Iran sanctions: Are we prepared for potential catastrophe?

Arab Spring of 2011 mercifully did not result in any crude oil disruption. Still crude oil reached an average historic high of $111 per barrel. It could have been worse if the democratic spirit had impacted any of the major West Asian oil exporting countries.

But in 2012, we may not be that lucky. Iran’s ambitious nuclear programme is coming under renewed attack by the US, Israel  and Europe. The US has now new sanctions against Iran since the beginning of 2012. These may result in reduced crude oil exports from Iran and even worse. Europe will follow the US in imposing its own restrictions on Iran soon.

Iran’s export earnings are 80 per cent dependent on oil. Iran has threatened that it would cut off the shipping route through Strait of Hormuz, the most important choke point. More than 16 million barrels of oil flow through the strait every day. India gets about 2.6 million BD through the strait.  But are we, as a nation, prepared to face the catastrophic consequences from any disruption in international oil trading?

At present despite the sabre-rattling by Iran (which ran a naval exercise to study the ways of closing the Strait of Hormuz), and the US (which continued to send the navy to the strait despite warnings from Iran), experts put a small probability on any possible clash. In the worst case scenario of Iran succeeding in closing the shipping channel, International Energy Agency (IEA)  thinks that stopping of oil flow may not last for more than a month. IEA has already planned to supply about 14 million BD of oil from its strategic reserves (SPR) to meet the exigencies of potential supply shortages.

The west did not hesitate to embargo Iranian oil since it felt that the world has adequate surplus capacity to meet any potential short fall from the loss of Iranian’s export of about 2.4 MMBD. Since there will always be leakage the loss will not exceed 1.5 MMBD in the worst case. China, however, is unlikely to accept the embargo terms.

Second, the US president has the power to give waiver to countries like Japan, India, China etc in case there is any chance of oil price increasing to an uncomfortable level.

Thus it is not the direct impact of crude oil embargo that will create the problem. It is the likely reaction of Iran to close the waterways as a result of any threat by the US, Europe, and Israel which should be a source of greater concern to India.
There are two likely consequences from any stoppage of oil flow from West Asia. There will be a quantum jump in already high level of oil price. Second there will be fierce competition to get access to reduced oil supplies.
Past disruptions
Some experts predict that the oil prices could jump by $50/b pushing Brent above $160/b. Based on past disruptions, $50/b sounds very optimistic. Prices could easily exceed $200/b which would be catastrophic to world and Indian economy. IEA countries may not face much hardships from shortages excepting high prices. They have adequate strategic petroleum reserves if the stoppage does not last for a long period.  But India is not in such a fortunate situation. India has no adequate level of SPR. Also in the case of India, 80 per cent of its total oil imports come through strait of Hormuz. It will be difficult if not impossible to locate alternate suppliers when other importers are also scrambling.

India has taken steps to get waivers from the US so that it can continue to get uninterrupted supplies from Iran. However it is not clear if India is taking appropriate steps to plan for potential blockade of strait of Hormuz as threatened by Iran. 

Higher oil price resulting from the closure of waterways will put unbearable burden on oil companies which are already bleeding from huge under recoveries, which accordign to them, exceeds Rs 135,000 crore per year. Because of subsidised products like diesel, LPG, and PDS kerosene for which the government has no funds to compensate, even higher prices will be a disaster for the oil companies.  The government should take steps now to strengthen their financial position and not when the crisis hits.

Oil ministry should  have a well developed plan to allocate limited supplies of petroleum products to minimise hardships to the consumers as well to the economy. Again this cannot be done at the last minute. This kind of optimum allocation requires elaborate planning involving many stakeholders and also at different levels of decision making. It also needs enormous amount of data which should be available in advance.

So far India and also the world has not faced such disruption in world oil supplies.Thus there is no past experience to help the planning process. Petroleum products play a critical role not only in commercial and industrial sector but also in residential sector. Is it possible to imagine what will happen in urban centres if there is a problem in securing LPG even for a week?

During the first oil shock in 1973, the US had experienced unrest in several cities when consumers had to wait for hours to get their petrol supplies. But such unrest will be nothing in comparison to the likely unrest we will experience in India should there be a LPG shortage beyond a week. 

So far India’s preparation has only been to try and convince the US to give the waivers.

It has no plan to face the tsunami of any shortages resulting from the closure of the strait. Petroleum ministry should form a high level committee of experts immediately and start drawing up a contingency plan to implement an optimum petroleum products allocation plan. New US sanctions will come in force only by the middle of the year. But Iran could act even before. Consequences of not doing anything will be catastrophic.