Crude shock, slick response

For an oil importing country like India, high oil prices are cause for major concern. Total production of indigenous crude has been stagnati...

For an oil importing country like India, high oil prices are cause for major concern. Total production of indigenous crude has been stagnating around 32 million tonnes per annum for several years now with no major oil discoveries and depleting fields, while dependence on imports has been growing year after year. We spend over Rs 100,000 crore on oil imports alone, and demand is growing at the rate of over 10 per cent a year. With refining capacity in the private and public sectors at over 110 million tonnes a year, India produces all products including downstream petrochemicals, plastics and synthetic fibers. It is easy to see that an increase in price levels of the imported crude would lead to increases in prices of all derivatives, and thus to an increase in inflation rate. An oil price hike acts like a tax on consumption and, for a net oil importer like India, the benefits of the tax go to major oil producers rather than the Indian government. Further, high prices may actually slow down output growth in various sectors.

Oil prices have been highly volatile in recent months and the precise price increase depends on where the oil price settles. At the early August 2004 price of $44, oil had increased by 65 per cent from its average 2002 price of $26. Some experts are pessimistic and calculate that if oil prices were to stay above $45, the reduction in the G7 growth rate may be closer to 1 per cent of GDP. Global growth would also de-accelerate. Persistence of oil prices at recent high levels of $43-44 per barrel could slow down the US economy below a 3 per cent growth rate, which could impact demand worldwide.

Reasons for the high prices are, by now, well known. Total oil production is not growing. There is very little room for output growth by OPEC — Saudi Arabia has just brought in two new production fields months ahead of target, with little impact — and demand from all economies, led by China and India, is growing (China alone will account for 40 per cent of the increased demand in 2004). Action against Yukos in Russia, uncertainties in Iraq, and little or no scope for further new fields to come into production in the short to medium term, are exacerbating the problem. The big question is, how long will oil prices stay at these rates?

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If prices stay between these levels for most of the year, this would impact Asian growth. Some experts feel prices would ease in the next few months. They also point out that any impact would not be homogeneous given that some countries are more dependent on oil than others, with South Korea, India and Thailand among the most vulnerable. Oil prices at $50 a barrel could shave off 1.1 percentage points from Asia’s projected gross domestic product growth in 2005 — China’s GDP would be trimmed by 1.1 percentage points and India’s 1.2 percentage points. According to an ADB estimate, at $50 a barrel, Asia’s trade balance by end 2005 would deteriorate 0.9 percentage points and inflation would rise by 1.9 percentage points.

It is always possible to hope that things will not worsen. Iraq may start pumping oil on a stable basis; Russian production may stabilise and increase; and the basic faith of the Indian economy on divine intervention may yet again be realised. But it is important to recognise that oil dependence is a game of competing for scarce resources in the world, and that producers and dealers will always dictate prices. In the eighties, the fear of dependence on oil importation in India led to several alternative strategies, which paid rich dividends in terms of energy management. These included rapid development of coalmines, a focus on alternative sources of energy, and efforts at conservation. Subsequent complacence needs to be shaken off. It is important to look at alternative strategies available in both the short and medium term.

Current reaction to the global price increase is oriented towards internal price adjustments, which continue to happen periodically. It is possible to cushion the consumer from these to some extent by reducing excise and customs duties — such adjustments will have to be at the cost of revenue realisations for the government. LPG and kerosene subsidies would continue to grow, the cost being borne either by the government or the oil companies. If oil prices remain high, contraction of demand growth can be anticipated.

It is a matter of some concern that energy management issues are not being addressed holistically. Several think tanks, including TERI, have been voicing their anguish over this. Several steps are possible and needed.

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There have been significant discoveries of natural gas, mostly by the private sector. It is important and urgent to have a coherent policy on gas use. These would include decisions on use for power generation and downstream products, mix and pricing of natural gas and LNG, and regional distribution of pipelines. In the early eighties, when the Hazira field was discovered, a special committee was set up to decide the optimum use of the field and the Union cabinet finally took a decision on the direction of the pipeline and end use of the gas. Regulation and pricing of gas are the first steps needed to decide on the use of this fuel.

Secondly, there has to be a rethink on power generation. There has been very little investment in coal mining in the last few years. The big push of coal fired power generation needs to be restarted. Focus on hydel generation has revived, but is still sporadic and largely left to state governments. Acceleration of nuclear power generation is possible through reduction of dependence on the NPC and bringing in international players, just as China is doing.

Prices charged by oil companies need to be re-examined. In particular, ONGC is compensated for its production at international prices, though its cost of production is very much lower. There is considerable scope for economy.

Finally, an integrated approach to energy is needed, which would, apart from optimising alternatives, focus on conservation, solar and other sources as well as bio-fuels.

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China has already started strategising alternatives. We should also do so immediately.

(The writer is a former Petroleum Secretary and Economic Advisor to PM)