Tensions in Iran: Spurt expected in crude oil prices

The year 2011 was an eventful one for crude oil. The commodity witnessed heavy action amidst rising political instability in the Middle East and North Africa (MENA) region as well as a slowdown in the developed economies of US and Europe. After flagging off the year at USD 94/barrel, Brent crude oil shot up sharply in May 2011 to USD 122.62/barrel on the back of rising political tensions in the Arab nations of Libya, Syria, Bahrain, Egypt, etc. Soon after, the prices cooled off to USD 95.6/barrel in Oct 2011, as the downgrade of the US economy by S&P and the never-abating Euro zone crisis took centre stage.

However, fresh concerns flagged off from the Middle East with Iran at the center. This managed to spike up crude prices yet again, with Brent rallying by almost 12% between Oct-Dec 2011. As per media reports, Iran’s flamboyant nuclear power-house ambitions have sparked off some-high intensity geopolitical tensions against the western powers, USA and EU, and the world economy is back on the brink of yet another war-for-oil situation.

In recent developments, it has come to light that USA has taken aim at Iran in an effort to choke off its oil exports, and has started work on restrictive measures intended to curb Iran’s nuclear program. On Dec 30, 2011, the US President Barack Obama signed into law a defence funding bill that looks to impose sanctions on financial institutions dealing with Iran's central bank, which is the main conduit for its oil revenues. The Obama administration has also gone on to sign a US$ 3.5 billion sale of an advanced anti-missile interception system with the UAE in a bid to accelerate the military buildup near Iran. As the UAE lies across the Gulf of Iran, the announcement of this deal has merely added fuel to the fire already raging between the US and Iran.

Iran, on the other hand, has threatened to disrupt oil trades through the Strait of Hormuz – a key shipping channel – in retaliation to the sanctions and embargos enforced by the western powers. In fact, the Govt. of Iran has also stated openly in the press that any move to block its oil exports would more than double the crude prices to US$ 250 per barrel, with devastating consequences. For a long time, the country has denied the US and its allies' allegations of using the nuclear program as a cover up for developing atomic weapons of mass destruction. Iran is claiming to merely harness nuclear energy as an alternative source to substitute its dependence on crude as a prime source. In fact, the atomic energy agency has also recently claimed to have produced the country’s first nuclear fuel rod to provide fuel for its nuclear reactors, but such claims could not be verified.

In other developments though, during the last days of its naval drills in the Gulf, the country has defiantly test-fired a new medium-range missile designed to evade radars. This raised the stakes in a budding confrontation between the long-time foes, as concerns mount that Iran could make good on its threats to close one of the world's most important oil routes, the Strait of Hormuz, if it is backed into a corner.

All this could spark off a spurt in crude oil prices going ahead, although the ongoing Euro crisis and a consequent scaling down of demand expectations for crude oil may limit the rise. There are growing fears over the globe that the soaring crude oil prices sparked off by the Iranian tensions will have a widespread effect on an already fragile economic scenario.

According to Bloomberg data, Iran pumped 3.56 million barrels of oil a day last month as compared to that of the top producer in the OPEC, Saudi Arabia’s 9.55 million barrels a day. Iran is the 2nd largest oil supplier in the OPEC, earning USD 56 billion dollars in the first 7 months of 2011. Accounting for almost 10% of global oil reserves and 15% of natural gas reserves, one can only imagine the impact it would have on the crude oil price movement.

On the Indian front, we believe that this spurt in crude oil prices coupled with a weak rupee will make our imports costlier, as 70% of our total crude oil requirement is met through imports. While this might improve the realisations of the upstream majors, it will be negated by the year end, as a result of the rising subsidy bill issue. In case of the OMCs, it seems quite likely that they may have to undertake a fresh round of price hikes to stay afloat in this crisis.

Also, if one looks at the recent past, where the RBI had decided to remove a payment clearing system with Iran in line with the US embargos on Iranian oil shipments, the country’s private oil companies suffered on account of rising debt as they failed to find a viable way to meet their payments. Iran also delivered a striking blow as it threatened to block oil supplies to India if it wasn’t paid its full dues. Finding switching costs high, India finally decided to pay off Iran through some 3rd party negotiations with Turkey. Thus, one can clearly gauge the implications of US-imposed sanctions against Iran on Indian oil companies.