Here's why India decided to cut Iranian oil purchases in row over gas field

India prefer the risk in buying of crude from spot markets than stick to long term contracts

The context to the apparently sudden dispute between India and Iran on oil has much more to do with expected trend in pricing of crude and less to do with the delay on the terms of Farzad B gas field. 

Indian policy makers feel they can slowly take on more risks in buying of crude from spot markets than stick to long term contracts. 

India has always played with a safety first approach to the purchase of its crude from abroad which accounts for 80% of its domestic requirement. The approach is a follow though from the impact of the successive oil shocks of the seventies and the periodic forex crisis,  which has occurred even as late as 2013, all of which have left their scars on the economy. 

So the petroleum and natural gas ministry prefers to deal with the oil exporters to set a price band known as the official selling price (OSP). These bands are used to sign a long term contract, usually of one year where India is assured of the contracted supply at a price that hovers around the OSP. It is a hedge against the day when crude prices would zoom upwards. As a measure of further safety even within the set prices, India diversifies the list of countries from whom it shops for oil. Saudi Arabia accounts for 18% of the total imports, while Iran accounts for 6% (it used to be higher before the sanctions) Venezuela accounts for 12% and even countries like Angola account for 4% of India’s crude import. The ratio of long term to spot purchase for India at any given period is roughly 80:20. 

From early 2014, as prices of oil has dipped globally, the expected bad day when prices would shoot past $100 a barrel has not happened even once for India. Instead as the analysis of IEA or BP shows, there is very little reason to believe it would happen in future too. 

These trends give India the confidence to depend on the spot markets a wee bit more and diversify the market even more. India wants to buy more from the African oil producers—it also makes sense as India pushes up investment in their upstream and downstream projects. Other than Angola the shopping list includes Algeria, Gabon, Equatorial Guinea, Cameroon and the Republic of Congo. It would cut the share of the existing sellers, especially for the heavy crude that Iran has more of and is thus more keen to sell. The market for this variety is limited—India itself has only two refineries that processes this crude, the RIL refineries at Jamnagar and state-owned Mangalore Refineries (MRPL). It is a bit of a buyers’ market here, as the bulk competitors for this type of crude are only China and Japan in Asia. 

The decline that has set in the price of crude also now appears to be long term trend. Any spike is expected to come up against the world of shale oil. Prices are not expected to shoot up in this top heavy environment. To test the waters IOC had for some time raised its spot component to 30%. It has not come to grief. The lower price helps to keep the prices at the petrol bunks low back home—a huge political dividend for any Indian government. There is enough temptation for India to bargain with its buying power in the global oil markets now.