WAY back in 1985 I authored a book on the global oil market, The Political Economy of Global Energy (Johns Hopkins University Press). The publishers, who were extremely enthusiastic about the book, produced a larger than usual print run. But soon after it appeared in the market, there was a sharp crash in oil prices, contrary to my predictions of further increases that I had estimated would take place in the second half of the 1980s. My only consolation was that almost every other analyst was also proved wrong.

The annual North American conference of the International Association for Energy Economics held in 1983 came to the conclusion that 1983 would be a period of no growth in the demand for oil in the non-communist nations and possibly a 1% growth in demand for energy as a whole. However, conventional wisdom projected that in 1984 oil would bounce back with an expected 4% rate of growth in energy demand. This was based on an analysis of various indicators including the fact that the usable commercial inventories of petroleum which had increased to 27 days of forward demand by the second quarter of 1981 had dropped to around 10 days in mid-1983, almost as low as the all time low of six days which occurred on 1 April 1979. This set of developments, like so much else that has happened on many other eventful days and weeks in the oil business, only proves that the best of analysts are more often wrong than right in predicting oil price changes. Who would have thought that from a low of around $12 per barrel four years ago, prices would touch $70 today?

These facts merit mention because the first and second oil price shocks of 1973-74 and 1979-80 resulted in a major reduction in demand for oil, which almost imperceptibly led to a crash in global oil prices in 1985. The extent of the response to the sudden oil price increases during these two periods of crises surprised most energy analysts who had never witnessed a downtrend in the demand for oil ever since the depression of the 1930s. Equally worth noting was the behavioural and technological response that influenced the demand for oil through a lagged effect resulting from price increases in the two periods mentioned above. Even more dramatic was the aggregate response on the supply side.

Not only were there renewed exploration activities triggered off by the 1973-74 oil price shock, particularly among OPEC nations, but also a shift to greater use of coal and a more serious role for natural gas in the oil supply picture. The behavioural response of consumers, particularly in the US, was also noteworthy, with the US Administration’s fuel efficiency standards mandated for the automobile industry and a price led consumer preference for smaller and more efficient cars coming into full play during the late ’70s and the early ’80s. All these factors combined to bring about an unprecedented reduction in oil prices.

 

India’s oil policy is largely dependant on global trends and developments, simply because the country is a heavy importer of oil. Notwithstanding the misplaced assurances that some in the oil industry provided in the 1980s about India becoming self-sufficient in the very near future, imports have continued to increase. Those assurances are symptomatic of the problems with our energy decision-making process and structure. First, we have not harnessed the best available intellectual resources in planning for the energy sector. Worse, there is little research carried out on energy policy issues and even less on the nature of structured interaction between decision-makers and research organizations.

Second, we do not consciously take into account probabilistic variations that must be built into scenarios of the future. No one can predict the future with any degree of certainty as far as global energy developments are concerned. Yet, in all our demand projections we do not bother to take into account any possible variations in energy prices or other factors that would have an influence on demand and supply in the future.

 

Third, we really have very meagre scientific research and development activities and targeted technological goals, the attainment of which could make a difference to our energy future both on the demand as well as supply sides. Finally, another major flaw in our energy decision-making is our overwhelming concern with only increasing the supply of energy without any regard to management of demand. Even a mention of such policies often meets with the stereotype response that as a country with such low per capita consumption of energy and with a large part of the population still deprived of access to modern forms of energy, we need only to invest in supply of energy. Any attempt at demand side management is seen as immoral.

This reminds me of what the conservative Republican Senator Barry Goldwater once said at a lecture that I attended soon after the second oil price shock associated with the Iranian revolution: ‘The American consumer is used to going to the gas station and saying "fill her up". The Iranians will come crawling on their knees wanting to sell us oil very soon. Are they going to drink it? We should not reduce our consumption under their empty threats.’

There are some organizational reasons for a neglect of demand side management in energy decision-making in India. Essentially, most energy decisions are influenced within the government by energy supply organizations, whether they are dealing with electricity or oil. Traditionally, these organizations have focused on expanding supply to enhance their revenues and profitability. In the case of the electricity sector, even the profit motive has been absent, because the state electricity boards responsible for supply of power were concerned largely with establishing power generating capacity and not necessarily maximizing returns on investments or increasing profits. The oil companies have been far more balanced in their approach, and 30 years ago set up the Petroleum Conservation Research Association for taking initiatives on the demand side against the spectre of future oil price increases. But the overall record of this organization too is open to questioning.

 

The current reality is very different from the circumstances that led to an unexpected crash of oil prices in 1985. The pressure of demand is coming largely from continuing increases in demand in the US, to which we can add the growing appetite for oil in China and to a lesser extent in India. The latest International Energy Outlook of 2005 has projected the demand for oil increasing from 4.9 million barrels per day (mbd) in 2001 to 14.2 mbd in 2025 in China. The projected increase for the same period in India is less dramatic, going up from 2.2 mbd in 2001 to 4.9 mbd in 2025. US consumption too is projected to go up in this period from 19.6 mbd to 27.3 mbd. All these increases of consumption in the reference case provided in the International Energy Outlook result in an increase in total world consumption from 78 mbd in 2001 to 119.2 mbd in 2025, an almost 50% increase within a period of 24 years.

Corresponding to these projections of consumption, the increase in production is estimated to double between 2002 and 2025 in the OPEC countries of the Persian Gulf. The projected increase in other OPEC nations is much lower, going from 9.9 mbd in 2002 to 16.7 mbd in 2025. Significantly, OPEC supply, which was 30.6 mbd in 2002 as against a total world supply of 80.0 mbd, is projected to go up to 56.6 mbd in 2025 out of a total world production of 122.2 mbd. This means that the share of supply from OPEC, and more significantly from the Persian Gulf OPEC nations, will rise quite dramatically. This clearly has important implications for the world and certainly for India which faces the prospect of increasing imports of oil in the coming two to three decades. This scenario clearly signals the possibility of sudden price increases on account of temporary imbalances in supply resulting from geopolitical developments or other factors.

 

The lessons from the past are very clear for a country like India. If import prices of crude oil go up, limiting product price increases would become politically difficult without imposing a huge fiscal burden on the government. But, if price increases in the international oil market are passed on to consumers, direct inflationary effects could prove difficult for the population as a whole, particularly for those with fixed incomes and the most vulnerable sections of society.

Energy security as a concept has more to do with economic security than merely the issue of guarding against temporary disruptions in the supply of oil, because those can be countered by maintaining strategic petroleum reserves within the control of the government for release whenever required. The danger of sudden price increases, however, could have far more serious consequences, which a mere stocking of oil as a strategic reserve will not help to mitigate. Against this background India has to exercise a deliberate policy choice to limit its dependence on oil imports with a sense of urgency.

 

The reduction of oil imports has to take place in three different ways. First, there is a need to plug wastage and inefficient use of petroleum products without any changes in the existing stock of equipment. These would be in the nature of immediate fuel efficiency gains, which could be achieved by pursuing the right conservation practices and proper maintenance and upkeep of equipment based on the use of oil. The second approach would be to bring about technological upgrading of oil using equipment, such as the use of improved design of diesel pump sets, more efficient cars and trucks, and so on. The third and perhaps the most important set of initiatives would require a restructuring of the economy as a whole. Essentially, measures under this category would include a shift towards much greater use of public transport, because the most oil dependent sector in India, as in most countries, is the transport sector.

However, such a shift can be achieved only through hard decisions and major reforms, such as in the case of the Indian Railways, ensuring a restructuring of this organization to help improve the quality of service it provides, the speed of movement of trains, both passenger and freight, and perhaps a major expansion of the whole system. It would also be necessary to bring about a shift in the country’s overall economic activities, such that the economy grows on the basis of comparative advantage by shedding those sectors which are energy intensive and establishing others that have low energy intensity. These would typically involve a shift towards a greater share of service industries rather than heavy manufacturing.

The energy sector also needs to be guided by a technology vision that unfortunately is largely absent at present. New technology has to define initiatives in major energy consuming sectors as well as in the exercise of supply options. On the demand side the development of hybrid vehicles, the use of fuel cells on a commercially viable basis and gasification of coal for power generation and other uses could provide a shift to more efficient use of fossil fuels and greater reliance on indigenous sources of supply. These initiatives also need to be complemented by the development of technologies for greater use of non-conventional and renewable sources of energy, which would include wind, solar, biomass and, perhaps in the not too distinct future, the use of ocean energy as well.

 

India is endowed with substantial renewable energy resources, and harnessing them on a large scale could provide an effective substitute for petroleum products. Yet, we continue to subsidize kerosene, which though labelled as the poor man’s fuel is actually used on a large scale to adulterate other petroleum products since it is priced substantially lower. If kerosene is perceived as the poor man’s fuel in rural areas and as the only means to supply lighting to our rural population, then it could be shown convincingly that the use of photovoltaic lighting devices is far more viable in economic terms. Hence, as a revenue neutral solution, these photovoltaic devices could be subsidized at the same aggregate level as kerosene currently, so that an efficient and environmentally friendly lighting technology can provide illumination to poor homes without any additional drain on the country’s exchequer.

 

Countries and societies have a wide range of choices in determining the growth trajectory of energy consumption in relation to economic growth and development. This is best brought out by Figure I which shows historical paths established by different societies over time in recording the intensity of energy use in relation to economic growth. Today, developing countries like India face choices that must reflect not only the outlook of much higher energy prices in the future but also the availability of technological solutions that might enable economic growth with much lower inputs of energy per unit than the record established by the developed countries in the past.

There are several examples of bringing about successful shifts in higher energy efficiency as well as in the mix of energy sources used for reasons of energy security and reliance on indigenous sources. For instance, France embarked on the path of nuclear power development, which has led it to a stage where almost 80% of the electricity produced in that country comes from nuclear sources. While doing so, France has also restructured energy consumption by investing in modern and fast rail systems such as the TGV, which effectively provide a shift from oil based transportation such as cars, buses and trucks to nuclear power based transport using the railways. Similarly Japan, during the late 1970s and throughout the 1980s, altered its industrial structure to a less energy intensive form of production by getting rid of its large steel production facilities and other energy intensive industries.

Drawing strength from the examples mentioned above, the role of oil in India’s energy future needs to be altered substantially towards a limited dependence on oil imports. This requires a clear vision, political initiatives at the international level and major reforms and restructuring domestically. At the international level, large scale imports of natural gas using pipeline transport would serve the country’s interests by diversifying sources of supply of hydrocarbons, but this would simultaneously need facilities for conversion of gas to liquid and diverting the output to the road transport sector.

Today, there is a serious constraint in coal supply, as a result of which certain power plants in the country have to back down, even while power is not being supplied to several sectors of the economy. Problems of supply of indigenous coal are likely to increase in the future, necessitating a shift towards greater use of natural gas. While India has recently found significant reserves, particularly in the Krishna-Godavari basin, natural gas supply will need to be augmented through imports by pipeline from other neighbouring countries. It was against such a prospect that this author put forward the proposal for a pipeline from Iran via Pakistan to India in 1989. Other possibilities for large scale natural gas imports exist from other countries as well, and these need to be pursued through enlightened diplomacy and negotiations.

 

There is today a strong rationale for breaking out of the totally unfettered growth of oil consumption that has led to our growing dependence on oil imports. In a globalized world, dependence on imports of any commodity, or set of products or services, is a perfectly valid part of economic reality. But in the case of oil, given the existing uncertainty in the global market, any major increase in dependence on a small region to meet incremental global demand raises questions about risks we might be assuming through a laissez faire approach that we have been pursuing for many years. In other words, the role of oil in India’s future has to be a totally predetermined one that requires a major shift in direction and a greater exercise of determined choices.

The dependence on oil increases as a result of failures in supply of other forms of energy as well. Captive power generation as a response to poor quality and reliability of power from the grid implies a shift to greater use of petroleum products. Hence, oil security is also dependent on reforms in the power sector, by which supply of power can be substantially enhanced with significant improvements in quality and reliability. This would happen only if the power sector is able to attract investment and when independent regulation reaches a level of professionalism and competence that supports consumer interest and provides fair returns to investors.

An energy policy for India needs to be conceptualized and implemented in an integrated manner to meet the objectives of security of oil supply. Some economists have advanced the view that global oil prices are essentially a common good, which affect the interests of consumers across the world. Based on this concept, at least within the Indian context, it can be stated that stability in oil prices and their linkages with the economy as a whole are to the benefit of the Indian consumer. Excessive dependence on imports could jeopardize this objective. To keep the situation within manageable limits against the risk of sudden price increases, the approach outlined in this paper needs urgent consideration. An integrated energy policy that encompasses all sectors of the economy on the demand side and harnesses, in an efficient and cost-effective manner and to the maximum extent, indigenous sources of energy would better serve the interests of Indian society.

 

References:

International Energy Outlook 2005, Energy Information Administration, U.S. Department of Energy, Washington, DC, July 2005.

World Energy Outlook 2004, International Energy Agency, Paris, 2004.

R.K. Pachauri, The Political Economy of Global Energy, The Johns Hopkins University Press, Baltimore, 1985.