The problem

IT is difficult not to be fascinated, even obsessed, by oil and not only because our lives are so dependent on it. At one level, as a non-renewable resource, there is constant fear about it running out, creating a ‘limits to growth’ syndrome, apprehension about consequent dislocation and economic hardship. No surprise that so many wars have been fought over its control. Equally, being blessed with it in abundant measure can be a curse, resulting in corruption and rent-seeking behaviour. It’s worth noting that many oil rich countries have found it difficult to create development friendly institutions. Less understood, but equally critical is its contribution to greenhouse gas-induced climate change. In short, both having it and not having it can be a problem – economically, politically, socially and environmentally.

From an oil economics and policy perspective the past three decades have been complex and exciting. Oil, the cornerstone of the global energy economy, has increasingly come under pressure on grounds of ‘security’, ‘sustainability’, or ‘carbon emissions’. An acute concern over the price and availability of oil, such as from the mid-1970s to the end of the 1980s, led to a search for alternatives and a move towards greater energy efficiency in the OECD (Organisation of Economic Cooperation and Development) countries. But the 1990s were in a sense a decade of lost opportunity when relatively low prices reduced this momentum despite the increasing global environmental concern with carbon fuels. The last four years, and especially 2005, was a period when oil, because of rising prices and fears of impending shortages, made a comeback in a big way, dwarfing other issues and pushing energy security concerns to the top of most policy agendas.

The period since the new millennium has witnessed a sharp rise in oil prices from 18 dollars/bbl (barrel) in November 2001 to 70 dollars/bbl at the end of August 2005, hovering at about 67 dollars/bbl in early September. Unlike the earlier price rises caused by supply disruptions – be it the OPEC oil embargo in 1973-74, the Iranian revolution in 1979-80, or the Iraqi invasion of Kuwait in 1990-91, the current price rise is due to the high oil demand triggered by vibrant economies. From the US to China to India, the growth in oil demand has been linked to the robust and strong economies. These three countries, which are also seen to be a major source of oil demand in the future, currently comprise 36% of the global oil demand. Given the current low per capita oil consumption in China and India relative to the world average, and the move towards the use of more energy-intensive products in consumption patterns in these economies, it is likely that this trend will continue.

This increase in global oil demand is unmatched by an increase in supplies due to an underinvestment in slack production capacity. Economic and political processes have squeezed out slack capacity, resulting in oil markets that have to operate with tighter supply margins. Unlike earlier oil price increases induced by supply disruptions, this one will take a longer time to return to the earlier price levels as the corrective demands an increase in supplies to meet the new and growing oil demand. And though release from strategic reserves, or small increases in production may produce marginal price falls, the general expectation is that prices will remain high for at least the next three years.

The price situation beyond this period is unclear as many argue that oil resources have peaked and that we are witnessing an end of the oil era; there are others who say that the problem is a lack of investment in production capacity. Most oil optimists, however, do not believe that we have run out of oil or are in danger of doing so during this century. The end of the cold war and the new openness to foreign investment by many economies is seen by many oil watchers to mean that regions previously under-explored are now available for oil exploration activity. Also higher oil prices and technological advances combined with new discoveries result in a regular revision of reserves. Experts believe that the existence of oil reserves is less uncertain as is the ability to obtain the required upstream investments, dealing with climate change issues, handling pipeline routing politics, and maintaining a stable output.

The global economy has been surprisingly resilient in the face of the current oil price rise. A combination of factors has been instrumental in this: lower energy intensity in the OECD countries since the 1980s, recycling of oil revenues from oil-exporting countries towards increased imports, and the investment of external payment surpluses in the US capital markets that have kept the bond interest rates low. But the question is, for how long will this resilience last? And how will this play out across regions, countries, and income groups if oil prices continue to remain high?

The IEA (International Energy Agency) projects world oil demand in 2030 at 121.3 mbd (million barrels per day) as against 77 mbd in 2002, of which the OECD oil demand will comprise 57.6% while China and India will account for 12% and 5.6%, respectively. With this large increase in oil demand, unless alternative oil sources are found, dependence on OPEC oil from West Asia will grow considerably. This is even more likely given the decline in OECD (North Sea, Canada, and Alaska) production in 2005.

Oil demand projections and expectations that oil prices will remain high for some years has given rise to concerns of energy security in several oil-importing countries. One manifestation of this concern with energy security is the rise in resource nationalism internationally, that is, those who have oil are increasingly wanting to develop it themselves or retain a control over the resource. This is a trend somewhat reminiscent of the responses in the mid-1970s and the earlier 1980s. What is different this time around is that those with deficient domestic oil resources are engaged in a race to secure oil resources internationally. Take countries such as China and India whose growing oil demand is creating concerns about the ability to buy and secure oil to ensure that oil availability does not constrain economic growth, leading these countries to adopt strategies akin to a competitive scramble for resources. The targets of this competition are both foreign oil companies, for example PetroKazakasthan or foreign oil resources as in the case of Angola, Sudan and Uzbekistan.

In the search for oil, two trends are observed: countries of the West are trying to search for new and secure oil away from the Gulf countries, seen as geopolitical risks particularly post September 11 and the Iraq invasion. The focus of the West, therefore, has shifted to Central Asia and Western Africa while that of China and India is more dispersed. The choice of strategies to secure oil by oil-importing countries reflects their perception of political and economic vulnerability in the international environment.

Overall, those who feel threatened by the possibility of embargoes, blackouts and supply disruptions are becoming more statist and inclined towards bilateral and regional alliances, while those less so remain more market oriented in their strategies to secure oil for the economy. That is, the perception of their geopolitical space seems to be an important factor in determining the oil-securing strategies. Mergers and acquisitions in the international oil industry witnessed today are more to ensure the acquisition of hydrocarbon assets, unlike the earlier period where the motive was to enhance technological capacity.

The issue of access to countries with oil resources is also mired in geopolitics. For both China and India, the Caspian Sea is a major attraction for its oil and gas resources. But the region is still difficult to access, given the geopolitics of the region and Russia’s strategic interest to make it a part of its security system; the lack of a clear international legal regime on resource ownership centred around the issue of whether it is a sea or a lake; and the absence of institutions to ensure that oil development is smooth and instils confidence in international investors.

Moreover, even as the newly independent states of Azerbaijan, Kazakhstan, and Turkmenistan are eager to develop their resources and create international linkages, the region needs access routes to global markets for its energy resources. Since the existing transportation routes are mostly through Russia, attempts are being made to diversify these routes through other neighbouring countries, both to increase geographical access to East and South Asia, and reduce dependence on Russia. Until these issues – strategic, security, economic and legal – are resolved, the Caspian Sea energy resources will remain a potential source of great conflict as the scramble for resources increases.

In the case of Venezuela on the other hand, China and India may benefit as President Chavez sees oil as a ‘geopolitical weapon’ to contain the US. In order to reduce its dependency on the US markets for its oil, Caracas is looking to China and India as potential markets. In March 2005, India and Venezuela concluded an energy cooperation agreement. Transportation economics, rather than politics, will play a big role in determining whether this alliance works.

That the current international oil situation is difficult does not require much argument. The key question is, what does this imply for India? How critical is oil to India’s energy economy today and how is it projected to be in the near future? How do the rising international oil prices impact its ability to buy oil and what impact will high oil prices have on the Indian economy? What price policy options are available to address the needs of various stakeholder groups in the current context? What room do the various actors – policy-makers, oil-producing companies, oil-refining and marketing companies, public or private, national and international – have to manoeuvre? How does India secure scarce oil resources in an increasingly competitive international environment? What are India’s long-term alternatives to oil? How do we use oil more efficiently? These are just some of the questions that energy economists, policy-makers, commentators and diplomats are currently engaged with.

India’s domestic crude oil production in 2004-05 was 34 million metric tonnes (mmt). In 2004-05, India imported 95.86 mmt, about 75% of its total oil needs. The IEA has projected India’s oil import dependency to rise to 94% by 2030. Given this dependence on imported oil, the pressure of rising international oil prices is high. It is increasingly argued that energy security is one of the most pressing challenges of the 21st century. How to deal with rising prices while remaining sensitive to the implications of such responses to various stakeholder groups has become an important policy challenge.

In India, the transport sector is the second-largest consumer of commercial energy after industry. HSD (high sulphur diesel) and petrol contribute to 98% of the energy consumed in the transport sector with road transport being the most dominant source. Over 80% of the passengers and 60% of freight is moved by road. Over the years, there has been an increasing reliance on personal modes of transport which are highly oil-intensive. However, motor vehicles and car ownership per capita is still very low in India compared to those in other countries in the West and South East Asia. Such a structure of energy consumption bodes ill for energy security as growing incomes and middle class aspirations will fuel an increasing trend toward greater ownership of motorised vehicles, especially as there is not enough investment in mass transit systems.

An increasing dependence on oil imports and high oil intensity of the economy thus makes India very vulnerable to high international oil prices, generating a quest for equity oil or alternatives to oil. A number of diplomatic and economic initiatives have been launched to address issues of energy security. These include recent dialogues on energy with Myanmar, Iran, Pakistan and USA as also new partnerships that strongly highlight the links between energy security and foreign policy interests. New instruments to tide over oil insecurity in the short term include trading in oil futures and developing strategic reserves.

The Hydrocarbon Vision 2025 for India has focused on the following: achieving energy security through increased indigenous production and investment in equity oil abroad; enhancing quality of life by improving product standards to ensure a cleaner and greener India; developing the hydrocarbon sector as a globally competitive industry benchmarked against the best in the world through technology upgradation and capacity building in all facets of the industry; and having a free market, promoting healthy competition among players, improving customer service, and ensuring oil security for the country, keeping in view strategic and defence considerations. More recently, energy experts at the launch of TERI’s Centre for Research on Energy Security and the petroleum minister suggested the need for a comprehensive energy security vision for 2025 to complement the Hydrocarbon Vision 2025.

In this new, internationally competitive environment for energy, Indian companies are actively and aggressively pursuing opportunities towards acquiring equity oil abroad in Central Asia and the Caspian Sea, Sudan, and West Africa. The GoI aims to produce 20 mmtpa equity oil by 2010 with a long-term target of acquiring 60 mmtpa by 2025. Sometimes this search has led India into competing against China, the other large and growing energy consumer. One such example is Angola where Shell wanted to sell its stake to the OVL (ONGC Videsh Ltd) but China beat India in the race with offers of aid. Similarly, in Indonesia, the OVL lost stakes in five oilfields to China.

There is, however, a growing realization in both countries that collaboration might be a better alternative rather than situations of potential conflict and rivalry. The immediate aim is to work in four areas: Africa, Caspian Sea, Central Asia, and Latin America. Searching together, they can only better the deals for themselves by keeping down the bid prices. There are already instances of joint working, as for example in the case of ONGC Videsh Ltd and China working together in Yadavaran gas field of Iran (with 20:50 equity participation) and the joint venture between the Chinese National Petroleum Company and ONGC in Sudan’s Greater Nile Project (40:25 equity participation). But such examples of cooperation are limited.

Strategic partnerships, certainly worth pursing, will require innovative thinking, a focus on reducing asymmetric information between the two, understanding both the energy and team dynamics of the partner country, and establishing clear rules of engagement for partnerships to work. Investing in trust building should be the first step in this partnership strategy. Increasing trade opportunities in complementary skills and competitive advantages of the two countries, and greater human and cultural capital exchanges may be good entry point activities in the language of building trust in community development work.

Another route that India has taken was to invite more investment in the domestic oil search. After years of following an insular policy where the domestic hydrocarbon exploration and development was reserved to the national oil companies, it finally opened up in the early 1980s. The NELP (New Exploration Licensing Policy) was introduced in 1997-98 with the twin objectives of enhancing indigenous production by attracting private capital and foreign technology and extensively mapping sedimentary basins. The first four rounds of NELP from 2000-04 resulted in contracts for 90 blocks covering 0.9 million sq km. The new policy has resulted in a 50% increase in in-place gas reserve accretion.

But India’s sedimentary basins are still under-explored; only six out of the 26 oil and gas basins have been explored satisfactorily so far. Currently, a number of private and domestic oil companies are active along with the national oil companies. The recently announced awards under Round V have added another 18 blocks and a greater diversity of actors in the domestic oil search. And those engaged in domestic exploration are quite bullish about the prospects of good finds in India. It is, however, not clear how much importance the state oil companies currently place on a domestic search relative to the search for oil abroad. What is interesting is a shift in the nature of risk taking: national oil companies seem to be more amenable to the political risks of securing oil even in unstable regions of the world as against greater exploration risks of searching for oil at home. As part of an energy security strategy, it is not clear how useful the option of securing equity oil in unstable regions is, although it might make good investment sense.

It is generally believed that sustained high oil prices might actually help in the long run to reduce dependency on oil and give a fillip to the R&D in alternatives to oil, thus resulting in both reducing dependence on oil as well as greater benefits to the environment if the alternatives are less carbon intensive. (This is one reason why countries such as Saudi Arabia with large oil reserves have never favoured very high oil prices as they perceive this as an incentive to move into a non-oil based economy.)

The Indian strategy to complement oil (we are still not in a position to phase it out) has been multi-pronged, albeit slow: on the supply side, invest in natural gas, clean coal technologies, renewable energy sources, and research into new energy sources such as hydrates, fuel cell technology, coal-bed methane, while on the demand side, invest in conservation and energy efficiency measures through suitable pricing policies. But the pace of reforms and investments in alternatives leaves much to be desired.

These are a few issues that confront us in the context of oil. Our demand is growing, import bills are rising, and time is running out if we are to ensure that the country is not gripped by an energy crisis that might cripple or at least slow down growth potential. The country needs some hard and radical thinking on energy issues and the creation of strategic energy partnerships based on mutual interest and trust to sustain the growth momentum that has been generated.

LIGIA NORONHA