Opinion & Analysis
by Nitin Desai
We have to look beyond oil for energy security.
Crude prices have now been hovering at over $60 for several months and show no signs of coming down. As always happens, when oil prices move beyond analyst’s expectations, the blame is put on the way the market functions rather than the more sensible diagnosis that something was wrong with the predictions.
The current flare-up in prices can be explained in terms of supply shocks—the impact of Hurricanes Katrina and Rita on the US Gulf of Mexico, some delays in the start-up of new fields and some loss of production in non-OPEC countries.
In India we have had a loss of production because of the accident in Bombay High. The impact of the hurricanes is quite substantial. At the end of September more than half the crude production capacity in the US part of the Gulf of Mexico was shut and several refineries have been damaged to an extent that will require some months of downtime. Because of this oil prices will remain relatively high for some months.
An immediate word of caution is in order. Oil prices are notoriously difficult to forecast. In the first quarter of 1999, crude prices were down to around $11 a barrel. Thereafter they have risen sharply in every year except 2001 and 2002. Despite this, each year analysts have predicted a fall.
We have to accept that oil prices are prone to supply shocks and are very unpredictable. Given the sheer size of the oil sector, the range of macro shocks can be large. Thus the difference between an oil price of, say, $30 per barrel and $60 per barrel translates into a terms of trade loss of some 2.5 per cent of GDP for India. This is by no means small and is a major challenge for macroeconomic management even with an energy policy that allows markets to function.
Of course it could be worse with an energy policy that is unwilling to face the consequences of cost increases. India, for instance, faces this now, with controlled prices calibrated to an oil price of around $45 per barrel.
Getting prices right is always desirable. But oil security is better looked at as an issue about quantity uncertainties rather than price uncertainties, about availability rather than the cost of oil. One could measure it in terms of four factors—the role of oil in the domestic energy mix, the dependence on imports, the diversity of foreign supply sources, and the alternatives available if there is supply disruption.
The role of oil in the domestic energy mix has increased in the 1990s mainly because of the rapid growth in vehicle population. Oil consumption has grown by about 6 per cent per year since 1989-90 as against the growth rate of 4.3 per cent per year for coal, which is the other principal energy source. These growth rates are not particularly worrisome.
However, import dependence has increased sharply. Crude production has stagnated at around 650,000 barrels per day since 1989-90, when the import dependence ratio dipped to its lowest level.
As a consequence, crude imports have risen at 11.6 per cent per year since then and we now import around 1.8 million barrels per day, which, at prevailing prices, costs more than $100 million per day. Our supply sources are limited and we have few fall-back options if there is any serious supply disruption.
The government and the petroleum industry in India have responded by bidding for stakes in oil concessions abroad. But unlike China, which entered the market aggressively when oil prices were low, we came in when prices were on the rise and attractive properties were not on offer.
Investments have been made or are being actively pursued in Russia, Kazakhstan, Sudan, Libya, and even Venezuela. The celebrated pipeline project with Iran and the deal with Myanmar are part of the same strategy.
But does ownership stake reduce supply uncertainties? The major source of uncertainty in West Asia and the Caspian is the risk of political disruption and great power geo-politics. If there is a political upheaval or great power intervention in these regions, then an ownership stake will not necessarily help. It may however make sense as a business proposition if oil is expected to become increasingly scarce.
What are the prospects for long-term oil supply and demand? There are analysts who claim that world oil production is nearing its peak, which they expect will be reached in the 2010-15 period. They point out that in recent years the rate of consumption has outpaced the rate of new reserve discovery. There have been very few big discoveries in the past five years.
Others are less pessimistic and look to reserve upgrade and the use of oil sands, shales, and heavy oils, which today are known but not extensively exploited. But even these analysts see a peak by about 2035.
On the demand side, it has been estimated that the current global consumption of 30 billion barrels per year will rise four-fold by 2025, mainly because of growth in China and India. In fact by 2025, the share of developing countries in oil consumption will be more or less the same as that of the developed countries.
The dependence of the world on West Asian OPEC oil will increase. Even now, one of the better predictors of oil price behaviour is the extent of excess production capacity available in the Gulf, which is very low at present.
The IEA projects a nearly three-fold increase in production in this region in the next 25 years. And this is also, perhaps, the least stable region in the world.
With tight supplies, risks of supply shocks and rising demands, the oil market may become even more unpredictable and volatile than at present. If the peak oil theorists are right prices will ratchet up. More than that, geo-political rivalries will surface between major consumers like the US, China, and India.
The oil business has always been a heady mixture of geo-politics and commercial adventurism. This will not change. The risk is that when prices fall, as they will in a few months, the armchair strategists at home will lose interest and we will be back at our tradition of muddling through.
Oil policy needs a long-term non-partisan appreciation in the political process. More than that, it has to be part of an energy policy that looks at non-oil supply options and demand management.