Oil prices on the boil as Middle East simmers

NEW DELHI| MUMBAI: Oil prices jumped $3 on Friday after a US air strike killed a top Iranian general, escalating tension in the world’s biggest crude-exporting region and stoking fears of a supply disruption. The impact of any possible retaliation worried key importers like India where fuel prices are already at a 13-month high.India's benchmark stock indices fell 0.4%, logging their worst weekly performance in a month, as global markets declined with rising tensions. Gold surged Rs 700 to Rs 39,872 per 10 gm and advanced toward a six-year high internationally. The rupee lost about 0.60%, or 44 paise, to close at 71.80 per dollar. Wall Street stocks opened sharply lower. The Dow Jones Industrial Average was down 0.56% at press time. Although local equity indices recovered some ground after dropping as much as 0.7%, the biggest one-day gain in four months in the local fear gauge India VIX showed that sentiment will remain wobbly amid concerns of retaliation by Iran. Any further surge in crude oil prices will also be a threat to India’s fiscal deficit, which is budgeted at 3.3% of gross domestic product in the year ending March 31.Iran vowed “severe retaliation” after Qassem Soleimani was killed by US missiles in Baghdad, triggering speculation about its next move and turmoil in the oil market early Friday. Brent crude rose as much as $69.16 a barrel, the highest since attacks on Saudi Arabian oil infrastructure in September.India, which imports 84% of its oil needs and nearly 60% of it from the Middle East, is closely watching the situation in the Gulf region.“We will have to see how Iran reacts to it. That would determine how the oil market behaves hereon,” said an oil ministry official after a meeting with top executives of state refiners. The September drone attack on the Saudi facility, which hit 5% of the world’s oil supply, caused barely any supply disruption but briefly sent prices soaring. Quick supply management by the Saudis and abundant supply elsewhere brought prices to pre-attack levels quickly.“After the Saudi attack, it was feared that there would be escalation and supplies will get disrupted but that didn’t happen. Let’s see if Iran shows the same maturity as Saudi did,” Indian Oil chairman Sanjiv Singh told ET. Refiners can plan for minor disruptions but if the region goes up in flames, no plan can really work, said an executive at a state refiner.Most Asian equity markets ended weak, with Japan’s Nikkei dropping 0.8%. Investors shifted away from risky assets. The Sensex fell 162 points to 41,464.61and the Nifty was down 55.55 points at 12,226.65, having hit a record in the previous session. India VIX surged 10.5% to 12.7. Oil marketing companies ended in the red and other sectors linked to oil prices such as paint manufacturers, also slipped. Asian Paints was the worst performer on the Sensex, down over 2%.Axis Bank, NTPC, State Bank of India, Bajaj Auto, HDFC Bank and Maruti ended down 1-2%. The BSE Mid-Cap index fell 0.4% and the BSE SmallCap index ended flat. Foreign portfolio investors (FPIs) bought Indian shares worth Rs 1,263.05 crore and domestic institutional investors (DIIs) sold shares worth Rs 1,029 crore on Friday.“Tensions building up in the Middle East have led to spike in crude oil prices and there is a negative undertone across global markets,” said Harsha Upadhyaya, chief investment officer, equity, Kotak Mahindra AMC. “Any upside in crude oil prices would be negative for India as it is coming at a time when fiscal space to kick-start the economy is limited.” The rupee joined other currencies in weakening.“An element of uncertainty weighed on investors with rising crude oil prices,” said Shreeshanth Arayangat, chief dealer at DCB Bank.“The rupee’s fall is in line with other emerging markets as investors seek safety of US-backed assets. The weakness is likely to extend unless the political turmoil between US and Iran dilutes down bringing stability in global oil prices.”The benchmark bond yield rose marginally to close at 6.51% Friday. Bond yields and prices move in opposite directions.The central bank will on Monday buy longer maturity bonds while selling shorter duration papers for Rs 10,000 each, seeking to bring yields down in line with the policy rate.Such a move was seen positive for bond market as yields were expected to fall.“This has checked any sharp rise in yields as traders won’t turn panicky unless US and Iran are engaged in a full-blown war,” said a senior executive at a large bond house.Oil prices had jumped nearly 15% in the last quarter of 2019 on the extension of a production cut pact by key producers, including OPEC members and Russia. Friday’s attack drove prices up more than 4% and dimmed hopes of a global economic recovery.“The market is adding a risk premium on fears things could escalate,” said UBS Group AG analyst Giovanni Staunovo in a Bloomberg report.“The Middle East is a powder keg — too much oil comes out of the region and no one knows if and how Iran will respond.” For a heavy energy importer like India, high oil prices cut consumer spending, stoke inflation, erode forex reserves, expand the current account deficit, balloon the fuel subsidy bill and leave less resources for more productive public spending.India is estimated to spend $112 billion on oil imports in FY20 but runaway prices could expand this further.A sharp rise in domestic fuel prices, which are deregulated and linked to international fuel rates, triggers consumer clamour for price control. Domestic rates of petrol and diesel are at a 13-month high.Although the year started off on a positive note for Indian equities due to easing US-China trade war tensions and expectations of growthboosting measures from the government in the February 1 budget, the immediate focus of investors will be on any retaliation from Iran. A hit on the balance of payments front could hurt India at a time when growth is weakening. Growth in the three months ended September fell to 4.5% — the lowest reading since 4.3% recorded for the January-March quarter of 2013.“Oil is likely to be on the boil. Bad for large oil importing countries, especially those with large trade and current account deficit like India,” said Ajay Bodke, CEO-PMS at Prabhudas Lilladher.Bodke said investors may again find comfort in large-caps and shun mid and small-cap stocks which had outperformed the benchmarks recently.Bond yields also need to be watched as any outflows by foreign investors due to rising risk-aversion may spark a selloff, leading to a rise in bond yields, said Bodke.War between the US and Iran could be damaging for global growth.“The major concern for the world economy is that events spiral out of control and the US launches a fullblown military assault on Iran...the resulting collapse in Iran’s economy could knock as much as 0.3%-pts off the global GDP – equal to our estimate of the damage from the US-China trade war,” said Capital Economics in a note. “In EMs, those countries where higher oil prices exacerbate balance of payments strains or an inflation problem would probably hike interest rates. Turkey would be a prime candidate, but India would face strains too.”Iran threatened to hit back hard after the US air strike killed Soleimani, commander of the elite Quds Force.Soleimani, a general, was regarded as the second most powerful figure in Iran after supreme leader Ayatollah Ali Khamenei. Top Iraqi militia commander Abu Mahdi al-Muhandis, an adviser to Soleimani, was also killed in the attack. Khamenei appointed Soleimani's deputy, Brigadier General Esmail Ghaani, to replace him as Quds Force head.With inputs from Saikat Das

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