Iran-Israel Tension | India could slip on high oil prices

The Iran-Israel conflict will have wide-ranging repercussions on the economy, but the aspect being watched with the most concern is oil prices. These had already been hardening over the past month, but Iran’s drone attack on Israel raised fears of an uncontrollable spike. For the time being, prices have settled down to around $89 per barrel for the Brent benchmark crude. This is still high from India’s perspective as a range of around $80 is easier to bear for the exchequer. Whether any further volatility is in the offing will depend on the future course of the strife. However, the shifts in global crude prices are a worrying development given that over 80 per cent of India’s fuel needs are met through imports.

Oil markets had been firming up even before the latest flare-up. Prices had touched $92 per barrel last week, the highest ever for the past six months. Geopolitical tensions are high on the list of reasons. Attacks on merchant shipping by the Yemen-based Houthi rebels have been a source of worry ever since these began in November. 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 the drone offensive by Iran in retaliation for the Israeli attack on its embassy in Damascus.

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 per cent of growth in demand which is forecast to reach a peak of 103 million barrels per day (bpd).

The outlook in the United States is also improved with interest rate cuts by the US Federal Reserve expected to begin by June. This should be the precursor to more buoyant economic activity leading to higher fuel consumption. Interestingly, the US continues to import oil for many of its refineries despite its huge output of shale oil. This is because 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 by OPEC-Plus will also affect the price scenario in the coming months. These amount to 2.2 million bpd, and have now been extended till June. This is in addition to the cuts of 3.6 million bpd announced in June 2023. The trimming of output had not affected oil markets much till now, and prices had been ruling at around $77-80 per barrel till December.

With heightened tensions in West Asia, it is becoming increasingly difficult to make forecasts for the coming months. Earlier, it was anticipated that prices would hover around $80-85 per barrel by the end of 2024. This projection could shift dramatically if the conflict widens, in which case prices could shoot up to $100 per barrel.

For India, the current level of crude at around $89 -90 per barrel is already a heavy burden for the exchequer. In case this rises further, the current account deficit (CAD), currently at 1.2 per cent of GDP, could widen significantly. Even at existing rates, domestic oil marketing companies are concerned over the prospect of losses. Company officials are already hinting at the need for price revision though there is little chance of any such move from now till the elections are over.

The global oil scenario is thus dynamic right now, dependent largely on geopolitical developments. To some extent, it must be conceded that the market has already factored in the impact of the current Iran-Israel tensions. But there is no doubt that any escalation of the conflict will 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. The hard reality is that India buys most of its oil from West Asian producers and it will be in a bind if there is a conflagration in the region. In this scenario, there is little option right now but to wait and watch.

(Sushma Ramachandran is a senior journalist.)

Disclaimer: The views expressed above are the author's own. They do not necessarily reflect the views of DH.