Options in ensuring energy security
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The price shocks that accompany large disruptions in oil supply have a ripple effect throughout the economy, observes Vinish Kathuria.
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THE RECENT upswing in oil prices touching an all-time high of over $58 a barrel has again brought the question of energy security into the spotlight. While the issue is relevant for all countries, it assumes added importance for a developing country like India that has embarked on a high growth path.
As of now, India imports 70 per cent of its surging oil requirement. With the projected rate of economic growth, this is likely to rise to 85 per cent within two decades. On the other hand, India's oil output has been stagnant around 32 million tonnes annually. This large import requirement leaves the country vulnerable to rising prices.
Urgency of issue
After the September 11 attack on the twin-towers in New York, two trends have clearly emerged that point to an urgency to frame India's energy policy. The West Asian region and the oil flowing from there are now more vulnerable than ever in the past.
Second, which is related to the first point, is the unprecedented growth in demand which, coupled with uncertainty in supply, has led to increased oil prices. The demand is showing no sign of let-up while the supply is running at full throttle.
Since these two aspects are beyond the control of an individual country, the only logical way out is devising a policy that aims at energy security for the country. The developments have forced even the developed countries to look seriously into the matter.
In this context, it is important to recognise that the present situation of high prices is entirely different from the oil price rises of the past. This time, the disruption of supply is understandable given the U.S. intransigence and its dubious role in the Iraqi crisis. The subsequent fanning of the Iran issue also does not augur well for future oil supplies.
The price shocks that accompany large disruptions in oil supply have a ripple effect throughout the economy. It gets reflected through a pure price effect and an income effect.
The former arises because petroleum products become more costly relative to other products and services (despite repeated deferment of revision in petrol and diesel prices by the UPA government, they cannot avoid it any longer given the current high international crude prices, so that users need to make adjustments in whatever they purchase: labour, capital, and materials for businesses; and goods and services for individuals.
On the other hand, with higher petroleum prices, incomes of individuals suffer a reduction in their purchasing power.
The issue of energy security can be looked at from the demand as well as supply sides. For secured energy (especially oil), the supply and demand side factors need to be tackled simultaneously.
Supply side factors
From the supply side, the most important and immediate step to improve the energy security will be to diversify the sources.
The diversification of sources involves attacking it from three angles — enhancing exploration efforts within the country; pursuing upstream investment overseas; and looking for alternative sources. Besides these, `stockpiling' can smoothen any supply shocks.
As for enhancing exploration efforts, the New Exploration Policy (NEP) has proved to be appropriate as the number of private and foreign players engaged in oil exploration on-shore and off-shore has gone up.
One policy lacuna here is that foreign firms are not yet allowed to set up refineries. Given the highly vertically integrated nature of the industry, this constraint may dissuade oil majors from India. However, any such modification in policy should not lead to the emergence of a monopoly.
Allowing the Oil and Natural Gas Corporation to acquire fields outside India is another important option that can go a long way towards energy security. The ONGC has already started acquiring stakes in promising oil and gas fields abroad. However, since many countries are seeking energy security through diversification of sources, the competition has already intensified.
In this exercise India can learn an important lesson from China, which prefers to acquire what has already been developed, instead of exploring and then developing fields as pursued by Japan.
Strategic tie-up
With regard to the third option, the recent visit to India of the Venezuelan President and the assurance given by him seem quite significant. This option has its own limitation in the form of geographic distance between the two countries.
Outside the OPEC, Russia is the largest supplier of oil and this alternative source option needs to be explored in depth. Given the historical ties between the two countries, there should not be any big problem except that other countries like the U.S. and Japan too are negotiating with Russia to access that rich source.
Stockpiling
Another important supply side measure for energy security is stockpiling. Stockpiling or maintaining reserves protects against unexpected disruptions of supplies. This option is gaining currency in many oil importing countries.
While stockpiling looks attractive it has an opportunity cost of keeping precious foreign exchange locked in oil stocks. Moreover, any sharp fall in prices will cause huge losses to oil companies and at the national level. Still, this is considered a small price to pay if energy security is the main concern.
Demand side factors
The demand side options can be divided into two categories — conservation in energy use and developing alternative energy sources.
India is one of the high oil intensive countries. This means the country consumes more oil per unit of output than most other countries.
According to the International Energy Association (IEA), Thailand and China consume twice the rich country average for the same level of output. India uses thrice as much. High oil intensity also implies that there is considerable scope for conservation.
One cause for high oil intensity is its subsidised price. Setting the right prices can go a long way in reducing wastage and hence demand for oil.
Developing alternative sources is another option to achieve energy security. The recent efforts of a number of countries to develop alternatives to hydrocarbons like hybrid technology, fuel cell, bio-diesel, advanced composites and lightweight steel construction are steps in the right direction. But many of these are at a nascent stage and on a scale which cannot replace oil in another 30-40 years. Many of these options have not yet entered India, but sooner or later they may find a place.
The spare capacity has been the oil market's main source of liquidity in the past. In 2002, spare capacity amounted to nearly 10 per cent of the 76 million barrels a day global oil market.
A year later, with daily demand rising to 78 million barrels, spare capacity dropped to about 5 per cent. This cushion was sufficient to prevent a crisis in late 2003 and early 2004. Now, mainly because of the increased demand in Asia and other factors, the OPEC's spare capacity has dropped to a precarious level of 2 per cent.
Any further increase in demand will lead to a further spurt in prices endangering energy security. Among the supply side options, stockpiling has to be done at the regional level. This is because the economies of Nepal, Bhutan and other South Asian countries rely extensively on India for trade and any regional instability in times of an oil shock will have repercussions for India too.
Another option that can facilitate securing better terms for oil is formation of a parallel cartel (of oil consuming countries). However, such as cartel will not have any teeth unless they have secure alternative supply.
Last, it needs to be kept in mind that a sufficient energy security is not an end itself, rather it is a step towards a larger goal which is energy independence, that is, minimum reliance on oil.
(Vinish Kathuria is Associate Professor at Madras School of Economics and can be contacted at vinish@mse.ac.in)
(Vinish Kathuria is Associate Professor at Madras School of Economics and can be contacted at vinish@mse.ac.in)
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