Flare-up in Iran-Israel conflict could lead to major oil price hike

Story by  Sushma Ramachandran | Posted by  Aasha Khosa | Date 20-04-2024
Celebrations erupt in Tehran as Iran showered some 300 drone missiles on Israel (Courtesy:Tehran Times)
Celebrations erupt in Tehran as Iran showered some 300 drone missiles on Israel (Courtesy:Tehran Times)


Sushma Ramachandran

he situation in West Asia looks grimmer by the day with Iran and Israel going ahead with retaliatory attacks. Though leading western powers are calling for restraint, it is difficult to predict the future of tensions in the region. The fall-out of these developments is likely to be wide ranging on the economy here but the immediate concern is over global oil prices. These had already been hardening over the past month but the latest offensive raised fears of an uncontrollable spike.

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Fortunately, after an initial spurt, prices have settled down to around 87 dollars per barrel for the Brent benchmark crude. This is still fairly high from India’s perspective as a range of 75 to  80 dollars is easier to bear for the exchequer. Any further volatility would lead to a steep increase in the country’s oil import bill as over 80 percent of the country’s fuel needs are met through imports. The shifts in international crude prices are thus a worrying development.

Oil markets had been firming up even before the latest flare-up. In fact, prices had touched 92 dollars per barrel last week, the highest ever for the past six months. One of the reasons has been growing geopolitical tensions in West Asia. Attacks on merchant shipping by the Yemen-based Houthi rebels have been a source of worry ever since these began in November last year. But the Israel-Hamas war has not had a significant impact till now largely because major producing countries in the Gulf region have stayed away from direct involvement. The situation has altered dramatically now with Iran and Israel attacking each other directly.

Other factors have also been at play in strengthening oil markets recently. This includes the perception that global demand is rising as against an earlier assessment that recessionary trends would be dominant and oil consumption growth would be muted this year. On the contrary, China’s economy is doing better than expected and demand is expected to be robust. The International Energy Agency (IEA) has said global oil demand in 2024 would be dominated by China, followed by India and Brazil. In a recent report, it concluded the three major economies are set to account for 78 percent of growth in demand which is forecast to reach a peak of 103 million barrels per day.

The outlook in the U.S. is also improved with interest rate cuts by the Federal Reserve expected to begin by June. This should be the precursor to more buoyant economic activity leading to higher fuel consumption. Interestingly, the U.S. continues to import oil for many of its refineries despite its huge output of shale oil. The reason being that shale oil is not suitable for processing at these refineries which are largely tailored for heavier types of crude.

Voluntary output cuts announced since January this year by oil cartel OPEC Plus will also affect the price scenario in the coming months. These amount to 2.2 million bpd and have now been extended right up till June. This is in addition to the cuts of 3.6 million bpd announced in June last year. The trimming of output had not affected oil markets much till now and prices had been ruling at around 77 to 80 dollars per barrel till December 2023.

In light of the latest crisis in West Asia, it is difficult to make forecasts for the rest of the year. Earlier, it was anticipated that prices would hover around 80 to 85 dollars per barrel by end 2024. This projection could shift dramatically if the conflict widens in which case prices could shoot up to as much as 100 dollars per barrel.

For India, the current level of crude at around 89 to 90 dollars per barrel is already a heavy burden for the exchequer. In case this rises further, the current account deficit, presently at 1.2 percent of GDP, could widen significantly. Even at existing rates, domestic oil marketing companies are concerned over the prospect of losses. The Petroleum Secretary Pankaj Jain recently expressed concern over rising world oil prices. He noted that if this situation continues for over a month, the oil marketing companies may have to take an ‘appropriate decision” hinting at the prospect of retail prices revision. At the same time, with elections now under way, it is unlikely that any decision will be taken on this issue till the new government takes charge in June.

It will then have to review the situation taking into account the dynamic global oil scenario in the context of geopolitical developments. For the time being, it appears the market has already factored in the impact of Iran’s strike on Israel. But any escalation of the conflict is bound to see oil prices spiralling beyond control. Over the past two years, it has been possible to weather the volatility in oil markets by relying on heavy discounts offered by Russia as well as the prolonged softening price trends last year. In fact, other exporting countries like Iraq were even offering higher discounts at one stage and purchases from this country had gone up considerably. The hard reality is that India buys most of its oil from West Asian producers. It could therefore face difficulties if there is a conflagration in the region.

On the plus side, the country has already been diversifying sources of supply in order to ensure availability of critical fuel is not hindered by geopolitical tensions. For instance, imports from Russia have risen from 2 percent when the Ukraine war began to 30 percent in 2023.  These supplies do not have to pass through Red Sea route which is facing attacks from Yemen-based Houthi rebels. Oil is also being imported from Nigeria, the U.S., Canada, Guyana, and Australia.

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The scenario remains uncertain, however, as far as international oil prices are concerned owing to the Iran-Israel imbroglio. For the time being, a leading oil importer like India will have to monitor the situation carefully to ensure that its strategic energy interests are not affected in any way.