The Hindu : Business : Riding the Oil Tiger

Online edition of India's National Newspaper
Monday, Oct 11, 2004

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Riding the Oil Tiger

While there is growing pessimism over global oil supplies, the Indian Government is trying to distribute the burden of the oil shock among the different stakeholders in the short term.

THE GOVERNMENT'S valiant decision to shield the Indian market from global oil price spikes might have been prompted as much by pragmatism as by political considerations. After all, in an energy-intensive economy like India, there is little leeway for demand to adjust itself to price signals without impacting the pace of economic growth that seems to be on a robust trajectory right now.

The energy-intensive growth paradigm of the last two decades has ensured that energy consumption growth has consistently outpaced gross domestic product (GDP) growth. And the share of oil in the energy basket is steadily rising. It is now around 40 per cent. Demand-side management measures are by definition long-term remedies and any knee-jerk response can have severe adverse consequences for the economy. In a sense, India is riding the oil tiger and can dismount only at its own peril.

But this will apply to most other countries as well. World over, oil price increases have not resulted in corresponding demand reduction even in economies that are not energy-intensive. For instance, during 1979-83, when oil prices rose by about 115 per cent in nominal terms, the volume of demand in Organisation for Economic Cooperation and Development (OECD) countries dropped by a mere 5 per cent.

While oil shock of 1973-74 in which oil prices rose by about 295 per cent did bring about a deceleration in oil consumption and consequently in economic growth, this was followed by actual annual increases in consumption from 1975 onwards, especially in the U.S. and Japan, two heavily energy-importing economies. Oil industry analysts call this the `adjustment and retrenchment' phase. It is somewhat like dieting to reduce weight. Once some palpable weight reduction has been achieved, dieting goes out the window to be replaced by binge-eating!

Major consumer

What is driving energy consumption growth? For most developing countries, the transportation sector accounts for more than half the oil consumption.

Today, oil's primacy as the preferred transportation fuel is unchallenged. No large-scale viable alternative to oil is as yet in sight when it comes to driving cars, trucks, trains, ships and planes.

Gas, the celebrated clean competitor to oil, is generally — and perhaps rightly — viewed as a regional resource whose economics work best when transported through pipelines within the region.

The assessment holds, despite the emerging markets for its expensive sibling, the liquefied version. Even though they have many advantages, compressed natural gas (CNG) and liquefied petroleum gas (LPG) still play a marginal role in the transportation sector.

India is no exception. Save a few thousand vehicles in the capital, the chunk of the ten million plus vehicles on Indian roads run on liquid fuels. The Railways are not able to keep pace with the burgeoning growth in freight traffic and have ceded the ground to roads. Our short-sighted policy of the early-90s in opting for individualised personal transport rather than efficient mass transit systems has come home to roost now.

Curtailing oil demand without causing a gridlock in the economy is a challenge that our policy makers have to deal with now. It is a long drawn-out process, but it must begin now.

Time for action

For, it appears that the era of cheap oil is coming to an end. Global energy planners and strategists are meeting in Germany next week to discuss the `facts and visions' of the `oil peak' which some believe has already been scaled. Oil industry jargon is under minute scrutiny as never before.

Analysts are poring over the nuances of proven, proved, probable, possible, potential and prognosticated reserves, not to mention in place reserves versus established reserves, reserves versus resources, conventional versus non-conventional — all in a desperate effort to ascertain how long oil will last. And this is quite independent of the climate change debate that seeks to wean economies away from polluting oil.

This panic over `peaking' oil also fuels the price spiral which is already being relentlessly pushed up by an unfortunate cascade of circumstances. A tight supply situation caused by troubles in Nigeria, Russia and Venezuela is compounded by a surge in demand especially from Asia.

In a market desperately trying balance demand and supply, the terror factor has thrown a spanner driving up prices by a substantial $10 per barrel which analysts say, is the terror premium.

That apart, punters seem to be having a field day, cashing in on the opportunity to make a windfall. In the U.S. 80 per cent of the commodity indices are composed of energy investments and Wall Street banks and brokerages have moved in for the kill prompting Federal Reserve Chairman, Alan Greenspan, to remark "The marked rise in the net long positions of non-commercial investors in futures and options since May 2003 has increased net claims on an already diminished global level of commercial crude and product inventories... oil prices accordingly, have surged" More than the price increase, it is the volatility that renders haywire, national budgets of energy-importing countries. With gas prices reigning high, fuel-switching, even if it were possible at short notice, is not an option for most developing countries at the moment.

The price spiral has driven home the message that India can no longer afford the luxury of not having a long-term national energy policy. Our policymakers must focus on diversification of energy sources but along with that, they will have to introduce pro-active demand-side management measures as well — as much in the interest of the economy as that of the environment.

Sudha Mahalingam

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