In May 2018, President Donald J. Trump withdrew from the landmark Iran nuclear deal following months of speculation. Formally titled the “Joint Comprehensive Plan of Action” (JCOPA), the multilateral agreement was aimed at curbing Tehran’s disputed nuclear program in exchange for relief from US and other Western sanctions targeting Iran’s lucrative oil trade with countries like India. Shortly after the agreement was announced in July 2015, Indian officials characterized it as the “best deal available” at the time. New Delhi seized the opportunity to repair its economic and commercial relations with Tehran, which had suffered under the longstanding sanctions regime.
Less than two years later, new, unilateral US sanctions on Iran’s petroleum sector are set to take effect following a 180-day “wind-down period” ending on November 4, 2018.What does the American withdrawal from JCOPA mean for oil trade between India and Iran, and particularly for Indian companies conducting business with the Persian Gulf nation?
The impact on trade
The most direct impact will be a quick increase in Iranian oil exports to India in the short-term followed by a sharp decline in the medium-to-long term after sanctions go into effect. Energy cooperation has long represented a crucial pillar of bilateral ties between India and Iran. India is the world’s third largest oil consumer and is expected to become the largest in twenty years. But its sparse reserves at home have forced it to import 80% of its oil from abroad, including from Iran, India’s third-largest oil supplier after Saudi Arabia and Iraq. India is Iran’s largest oil customer after China, and the two Asian giants have historically accounted for 60% of Iran’s oil exports combined. Put simply, India’s energy security is highly dependent on Iran.
Iran’s close geographical proximity to India and the resulting inexpensive shipping costs are key reasons underlying India’s preference for Iranian crude. Moreover, Tehran has traditionally offered favorable financial terms to India on its oil sales, including the longest credit period of any of its other suppliers. The South Asian giant imported more than 27.2 million tons of crude oil worth of $11.1 billion between 2017 and 2018 alone.
Past is Prologue
Less than a decade ago, Iran accounted for nearly 17% of India’s oil imports. Sanctions imposed on Tehran by the Obama Administration in concert with several other Western countries in 2012, however, forced India to dramatically curtail its imports of Iranian crude by half their previous levels. Failing to otherwise do so risked jeopardizing India’s access to the US banking system as a result of so-called “secondary” or extraterritorial, sanctions.
Between 2012 and 2015, India gradually reduced its oil imports from Iran, but did not halt them completely. New Delhi instead continued purchasing crude shipments from Iran at lower levels while diversifying its energy supply through increased oil purchases from other countries in Latin America and the Middle East. The continued, albeit diminished, flow of Iran crude to India reflected the reality that many of the country’s biggest oil refineries have been designed to process Iran crude exclusively. Complete termination of imports from Iran was simply not an option for India.
In the end, New Delhi ultimately received multiple sanctions waivers from Washington, effectively permitting the smaller oil purchases. But Iran’s share of India’s imports fell to less than 7% by the end of this period, a 10% decline from peak levels. India will once again have to obtain these waivers from the US by slashing imports significantly.
Although exports of Iranian oil to India predictably surged by more than 110% after sanctions were lifted following implementation of JCOPA in mid-2016, American withdrawal from the accord has found India back in a familiar position: forced to either reduce its oil imports from Iran or risk exposure to US sanctions. Indian officials recently announced that India does not recognize—and would therefore not abide by—unilateral American sanctions, effectively pledging to maintain current import levels. New Delhi had made similar pronouncements in 2012. But if the past is any indication of the future, India is likely to experience a reduction in crude imports for several separate, but closely related, reasons nonetheless.
Indian Refiners Commence Cuts
First, Indian refiners have already begun to voluntarily reduce their imports of Iranian oil. Just days after President Trump announced his decision to withdraw from JCOPA, for example, Reliance Industries, owner of the world’s largest oil refining complex, and the biggest Indian purchaser of Iranian crude, announced it would be ending oil imports from Iran in October or November 2018 as a result of the sanctions risk from the United States.
The numbers are revealing. In 2017, Reliance imported approximately 67,000 barrels per day (bpd) worth of crude from Iran. These imports increased to 96,000 bpd during the first quarter of 2018. With India currently importing 604,000 bpd from Iran, Reliance’s decision will reduce Iran’s exports to India by more than 15% alone.
Other Indian oil companies have already begun to follow suit. Indian refiner Nayara Energy, another one of the India’s largest customers of Iranian crude, initiated cuts in its imports soon after President Trump’s announcement and well before Reliance’s planned reductions. Previously known as the famed Essar Oil, Nayara was purchased by the Russian state-owned company Rosneft and its partners in a headline grabbing deal worth almost $13 billion.
According to recent data, Nayara buys approximately 5.5 to 6 million barrels of crude per month from Iran. But sources within the company have indicated that cuts are already aimed at reducing Nayara’s imports by 50% by the end of the year. Company management is optimistic that it will be able to find alternatives to compensate for the loss from Iran. The question that arises is whether India’s other major private and state-owned refiners, including Indian Oil and HPCL-Mittal Energy Ltd., will be next to slash imports.
Second, refiners seeking to maintain present crude import levels from Tehran will be forced to contend with global insurance and shipping companies increasingly unwilling to engage in Iran-related transactions due to the looming sanctions risk. Reliance’s decision to halt Iranian crude imports, for example, was partially motivated by the company’s own insurance companies notifying the Indian conglomerate that it would no longer extend insurance coverage to the crude shipments from the Islamic Republic. Shipping companies are similarly unwilling to transport Iranian oil targeted by US sanctions, especially if the cargo is uninsured.
The dilemma is the same one that confronted Indian and other oil companies between 2012 and 2015 when sanctions were previously in effect against the Persian Gulf nation. After Western sanctions were first imposed, the London-based International Group of Protection and Indemnity Clubs (IG Clubs) stopped providing third-party liability coverage to tankers transporting Iranian oil. The IG Clubs, comprised of 13 member companies, provide insurance coverage for roughly 95% of the world’s tankers. The absence of established insurers resulted in the emergence of new, less reputable insurance providers, underscoring the precariousness of India-Iran oil trade.
Oil tankers from the National Iranian Tanker Company were dispatched to deliver crude to refiners in India, while exports of non-oil commodities and industrial goods employed ships from two prominent, but local, Iranian shipping companies. India subsequently allowed two Iranian underwriters, Kish P&I Club and QITA P&I Club, to provide insurance for vessels calling upon Indian ports, including those containers and tankers carrying Iranian crude oil. The approvals were granted initially on a quarterly basis, and then every six months thereafter.
Based on this previous practice, officials from the Persian Gulf nation are now seeking to obtain permanent authorization from India for these two local underwriters to provide coverage to Iranian tankers transporting crude to India to preserve current import levels after US sanctions come back into effect. At the time of this writing, decision makers in New Delhi have yet to respond to the proposal.
In the past, India demanded that Tehran provide a high-value bank guarantee through a non-exposed Indian financial institution in the event of any major maritime accident in Indian waters involving the local Iranian vessels. Although it is unclear whether India will insist on a similar arrangement once again during the upcoming round of sanctions, the uncertainty surrounding the insurance coverage will also weigh in favor of major cuts to India’s crude oil imports from Iran moving forward.
Third, payment for Iranian crude imports to India will once again resurface as a serious obstacle for both countries. Without access to the US financial system, India and Iran will have to resurrect complex rupee payment mechanism to facilitate and preserve their oil trade akin to what was done during the last round of sanctions. Once again, past practice is instructive and does not portend well for the future.
Although Iranian crude exports to India continued after 2012 at reduced levels, New Delhi was compelled to pay for them through a complex combination of euros, rupees and barter exchange. Specifically, 45% of oil payments to Iran were made in rupees through India’s UCO Bank, which had no exposure to the US financial system and was thus immune from US sanctions. The rupees deposited with UCO Bank were then used by the Persian Gulf state to buy a plethora of different Indian exports to the country, including wheat and other grains. Oil purchases not covered by the rupee-barter hybrid payment system were bought on credit in anticipation of more traditional banking channels being reestablished in the future.
After sanctions were lifted in 2016, the amount in the rupee account at UCO Bank fell to less than $300 million. The nuclear deal re-opened certain banking channels that had been foreclosed while Western sanctions were in place. The two countries effectively abandoned the UCO Bank channel. Instead, Indian companies have been paying Iran in euros by first sending payments to the state-owned State Bank of India (SBI), which then transfers the funds to the Germany-based Europaeisch-Iranische Handelsbank AG (EIH) and then ultimately to Iran.
With sanctions once again visible on the horizon, India and Iran will be compelled to resuscitate the rupee-barter payment mechanism, and talks are already underway toward this end. Resurrecting the arrangement will be not be an easy task, especially given that several Indian banks have already instructed their commercial clients to complete their financial transactions with Iran before sanctions take effect.
Chief among these is SBI, which announced recently that it would no longer be processing Iran-related transactions, instructing its account-holders to complete any oil payments with Iran by October 2018. A recent meeting among Indian officials and their counterparts from several Western capitals aimed at exploring the viability of alternative European banking channels to facilitate crude payments yielded no results.
There is little doubt that the road ahead for India-Iran oil trade has become a more perilous one since President Trump’s withdrawal from the Iran deal. At the same time, it is important to recognize that while reductions in India’s oil imports are virtually inevitable by the end of 2018, these cuts will first be preceded by a significant surge in oil purchases from the Persian Gulf nation. Indian companies will seek to accelerate crude imports from Iran and build their respective oil reserves before US sanctions are re-imposed on the Islamic Republic.
Recent data illustrates that India imported roughly 771,000 bpd of crude from Iran in May 2018, a 35% increase from the previous month. Indian Oil Corp., one of India’s biggest refiners, increased its oil purchases from Iran seven-fold, and aims to purchase supplies of 7 million metric tons during the 12 month period beginning April, up from 4 million tons during the same period last year. Similarly, state-owned refiner Bharat Petroleum Corp. boosted its purchases from the National Iranian Oil Co. (NIOC) by an extra one million barrels in June 2018. Sources indicate it will likely continue to do so until the end of the wind down period.
Another factor that is both a symptom and a cause of this trend are the shipping discounts and other concessions the Islamic Republic is offering India on its crude exports as an incentive for New Delhi to maintain current import levels, particularly as India looks to diversify its oil supply. Despite the turbulent path ahead, Iranian crude will remain one of the most attractive oil commodities on the market until October 2018. Longtime customers like India will be keen to take advantage of Iran’s eagerness to mitigate the impact of US sanctions.
Other related consequences of President Trump’s decision to pull-out from the Iran deal have already begun reverberating across India. News of the withdrawal was followed by the rupee’s weakening against the dollar, increased foreign exchange outflows and higher gas prices at Indian pumps across the country due to more expensive import bills.
India has already begun endeavoring to diversify its oil imports and will look to OPEC member states to compensate for any portion of Iranian crude removed from the global supply. But beyond OPEC, rising Russian crude production will also bolster Indian energy reserves. Ties between New Delhi and Moscow remain close, and this is an area where their geopolitical and geostrategic energy interests continue to align.
Another option still in the early stages of consideration by officials in New Delhi and Washington is for the United States to increase its shale and LNG exports to India in an effort to reduce the country’s dependence on Iranian oil. In March 2018, India received its first consignment of LNG cargo from the US under a long-term supply contract. Proponents of such an idea contend that greater American shale and LNG exports to India will not just reduce the country’s historic reliance on Iranian crude, but will also transform its entire energy footprint, including its voracious coal consumption.
Perhaps more compelling, however, is that any increased US-India energy cooperation in this arena will help blunt criticism directed at New Delhi over its oil trade with the Tehran and render the issuance of any sanctions exemptions from Washington more politically palatable.
Ultimately, New Delhi is likely to obtain the requisite sanctions waivers from Washington and oil trade between India and Iran will continue, but at diminished levels. Indian companies with commercial ties with Iran must now address a host of formidable challenges to continue conducting business with the country.
Ronak D. Desai is an international investigations, enforcement defense, and compliance attorney at a prominent international law firm in Washington DC, where he serves as Vice-Chair of the firm’s India practice. He is also an Affiliate at the Lakshmi Mittal South Asia Institute at Harvard University. He earned both public policy and law degrees from Harvard University. He can be reached at Ronak.Desai@post.harvard.edu