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Middle East on edge over Iran's possible retaliation against Israel: How it would impact oil prices?

A suspected Israeli attack on Iran's embassy in Syria, killing 12, has dramatically raised the stakes in the Middle East as nations prepare for Iran's retaliation. This can result in an expansion of the war in the region and would have repercussions in the oil market, including India.

Written By: Aveek Banerjee @AveekABanerjee New Delhi Published on: April 12, 2024 17:31 IST
Israel, Iran, embassy attack
Image Source : AP (FILE) A funeral procession for the seven Iranian Revolutionary Guard members killed in an airstrike suspected to have been conducted by Israel.

Israel-Iran tensions: Six months of the Israel-Hamas war has brought death, destruction and despair in the Gaza Strip and has drawn the entire world's attention. In the course of this conflict, there have been several instances where the Israel-Hamas war has threatened to spill over the wider Middle East region - mostly due to the involvement of Iranian proxies. However, these threats feel considerably weak when compared to a direct attack from Iran on Israel, which has alarmed the entire world.

Iran's involvement in the Israel-Hamas war is well-known. While Hamas, one of the members of its 'Axis of Resistance', stormed into Israel and started the war in Gaza, other proxies have also led a multipronged offensive against Israel. The Hezbollah group in Lebanon has exchanged cross-border with Israel at the border that has left several dead, and the Yemen-based Houthis resorted to attacking international ships in the Red Sea that heavily impacted global commerce and raising oil prices.

As if this was not enough, stakes are now significantly high as countries are weighing a direct attack from Iran upon Israel in retaliation for a suspected Israeli attack that killed seven Iranian military personnel at its embassy in Syria. The United States is on high alert with President Joe Biden pledging to defend its closest ally Israel against one of its arch-rivals, while Britain, Germany and Russia have urged countries in the Middle East to show restraint.

How did this flareup happen?

Israel and Iran have long been embroiled in a shadow war - that has involved cyber operations, support to proxy forces, airstrikes and targeted killings, resulting in casualties on both sides. However, things took a dramatic turn when suspected Israeli warplanes bombed the Iranian embassy in Syria, killing at least 12 people. Among these were two Iranian generals and five officers in the Islamic Revolutionary Guards Corps' Quds Force.

Most importantly, the attack claimed the life of Mohammed Reza Zahedi, the Iranian commander who was directly responsible for managing relationships with foreign allies. His death is the most high-profile killing since a US drone strike killed Qassem Soleimani in 2020. Iran has never lost that many officers in a single operation. So naturally, Iran threatened to retaliate against its arch-nemesis, sparking alarm within the Western countries.

Iran's Supreme Leader Ayatollah Ali Khamenei and other senior officials blamed Israel for the attack and vowed revenge. While Iran is considering several options for an attack, the Israeli administration has also vowed to defend itself and strike back - which has increased possibilities for direct conflict between the two enemy countries and will certainly expand the ongoing war in Gaza. The war is likely to become a geopolitical quagmire, as once Iran battles Israel, the US will most probably step in, which would then result in Russian intervention.

How would the conflict impact oil prices?

While the geopolitical danger of the situation is clearly outlined, the impact of the possible Iranian attack on Israel would also have implications for the global oil trade. Wars lead to geopolitical uncertainties that put a burden on global economies and fears of supply disruptions lead to sharp upticks in oil prices. Consider the Russia-Ukraine war's profound impact on the global economy - which hit the energy market the hardest as economies still reeled from the COVID-19 pandemic

A couple of weeks after Russia invaded Ukraine, the WTI (West Texas Intermediate) crude oil prices touched over $133 per barrel, while Brent crude oil prices reached over $139 per barrel, according to a study. This was the highest price hike since 2008. The trend was further exacerbated by the US decision to ban Russian oil imports. Europe followed suit, opting to find alternative sources of oil to avoid Russian supplies, the second-largest producer of the commodity. Since then, oil prices have fallen sharply due to the slowdown of the global economy, but they have still remained much higher than pre-war levels.

Collectively, the Middle East is the world's largest supplier of oil. As such, any risk of supply disruptions will undoubtedly result in a price hike. That was evident when the Israel-Hamas war broke out, as oil prices soared and threatened to breach the $100 a barrel mark, threatening efforts to curtail inflation. However, after a few days of anxiety, the oil prices remained largely unscathed due to the ongoing war in Gaza as Brent crude showed prices at $80 per barrel. Analysts argued that the war in Gaza has produced little to no disruption in petroleum prices which have remained stable so far.

However, the possibility of Iran's attack on Israel has added fuel to the fire, as crude oil prices are nearing six-month highs despite a rate cut from the US Federal Reserve. This comes on the heels of the Organisation Petroleum Exporting Countries (OPEC) extending voluntary cuts of 2.2 million barrels per day to maintain market stability. According to some reports, crude oil prices rose by 1 per cent this week as the US is on high alert over Iran's retaliation. Some analysts have predicted that if Iran's attack results in a wider war, it would drive up prices over $100 per barrel. One silver lining is that the US expects that Iran's attack would not be big enough to draw the US in as Tehran seeks to avoid a major escalation.

How would this impact India?

India is one of the top oil consumers and importers in the world. When the Russia-Ukraine war broke out, Russia's crude and fuel exports were redirected to South and East Asia, including India. Due to Western sanctions on Russian energy imports, the Indian trade with Russia was deeply affected. Amid all this, the Indian government strategically boosted crude oil imports from Russia at hefty discounts, accounting for over 35 per cent of crude imports in 2023.?

It is important to understand that India overwhelmingly relies on oil imports to fuel its energy demand. The cheap import of crude oil was helpful in India's own macroeconomic interests, reeling from surging oil prices, along with other domestic and trade compulsions. Despite this, a majority of India's imports still come from the Middle East, amounting to 44 per cent in 2023. This means that India is vulnerable to supply disruption in crude oil prices if the war escalates.

The war did not impact India's trade relationship with Israel immediately, as bilateral trade, mostly petroleum products from India, is still strong. The initial days of the war resulted in a slight price hike on Indian imports, the costs fell sharply after some weeks. However, the Indian oil supply would be in jeopardy if Iran attacks Israel, which would mean a dramatic escalation of the conflict, as more bottlenecks are expected, according to analysts.

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