Sustained high crude oil prices to hurt downstream players

The Iran-Israel conflict entered a more intense phase with the US carrying out airstrikes on Iran’s nuclear facilities over the weekend. The heightened tensions have led to further spikes in crude prices with Brent crossing the $81 per barrel or bbl mark.

 

The fears centre around the possibility of supply routes being interdicted and hence, supply being disrupted, rather than Iranian oil being taken off the market.

 

Iran’s exports are mainly to China and the quantum of Iranian exports could be compensated for by Saudi Arabia and other OPEC-plus nations. Net-net, even with Iranian supply off the market, there could in theory be over-supply given weak global demand. 

 

There is however, a significant possibility that the Straits of Hormuz could be blocked by Iran. Or, if the US intervenes to keep the Straits open, this narrow passage could turn into a war zone, leading to supply disruptions anyway. Around 20 per cent of the world’s oil and a large proportion of its gas passes through the Straits.

 

 

Another route that could see heightened tensions is the Red Sea where Houthi attacks on all shipping may intensify. Given that crude and gas are necessary goods, even a small gap in demand -- supply can lead to large price volatility.

 

India is particularly badly exposed since 85 per cent of its oil and 50 per cent of gas is imported. Crude oil imports from Iraq, Saudi Arabia, Kuwait and the UAE that pass through the Straits of Hormuz account for 45-50 per cent of total crude imports by India. About 60 per cent of natural gas imports by India (from Qatar) also pass through this route.

 

India does have a strategic oil reserve which would last less than a fortnight. If prices shoot up, there would be a larger import bill, which would affect the trade balance and create downward pressure on the rupee. Moreover, high oil prices would lead to inflation and affect transporters, as well as downstream industries like fertilisers, paints, tyres, among others.

 

High energy prices are therefore a clear negative for the Indian economy. For the energy sector itself, it is a simple equation. Upstream producers such as ONGC and OIL which have their prices linked to international prices could gain. Downstream and midstream players, refiners, retailers, and petrochemical players, stand to lose as their raw material costs rise.

 

For a while, inventory gains could provide a cushion that offsets compression of refining and marketing margins for OMCs. But if there are sustained high prices for a period of several months, that offset will play out. Gas distribution players will also come under pressure since their costs are also linked to international prices. 

 

This situation presents a difficult problem for policy-makers. The windfall tax was withdrawn, that capped the gains of upstream players at a price of around $75 per bbl. A reintroduction of windfall tax is believed to be unlikely. Also, will the government be comfortable with OMCs, which are PSUs, passing on costs by hiking retail prices of fuels at the pump?

 

ICRA expected crude prices to average between $70-80 per bbl for FY26. A sustained conflict poses major upside risks for prices. A $10 per bbl increase in the average price of crude will push up net oil imports by $13-14 billion during the financial year. Spot LNG prices may rise sharply as well and administered price mechanism or APM prices which dipped below the ceiling set by the Kirit Parikh Committee may climb back up.

 

OMC under-recoveries on LPG may expand by ₹16,000 crore or more in FY26. Marketing margins for OMCs could moderate, from the current ₹5-6 per litre blended for petrol and diesel (assuming crude prices don’t cross $80). On the positive side, OMCs believe that gas under-recoveries in FY25 will be compensated and a reduction in global refining capacity implies that gross refining margins will not compress too much. The shares of BPCL, HPCL and IOCL all held steady on the market on Monday.