Iran produces about 3.5 million barrels per day (mmbpd) of crude, and exports around 1.5-2 mmbpd which is mostly shipped to China. On paper, there is global over-supply and spare Saudi capacity alone can compensate for loss of Iranian production. OPEC-plus will boost production from April also.
But the logistics could be very difficult. The closure of Straits of Hormuz and Houthi actions could disrupt supplies. Roughly 20 per cent of global oil and gas is evacuated via the chokepoint of The Straits of Hormuz, including supply from Saudi, Kuwait, Qatar, etc. The disruption will be hard to replace and a lot of the Saudi capacity could be stranded.
Further escalation cannot be ruled out. In that case, infrastructure across the region could be damaged. Airports across GCC have been shut down and flights between Asia and Europe are affected. Crude and gas prices have zoomed, along with insurance rates and very large crude carriers or VLCC charter rates.
The US is hoping to provoke regime change and a favourable ceasefire. But there’s no clear timeline for such an outcome. A physical invasion is unlikely since that would incur massive casualties. The duration of conflict is key. US commentary suggests it is looking for a short conflict but Iran may not cooperate.
The conflict could continue and while it continues, energy prices will remain elevated with volatility depending on news flow. This inevitably triggers forex volatility as well. If the Straits are closed for an appreciable length of time, say over a month, it is easy to model sensitivity scenarios where crude crosses $200/bbl and gas prices hit $40/mmbtu (million British thermal units).
If the Straits is closed, Qatar and UAE LNG exports to the tune of 83 million tonnes per annum (100 billion cubic metres) would be removed from the equation. This is similar to the loss of Russian gas circa 2022, when spot LNG hit $40/mmbtu (currently priced around $11). Very high prices could also trigger recessions.
India is among the most exposed. It imports over 50 per cent of its gas and over 85 per cent of its crude, including large shipments out of the Straits. Energy imports are roughly 3.1 per cent of GDP at current rates. A 10 per cent rise in prices would translate into extra 40 basis points of GDP in import costs. The trade deficit would climb, putting pressure on the rupee. While Oil India and ONGC gain in theory from high prices and the oil marketing companies or OMCs lose, the government would likely take action to control retail prices, which means absorbing retail under-recoveries.
In the long term, Iran which resumes production without sanctions could push production to 6 mmbpd and LNG exports to levels similar to Qatar. But a long-term conflict may keep that off the market indefinitely. If the conflict is short, analysts may model for $80/barrel prices through 2026. But $120 or more is possible, given a long conflict. Similarly, gas could climb above $25-30 /mmbtu if conflict is prolonged.
As of now, India’s policy-makers are likely to await clarity on the geopolitical situation. The Reserve Bank of India would have a difficult task if prices spiked and it had to manage currency pressure as well as domestic inflation. Fiscal policy would have to find ways to soften the inflation impact.
There’s been downgrades of OMCs, refiners and petrochemical players while ONGC and Oil India have seen upgrades. However the upside for producers is likely limited. OMCs may need to review sourcing if there’s a prolonged conflict, given Russian sanctions and the Straits blocked.
ONGC has a return on capital employed or ROCE of around 12 per cent. Less than 50 per cent of consolidated free cash flow comes from oil (it was 85 per cent in 2019) with gas providing most of the rest. Assuming ONGC delivers on a 3 per cent production growth annually over FY25-28, it could be a long-term play. Dividends can be expected to remain generous. Oil India is looking at a high (5-6 per cent) production rate and mid-teens earnings growth over FY25-28. As it completes pipeline and fuel refinery capex, return on equity or RoE will also improve.
 "ONGC, OIL SECTOR, CRUDE OIL")
