Lifting of sanctions on Iran: Further dampener for energy prices; Credit positive for Indian R&M industry
In July 2015 Iran had entered into an agreement with six world powers led by the United States, that paved the way for ending sanctions imposed by the US and Europe over the former’s nuclear program that the Western governments feared was intended for developing nuclear weapons (Refer ICRA’s release Iran nuclear deal: Positive for the Indian oil and gas industry). The agreement limited Iran’s nuclear capabilities for a decade and put in place a tighter inspection regime and allowed for lifting of financial and military sanctions in case Iran met with its commitments. Based on the report by International Atomic Energy Agency confirming compliance by Iran with the July 2015 agreement, the sanctions on the latter were lifted on January 17, 2016. With the lifting of sanctions, which included ban on any transactions with Iranian banks and financial institutions, the import, purchase or transport of Iranian crude oil and natural gas and insurance of Iranian oil shipments, Iran would be once again able to freely trade in the international markets.
With the lifting of sanctions, 38 million barrels of oil which are in Iran’s floating oil reserves, in the Persian Gulf, will be added to the international markets besides an additional production of 500,000 barrels of oil per day (bpd) over and above its existing exports of 1 million barrels per day. However, post imposition of sanctions, dozens of Iran’s oil wells were mothballed and bringing them back to production would involve fresh investment. Accordingly it is estimated that over and above the aforementioned 1.5 million barrels of oil per day, an additional 250,000-500,000 bpd could enter the markets in the latter half of 2016. The additional production of Iranian oil assumes significance considering the already oversupplied market and weaker than expected demand and would have a further dampening effect on crude oil prices. With the decline in crude oil prices, spot prices of LNG are also expected to trend downwards in order to retain competitiveness with crude derived alternate fuels.
Besides the current and near term increase in production, it is pertinent to note that Iran holds about 9.3% of the global oil reserves and 18.2% of the global gas reserves. While exploiting these reserves, which require significant capital expenditure, it nevertheless indicates the potential to ramp up production over the long term.
A decline in crude oil price is positive for the current account deficit as India imports about 80% of its crude oil requirement, as well as the petroleum subsidies as domestic fuels i.e. LPG (domestic) and Kerosene remain subsidised. Every one dollar decline in international crude oil price reduces the import bill by about Rs 65 billion and the gross under recoveries by Rs 8-9 billion. A lower crude oil price is also positive for the Indian downstream companies due to lower working capital requirements and lower under recoveries (for the oil marketing companies). Besides, Iran being one of the geographically closest neighbours leads to lower freight costs for crude oil imports as compared to Africa or South America.
Additionally Iranian crude was also attractive for the India refiners owing to sops that Iran offered such as concessional pricing and 3 month credit period as against 1 month credit period which is the norm in the industry. These sops significantly buttressed the GRMs of the Indian refineries and aided their liquidity. Whether the sops would continue remains to be seen, however with India’s huge oil requirements and the Iranian leadership’s emphasis on increasing production and market share, it is expected that Indian refiners would continue to enjoy favourable terms.
The decline in crude oil prices would be negative for the upstream companies like Oil and Natural Gas Corporation, Oil India, Cairn India as their realisations on crude oil sales would also decline, though the impact would be partially offset by the lower under recoveries. Additionally with the Indian Upstream Companies looking to acquire overseas E&P assets, the Iranian market could offer attractive projects especially considering the close diplomatic ties that the two countries enjoy.
With the lifting of sanctions, the GoI could also consider revival of projects for setting up fertiliser production plants in Iran with the latter providing gas under long term contracts. Rashtriya Chemicals and Fertilizers, Gujarat Narmada Valley Fertilizers and Chemicals and Gujarat State Fertilizers Corporation had been nominated earlier by the GoI for setting up a 1.3 million tonne urea plant. The lifting of sanctions could provide impetus to the project.
