Oil firms' freight costs spike as war clouds gather in Gulf

Geopolitical tensions in Strait of Hormuz have led to rise in freight costs of the Indian oil refining and shipping companies as insurance premiums have spiked by up to $3,000 per day.

The increase in the insurance premium is to cover the gas and oil cargo from "additional war risk premium".

In the last few weeks, the war rhetoric has been rising after attacks on tankers and the downing of a US drone. These incidents have also prompted the Indian government to dispatch two Indian Naval warships to the busiest oil shipping lane of the world.

Already, war risk underwriters have started levying additional premiums for calls to and from the Gulf of Oman and Strait of Hormuz.

"The insurers have started levying a steep amount to cover the cargo and ship's hull and machinery. In some cases it is even 0.25% of the ship's value," said a source from a shipping company.

Nevertheless, the increase in freight costs is fully passed on to the end customer – the oil refining companies. India is the world's third-biggest oil importer with 84% of the country's crude oil demand imported during FY2019. A substantial of these supplies are from the Middle East and Gulf countries.

During peacetime, when the geopolitical tensions weren't there, each call or vessel only had to pay a marginal war risk premium of 0.05%.

Due to the war risks involved, the shipping and refining companies end up paying additional war risk premium on and above the nominal war risk premium that is levied during peacetime. "Now, the additional war risk premium has increased up to sevenfold, or up to 0.30% of the ship's valuation. During the initial weeks, this additional premium was a lot less," said a correspondent from an insurance brokering company.

In Indian rupees terms, the freight rates for sailing between Arabian Gulf and India has shot up in the range of Rs 1.50-3 lakh per day because of the additional war risk premium levy.

This additional levy isn't limited to the cargo sailing for India, but also that being shipped to other countries across the globe.

Usually, the insurance cover is issued for the duration of seven days, and a longer stay in those waters would mean paying a higher premium.

"The premium and additional war risk premium percentage or amount vary for different carriers (type of oil and gas ships)," the correspondent said.

Older ships have more benefits because the overall valuation is less after having deducted depreciation over a period of years. In certain instances, smaller vessels end up paying a higher premium due to varying factor involved while calculating the premium.

With the underwriters quoting the premium figure only 48 hours prior to the sailing, industry players said the worsening situation means freight costs with only continue to move northwards.