US Sanction On Iran: How It Will Impact Indian Oil Imports

The American withdrawal from the nuclear deal struck between Iran on the one side and the P5 +1 countries (consisting of US, UK, France, Russia, China and Germany) on the other has left oil markets in a tizzy. Iran is a key player in the crude market as it meets 3 per cent of the global demand and is the third largest producer in the Organization of the Petroleum Exporting Countries (OPEC) contributing 2.5 million barrels per day (mbpd).

India is a major oil guzzler importing 80 per cent of its crude requirements totaling approximately 4.34 mbpd and therefore any disruption in the supply from a source as important as Iran has significant implications for India’s energy security and costs of oil imports. To further bolster the importance of Iran, it should be noted that the country meets 15 per cent of India’s crude requirement and is the third largest supplier of oil after Iraq and Saudi Arabia.

The re-imposition of American sanctions is slated to have effect from 4 November 2018 and there is no doubt that India would have to make some tough calls in terms of either continuing to source Iranian oil and braving American sanctions or looking for alternative sources of oil. While Iran occupies a prime position in India’s strategic calculus, especially in respect of the potential gateway to Central Asia and Afghanistan, this piece is restricted to examining the impact of reduced Iranian imports on India’s external finances.

The importance of Iranian oil in the Indian crude mix arises from the easy terms afforded by Iranian exporters, who typically extend a 60-day credit period for payments which is twice the average period extended by other export parties in the market. Added to the extended credit period is the cheap freight option for shipping Iranian oil to Indian shores and these factors together make Iran an attractive supplier of crude oil for India.

The Indian economy benefitted to a great extent courtesy the steep fall in crude prices, the extent of which can be gauged from the fact that at the time of the present government assuming office in 2014 crude oil prices were in the range of $108.05 per barrel which slipped to $33.36 by the end of 2015. The crash in oil prices cannot be solely attributed to the Iran nuclear deal which was struck in July 2015 as at that point itself crude prices had slipped to $57.19 per barrel. This crash in crude prices reined in both the fiscal and current account deficits giving the government the necessary financial cushion.

However, a deterioration in supply side conditions even prior to the American walkout from the Iran nuclear deal, notably the fall in production in Venezuela due to domestic troubles and a concerted effort by the oil producing cartel to push up prices, had inched crude oil prices higher. Removal of Iranian crude from the import mix could be potentially costly as the replacement for the same would have to be paid in dollar terms thus exacerbating the current account deficit (CAD). While countries like Iraq, Saudi Arabia, Russia and the US to name a few could step up to replace the quantum of crude exported by Iran, the discounts offered by these nations do not match those of Iran’s which also offers generous terms on shipping. Also, other than Saudi Arabia, all other countries have a higher cost for producing one barrel of oil and gas compared to Iran, which would also be a factor in determining the eventual import price of crude.

With the Indian rupee being hammered by external crises there has been additional pressure on Indian forex reserves, which could be further exacerbated by the outflow of dollars needed to cover imports from non-Iranian sources. As the subsequent section explains, a chunk of Indian payment for Iranian crude is in rupee terms which helps the country retain its forex reserves which is crucial in a time as uncertain as the present.

During the last round of Iranian sanctions, both countries had arrived at an alternate mechanism in terms of payment for Iranian oil whereby the Indian rupee was used to settle outstanding payments. Essentially, India would cover 45 per cent of its crude imports payment by paying the Iranians in rupee terms and the same was routed through the UCO Bank in Kolkata which was not affected by the American sanctions. This money received by Iran was subsequently used to pay Indian exporters, who shipped across various commodities including rice, wheat and medicines among others, which were not affected by any sanctions. Thus, not only did India manage to continue sourcing cheap crude from India but also aided in the opening of a new market for its exporters.

A continuation of such alternate mechanisms would be a cheaper fix for India. According to a Kotak Institutional Equities report, a $10 per barrel increase in crude prices would lead to an adverse impact on Indian CAD to the tune of 50 basis points and impact inflation to the extent of 30 basis points. While there are talks of a possible Indian waiver in respect of sanctions imposed by the US, the same comes with a rider that India reduces the quantum of crude imports significantly. This is in line with the arrangement formulated the last time US imposed sanctions on Iran.

While recognising that an absolute cut in Iranian imports would not be prudent given the elevated global oil prices prevailing at that time, the Barack Obama administration in the US had linked sanctions waivers to a reduction in Iranian crude imports. American officials have in recent days held talks with their Indian counterparts and the American treasury secretary has also spoken of possible waivers on a case-by-case basis thus giving rise to the expectation that an arrangement similar to the one formulated under the Obama administration could be worked out thereby giving India some relief from a hefty oil import bill.

Regardless of whether India secures a waiver from American sanctions, the country faces a significant challenge in balancing its requirement of cheap crude with geo-strategic preferences and the coming days will be witness to the course India chooses to adopt.