 8, amidst tensions in the Iranian airspace, Air India and Air India Express flights overflying Iran were temporarily rerouted. Air India spokesperson Dhananjay Kumar said the safety of passengers and crew members came first. “In view of tensions in the Iranian airspace a decision to temporarily reroute flights of Air India and Air India Express overflying Iran has been taken. This may lead to an increase in the flying time by approximately 20 minutes for flights from Delhi and by 30-40 minutes for flights from Mumbai. The situation is being closely monitored,” Kumar said.

The development came after Iran targeted the Al Assad airbase and another one in Erbil in Iraq that houses American troops. The missile attacks also came hours after the funeral of Soleimani.

Meanwhile, the Indian government issued a travel advisory for its nationals, advising them to avoid “all non-essential travel” to the Middle East country. The government said the Indian embassy in Baghdad and the Indian consulate in Erbil will continue to function normally and provide all services.

Divided Opinion

During the period of tension between US and Iran, analysts remained divided over the sort of impact that Indian economy could have due to the rise in crude oil prices. India’s import needs are around 4.6 mbpd of oil, out of which Iraq and Saudi Arabia cumulatively account for around 40-45 per cent of the total supply. 

Hitesh Jain, Senior Analyst -- Institutional Equities, Yes Securities says: “We sense that markets can afford to see a measure of instability in the Middle East (it’s been there for years) as long as it does not destabilize the oil supply.” Jain pointed out that India’s oil imports from Iran had already come to a halt given the US sanctions on Teheran. “However, there could be a problem for India if US imposes sanctions on Iraqi oil supplies in retaliation for forcing Washington to withdraw its military forces from Baghdad,” Jain said. 

What would happen if there is a full-fledged US-Iran war? “Although the Iranian situation poses a risk to oil supply, we do not think that this will take the shape of a full-fledged US-Iran War. European forces will likely intervene to diffuse the conflict, which will allow markets to stabilise eventually,” says Jain.  

However, Arvind Virmani, an Indian economist and a former Chief Economic Advisor to the Government of India said continued tension in the Middle East could possibly result in the postponement of FII and FDI investments. “Any increase in oil prices will have a negative impact on India’s CAD and GDP growth, but US and Saudi Arab may try to limit the rise in oil prices over the year,” says Virmani. 

Agrees Kavita Chacko, Senior Economist, CARE Ratings. “If the conflict escalates and is prolonged it could lead to a rise in crude oil prices which would add to the inflationary pressures and come in the way of RBI’s monetary easing. It could prompt foreign investment outflows and weaken the rupee. All of this would further weigh on an already weak domestic economy and prolong the economic recovery,” she said.