As the Iran war rages, crude oil prices jumped 30% early Monday to nearly $120 per barrel, levels not seen since 2022. Prices retreated, but still traded above $100 per barrel, after reports indicated that the G7 countries will be discussing a coordinated release of around 400 million barrels of crude oil from their strategic petroleum reserves to improve the supply situation. At 8.30 pm India time, benchmark Brent crude was still up 11% at over $102 per barrel.

The conflict, which began on February 28 and currently doesn’t seem to have an end in sight, has led to growing concerns of an extended supply disruption due to the effective suspension of tanker movements through the critical chokepoint of the Strait of Hormuz, and major Gulf oil producers cutting oil production as they run out of storage.

Moreover, intensifying attacks of oil infrastructure in the region over the weekend, and Iran’s appointment of Mojtaba Khamenei—son of the late Ayatollah Ali Khamenei—as Iran’s new supreme leader have also contributed to the surge in prices. Mojtaba Khamenei’s appointment has signaled continuity in Iran’s leadership; regime change was a key objective of the US-Israel attack on Iran.

With the jump in oil prices, Asian stock markets tanked on Monday amid concerns of higher inflation and interest rates globally. In India, benchmark share market indices Nifty and Sensex were down nearly 3% in early trade on Monday, the rupee also fell to a new low against the dollar. Nifty and Sensex ended the day’s trade down 1.7%.

India’s economy is vulnerable to oil price volatility as the country has an oil import dependency level of over 88%. India’s heavy reliance on imported crude oil has a bearing on the country’s current account deficit, foreign exchange reserves, the rupee’s exchange rate, and inflation rate, among others. Notwithstanding all that, the immediate priority is to ensure crude oil and fuel availability on a continuous basis.

Hormuz disruption, production cuts, attacks on oil infra

Oil flows through the Strait of Hormuz—a critical artery for energy trade—have virtually stopped. With Iran warning vessels to not transit through the Strait, and even hitting a few vessels that were passing through the waterway, there is an effective halt in maritime traffic through the Strait with most trading houses, insurers, and vessels loath to get involved in the prevailing extremely high-risk environment.

Seen as the most important oil transit chokepoint globally, the Strait of Hormuz—the narrow waterway between Iran and Oman that connects the Persian Gulf with the Gulf of Oman and the Arabian Sea—handles approximately one-fifth of global liquid petroleum consumption and global liquefied natural gas (LNG) trade. Around 15 million barrels of crude pass through the Strait every day. While some pipelines exist in the gulf states to bypass the waterway, their capacity is restricted. Even at full utilisation, 9 million barrels per day (bpd)—9% of global demand—would remain structurally at risk if the Strait is closed, according to industry experts.

Around 2.5–2.7 million barrels per day (bpd) of India’s crude imports—accounting for around half of the country’s total oil imports—have transited the Strait of Hormuz in recent months; the longer-term average is around 40%. This oil is mainly from Iraq, Saudi Arabia, the UAE, and Kuwait.

With tankers unable to pass the Strait of Hormuz leading to an oil inventory build-up in the region, major West Asian oil producers are being forced to cut crude oil production as they are running thin on storage capacity. Iraq and Kuwait have already started cutting production, and the UAE and Saudi Arabia could be next in line. There have also been attacks on oil infrastructure in the region, raising concerns over potential supply outages and spooking the markets.

“Shipping activity suggests most ship owners remain reluctant to transit the Strait of Hormuz, with only a handful of vessels entering or leaving the Middle East Gulf in recent days. Storage pressure continues to build across Gulf producers, raising the likelihood of further output cuts or well shut-ins as tanker availability remains constrained,” said Muyu Xu, senior oil analyst at commodity market analytics firm Kpler.

The impact on India

Given that India imports 1.8-2 billion barrels of crude oil a year, every $1-per-barrel increase in oil prices would bump up the country’s oil import bill by up to $2 billion on an annualised basis. According to a report by Nomura, India is among the three most vulnerable Asian economies to high oil prices in terms of import bill and current account balances, the other two being Thailand and South Korea. It said that every 10% oil price increase typically widens India’s current account deficit by 0.4% of the GDP.

Despite the spurt in international oil and fuel prices, there are no immediate plans for hiking petrol and diesel prices, which is in line with the government’s policy of the past few years to keep pump prices stable notwithstanding the volatility in international energy markets, according to sources. A continued freeze in pump prices are expected to blunt the inflationary impact of the oil price spurt. Petrol and diesel prices have effectively been flat since April 2022, with public sector oil retailers taking losses when global prices jump, and recouping them when they fall.

In its monthly economic review released Friday, the Ministry of Finance had pointed out that crude oil prices remaining above $100 per barrel could result in a strain on the macroeconomic aggregates, as suggested by scenario-building exercises on the macroeconomic impacts of higher oil prices. Apart from crude oil as the obvious stress marker, the Ministry had also underlined that supplies of natural gas and cooking gas also matter.

The ongoing US-Israel strikes on Iran have heightened geopolitical risk around the Strait of Hormuz, driving oil prices upward. Considering India’s heavy reliance on imported crude, this could feed through into higher imported inflation by raising fuel costs and weakening the rupee, complicating the inflation outlook for India, the Ministry said. However, the Ministry said given that India’s inflation is near the lower bound, the impact on inflation is not estimated to be substantial at this point.

While higher oil prices are sure to create a headache for the Indian economy, the current priority is to ensure continued availability of crude oil and fuels in the country. According to sources in the government, Indian refiners are ramping up oil purchases from non-Hormuz regions, which account for 60% of the country’s oil imports. India’s stocks of crude oil and major fuels derived from it—like diesel and petrol—are increasing as oil cargoes from other regions, including Russian crude already in tankers on water, are coming in, they said.

On Tuesday, government sources had indicated that the country had six-eight weeks of crude and fuel stocks, which would be replenished on an ongoing basis with supplies from other regions being increased. As refineries continue to process crude, produce fuels, and get more oil from regions other than West Asia, these stocks will keep shifting, and the effective coverage would be extended, they had said.

According to sources in the know, the government and Indian oil and gas companies are in touch with all international suppliers, including national oil companies and even large traders like Vitol, Trafigura, and ADNOC Trading, to source additional volumes of crude oil and LPG from their international portfolios in view of the West Asia conflict, even as the country is in a “comfortable” position to prevent any near-term shortage of major fuels like petrol, diesel, and LPG.

In order to ensure continued availability of cooking gas to crores of Indian households, the government invoked emergency powers derived from the Essential Commodities Act to direct Indian refiners to maximise LPG production and ensure that all the gas is supplied solely to domestic LPG consumers and not used to produce petrochemicals. Over 80% of India’s LPG imports come through the Strait of Hormuz.

Natural gas supplies to some sectors in India have already been reduced in the anticipation of tighter LNG deliveries; over half of India’s LNG imports come via Hormuz. Government sources indicated that if the situation worsens, reprioritisation of sectoral gas allocation may be undertaken to ensure that the critical sectors don’t suffer for want of fuel. Some sectors can also switch to alternative fuels, they said. Domestic natural gas is allocated to various sectors—like city gas distribution, fertilisers, and power—based on a priority list.