The proposed European Union ban on oil imports from Iran aims at isolating the country and starving it of oil revenues. It could introduce another worrying dimension to India's energy security.

The recent European Union proposal to ban the import of Iranian crude is bad news for all oil-importing nations, including India. As if that is not bad enough, the United States Senate just approved sanctions on the Central Bank of Iran, a move intended to shrink Iran's oil exports and deprive the country of cash that might be channelled into its nuclear or missile programmes. As if on cue, Brent crossed the psychological barrier of $100 a barrel as soon as the EU ban was proposed and is cruising well above that limit. With the American sanctions, the global crude price is firmly set on a northward spiral.

While the proposed embargo is only on the EU that collectively buys 8,65,000 barrels a day, the fact that EU Energy Commissioner Günther Oettinger has sought the support of Russia and others points to a larger scheme to isolate Iran and starve it of all oil revenues from its entire export which, according to the U.S. Energy Information Administration, stands at around 2.2 mbd (million barrels a day). Iran's total production of around 3.5 mbd makes it the third largest producer after Russia and Saudi Arabia.

Price spike might not be the only concern for India although it is a very aggravating one. In 2010-11, the POL (petroleum, oil, lubricants) import bill was $106 billion but in 2011-12, it is bound to be much higher, even without the threat of the ban. The Indian basket is a composite index comprising Dated Brent, Dubai and Oman sour crudes and, therefore, usually costs a good $10 more per barrel than what our European and American counterparts pay for their imports. The Indian basket already soared to $118 dollars in April 2011 and has been hovering around $110 dollars ever since. Now, with Brent crossing the Rubicon, the Indian basket could soar into the stratosphere. In fact, most analysts predict that oil will firmly remain above the $100-mark henceforth. For emerging economies with galloping oil consumption, that is a grim prospect — one that could slow down growth.

Iran is the second largest supplier to India, just behind Saudi Arabia. Last year, it supplied roughly one out of every eight barrels imported by India. If ever there was a possibility of the oil spurned by the EU finding its way to Asian markets, that has been thwarted by the U.S. sanctions. But even continued supplies of Iranian crude currently bought by India may face problems if all payment channels get blocked. Replacing Iranian crude with other supplies is going to be difficult because India will have to compete with the EU and China for non-Iranian supplies, which may or may not be compatible with our refinery configurations.

Few options

India's situation is aggravated by the fact that unlike China, it has few options for diversifying its sources of supply. It will have to hark back to the Persian Gulf for imports. Other than from the Gulf region, only marginal supplies come from Nigeria and Angola currently. Bringing tankers from Latin America or Russia does not make economic sense. Even our own oil assets in Angola and Sudan do not ship any significant quantities of their production to India. Apart from the economics involved, prior contractual commitments made by the operators of these fields come in the way.

A whole host of countries that buy Iranian crude are not too happy with the EU proposal and they have not shied away from saying so. China, which imports 5,00,000 barrels a day of Iranian oil, is already on record rejecting the proposal. Russia, the largest oil producer in the world today, does not import any oil from anywhere. Yet its Energy Minister Sergey Shmatko has voiced the country's opposition to the move. Heavyweights OPEC and International Energy Agency are also reportedly unhappy with the proposal, while several EU members are fence-sitters. It is probably unlikely that the proposal will go through.

Nevertheless, these developments do not augur well for importers because they have the potential to send prices skyrocketing. For the last one year, oil prices have been hardening owing to a number of factors. On the demand-side, the second half of 2010 was surprisingly buoyant, global recession notwithstanding, primarily due to a burgeoning demand in China and India. In fact, more than half of all incremental oil demand comes from just one country — China. The U.K.-based Centre for Global Energy Studies estimates that oil demand growth, which was in the region of 2.3 million barrels a day from 2005 to 2010, is now galloping at 6.5 mbd and is expected to continue till 2015. India's own oil demand is growing at 5.6 per cent per annum which will push the country from its current 78 per cent import dependence to 90 per cent by 2020.

Contributory factors

On the supply-side, there have been several contributory factors. The Arab Spring has effectively driven 1.6 mbd of Libyan oil out of the market, leading to a tightening of the markets. But even non-OPEC supplies have been dwindling. Iran's domestic consumption is considerable but its potential for ramping up production and, therefore, increasing exports, is even more considerable. But with the muscle-flexing that we witness now, the latter prospect has receded into the background.

The embargo comes at a time when the oil market is reeling under the effect of what some analysts call, financialisation of oil markets. Forward trades in crude are more in the nature of self-serving and self-fulfilling prophecies than legitimate hedging for price volatility. While it is difficult to put a figure on the speculative premium in today's crude prices, the fact that trading volumes on NYMEX (New York Mercantile Exchange) have increased by 400 per cent since 2001 points to the highly lucrative nature of futures trading.

However, India's public sector companies which import most of the crudes they refine are shackled by a whole host of restrictions and regulations. Besides, they are woefully ill-equipped to play a market dominated by giant players with very deep pockets and well-honed skills in market manipulation. Indian importers who also happen to be the big refiners often hedge only to protect refining margins, that too for limited quantities and hence are hugely vulnerable to crude price volatility.

Inflationary impact

India may have to gird itself for the inflationary impact of higher oil prices. Its energy intensity remains high despite the various measures undertaken to improve energy efficiency although in recent years it has begun trailing GDP growth. Within the energy basket, the share of hydrocarbons is increasing, propelled by the demands mainly of the transportation industry. The service sector, traditionally seen as being less energy-intensive than manufacturing, no longer remains so, thanks to the lifestyles of those employed by it. High-rise offices and apartments, invariably built with hugely energy-intensive construction materials like glass, chrome, cement and steel, frequent travel both for work and leisure by the service-industry professionals, their personal lifestyles that have spawned huge malls and multiplexes in urban spaces, and the manifest preference for personalised but inefficient automated transportation, all point in one direction — to higher energy intensity. Increasing import-intensity is an ineluctable reality of our times and ballooning import bill seems a certainty. The Iran factor could now introduce another worrying dimension to India's energy security conundrum.

(The author is Member, Petroleum and Natural Gas Regulatory Board. The views expressed are personal.)

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