Opinion
Dark clouds of war over global economy, markets. Brace for extended uncertainty.
Summary
- As geopolitical tensions threaten to disrupt energy supplies and economic stability, investors keep a wary watch
Tensions in West Asia have been high since the Hamas attack on 7 October 2023. Israel’s military actions in Gaza persist, and recent hostilities include an attack on the Iranian embassy in Syria, straining relations with Tehran. In response, Iran launched missile attacks against Israel, with the US assisting Israel in intercepting most of these missiles. These developments did not come as a surprise; geopolitical experts have anticipated such scenarios since last October, yet tensions remain unmitigated.
The ongoing conflict between Iran and Israel could have severe global economic repercussions, particularly affecting India, if it continues. There is a heightened concern over potential disruptions in energy supplies, which could impact crude oil and gas availability in Asia.
Gas and crude oil from West Asia reach Asia primarily through two routes: the Red Sea and the Straits of Hormuz. The Red Sea route has been compromised by Houthi attacks, while the Straits of Hormuz, a critical channel that Iran might blockade, poses a significant risk. Should Iran block these straits and the US intervene to keep them open, it could escalate into direct conflict between the US and Iran.
An estimated 15% of the global crude supply and 20% of the world's gas transit through the Straits of Hormuz. This includes supplies from Iran, LNG from Qatar and the United Arab Emirates, and crude oil from Iraq, Saudi Arabia, Kuwait, and others. Closure of the Straits to tanker traffic could disrupt these supplies significantly, making alternative sourcing costly and time-consuming.
All of Asia, and especially India, depends on supplies through the Straits of Hormuz. India imports over 85% of its crude oil and more than 50% of its natural gas, with the majority sourced from West Asia. Rising energy prices would adversely affect public sector oil marketing companies such as Hindustan Petroleum Corp. Ltd, Bharat Petroleum Corp. Ltd, and Indian Oil Corp. Ltd, as increased raw material costs would challenge refiners. Due to the elections, these companies would likely be unable to offset these costs by raising retail prices until at least early June.
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A ₹1 change in gross marketing margin substantially impacts the Ebitda (earnings before interest, taxes, depreciation, and amortization) margins of oil PSUs by over 20%. Increased LNG prices or supply shortages would adversely affect gas companies like GAIL, Petronet LNG, and city gas distributors such as Gujarat Gas, IGL, and Mahanagar Gas. Additionally, the windfall tax limits profit margins for producers like ONGC and OIL, capping net realizations at around $75 per barrel.
Moreover, high energy prices could drive inflation and put pressure on the rupee as the current account deficit widens. Budgetary forecasts might need adjustment due to a potential rise in fiscal deficit if the conflict prolongs.
As this situation develops, three main scenarios emerge: First, the conflict could escalate further, pulling in more nations. Second, there might be mediation efforts leading to de-escalation. The third scenario, which appears most likely, involves the conflict dragging on indefinitely without major escalation but also without any resolution of tensions.
This protracted situation is probable because few nations maintain favourable relationships with both Israel and Iran to serve as effective mediators.
Countries like Russia and China maintain strong ties with Iran but do not share a similar relationship with Israel. Conversely, the US and UK are well-aligned with Israel but have strained relations with Iran. India stands out as one of the few countries with amicable relations with both, yet the focus on upcoming general elections limits the government's capacity to intervene in this complex dispute.
Investors are taking these uncertain outcomes into account, which explains the recent depreciation of the rupee and significant volatility in the stock market. While a relief rally is possible if tensions quickly ease, it would be wise for investors to prepare for a prolonged period of uncertainty.
