Oil prices remained elevated at over $90 a barrel last weekend following the bloody incursion of Hamas forces into Israel that triggered an ongoing war between the former and Israel’s army. This reflects a so-called “fear premium” or market jitters over potential disruption in oil supplies as there is considerable uncertainty if the conflict engulfs the region beyond Israel to Lebanon and ultimately involves Iran for supporting Hamas and other militias like Hezbollah in Lebanon.
Currently, there is intense shelling from Israel into southern Lebanon with Iran sternly warning that the militias it supports could open a new front in the ongoing conflict if Israel’s “war crimes” continue with the intense bombardment and loss of lives in Gaza. As yet, there is no evidence of Iran’s direct involvement behind Hamas’s attacks in Israel but the probability of further US-led sanctions cannot be ruled out, including curbs on its sale of oil as it is the third largest Opec producer generating 2.93 million barrels per day in July-September.
These sanctions would straightaway take out 2.9% of global crude supplies and prices could zoom to $100 a barrel or more.
More so, if Iran chooses to retaliate by blocking the Strait of Hormuz, through which 30% of the world’s sea borne oil passes through every day, threatening the world economy with stagflation as in the 1970s. Market experts and commodity analysts reckon that the crude oil market remains hyper-alert to any indication that the conflict is poised to expand into the oil-producing region in West Asia.
An import-dependent India is bound to be seriously concerned as geopolitical tensions in West Asia support higher oil prices. Union petroleum minister Hardeep Singh Puri said last week that “the place where action is taking place is in many respects the centre of global energy,” adding that $100 a barrel was unsustainable. All of this is a recipe for costlier imports and build-up of inflation in the economy if global oil prices pass-through to higher domestic prices.
This is most unwelcome ahead of crucial state and national elections as the government is keen to insulate the vocal urban middle class from rising fuel prices. Elevated global oil prices are also bad news for the country’s external accounts. A rule of thumb is that every increase in global oil prices by $10 a barrel raises the current account deficit—which is the broadest measure of India’s goods and services transactions—by $9 to 10 billion. The deficit this fiscal may thus widen to much more than 1.1 % of GDP in the first quarter and 2% of GDP in FY 23.
Unfortunately for India there is no respite from costlier energy even if the Israel-Hamas war does not spill over to West Asia. Oil has been on the boil before these hostilities began due to the relatively tight market conditions and Saudi Arabia and Russia’s decision to unilaterally extend their cuts of 1 million barrels per day and 300,000 bpd respectively till December.
Such a significant reduction in oil supplies led to oil prices breaching $97 a barrel in late September. Even without the ongoing conflict, prices were expected to average $90.95 a barrel in the October-December quarter and $95 a barrel in 2024 according to the US Energy Information Administration. To reduce its vulnerability to higher oil prices, India must aim for greater relative self-sufficiency through higher domestic oil and gas production over the medium-term.