India's energy security dilemma

ndia's energy security dilemma

Ashish Vachhani

Fluctuating global fuel prices slow down the rate of economic growth, propel inflation and reduce economic output by acting as a tax on consumption. India has to take proactive steps to bridge the increasing energy demand-supply gap if a high rate of growth is to be sustained. Can the country, which has been a net oil importer for over 50 years, handle such recurrent and high fuel price flare-ups, wonders Ashish Vachhani.

THE past few weeks have seen global oil prices entering the "super-spike" phase. International oil prices have vaulted to over $55 a barrel. Energy experts predict that prices could surge all the way above $100 as consumption peaks with the onset of summer. With the prospect of a further steep hike in fuel prices looming large, the vulnerability of the economy to the vagaries of the global oil market comes into focus yet again.

This is not the first time that the economy is being subjected to the pull and push of high and fluctuating global fuel prices. There have been over 20 such instances in the last 50 years. However, this time, there are reasons for worry. By April, the oil prices had climbed around 25 per cent compared to the levels seen in the previous year.

Oil futures on the New York Mercantile Exchange have averaged $50.02 a barrel so far in 2005, up from a record $41.48 a barrel last year.

Studies have indicated that a sustained 5 per cent rise in the oil price over a year would slash India's GDP growth rate by 0.25 per cent and raise the inflation rate by 0.6 per cent.

Global oil price fluctuations have a stagflationary impact on the macro-economy of an oil importing country. It slows the rate of economic growth, propels inflation and reduces economic output by acting as a tax on consumption.

The oil price shock in 1973, for instance, decelerated the economy by 0.3 per cent and pushed the inflation rate to a high of 20.2 per cent.

In 1979, the spurt in global oil prices sent the economic growth hurtling down by 5.2 per cent with the inflation rate skyrocketing to 14 per cent.

Can the country, which has been a net oil importer for over 50 years, handle such recurrent and high fuel price flare-ups?

Burgeoning population, coupled with rapid economic growth and industrialisation, has propelled India into becoming the sixth largest energy consumer in the world, the prediction being that by 2010, it should emerge as the fourth largest energy consumer. With the gap between domestic oil consumption and production particularly wide, India is in a rather desperate predicament compared to its peers.

Its energy vulnerability can be gauged from the fact that the country imports about 70 per cent of the total oil consumed. Oil imports constitute the single largest item in the country's total annual import bill. About 40 per cent of the export earnings are funnelled back into importing oil for domestic consumption.

The country is rated as one of the highest energy-intensive economies in the world and the expectation is that the annual demand for oil will only rise with time. Energy intensity is a measure of energy required by an economy to produce one unit of GDP growth.

According to the International Energy Agency (IEA), the energy intensity of the economy is nearly 2.88 times that of the developed countries. This means that for producing the same quantity of output, the consumption of energy in India is almost three times that of any developed country.

With the domestic demand for oil growing at the rate of 3.5-6 per cent a year, India's dependence on imported oil is likely to become near-total within the next four decades.

The real challenge is to ensure that India is insulated from the ever-volatile international energy market by enhancing energy-use efficiency in the domestic economy, ensuring source diversification to minimise possibilities of supply disruption, and exploring possibilities of developing strategic petroleum stockpiles to handle sudden supply disruptions.

Often, it is argued that India has to take proactive steps to bridge the increasing energy demand-supply gap if a high rate of growth is to be sustained over a secular period.

Bridging this gap is critical but more oil for an oil guzzling economy can be disastrous. Global development experience has shown a definite negative correlation between the energy intensity of an economy and its growth trends.

Net oil importing economies with high levels of energy consumption are particularly vulnerable to economic shocks. Incessant global fuel price fluctuations create prohibitive economic costs in the medium term as they erode the purchasing power and crowd out public resources into financing the mounting oil import bill.

Ordinarily, one would expect the solution to the problem of ballooning global fuel prices to come naturally — high fuel prices would impose an automatic restraint that will limit unbridled energy consumption in the economy. But this is not always the case. High domestic oil prices have not deterred industries from putting up petroleum-based captive power generating units. The demand for diesel-run farm pump sets far exceeds those run with electricity.

India no longer enjoys the liberty of fuelling economic and industrial expansion in commodities and sectors that are inherently energy-intensive. Importing of commodities that consume more energy in their production process is a more viable option than importing oil to produce such commodities locally.

Fuel substitution that reduces dependence on import of oil and encourages use of low-cost energy sources has to be encouraged.

Comprehensive policy changes that foster opening up of the domestic energy market to multiple players encouraging competition, adoption of rational principles for energy pricing, establishment of credible energy pricing regulatory framework, development of alternative energy sources and decentralised mechanisms for energy conservation, have to form the core of India's economic and industrial development policy.

The next major test of the foreign economic policy lies in ensuring successful diversification of sources for oil procurement to minimise possibilities of disruption in supplies.

In a world of growing petro-rivalry between nation States, India has to catch up and outpace other major players in the global energy game. With the future of West Asia as a reliable crude supplier becoming uncertain since the US-sponsored "Operation Iraqi Liberation" (OIL), India is stepping up energy diplomacy with the countries in the South Asian region, Central Asia, Russia, Africa and Latin America.

Oil and Natural Gas Corporation, for instance, has invested in off-shore oilfields and energy projects in Vietnam, Algeria, Kazakhstan, Indonesia, Libya and Syria. Talks to acquire energy assets in Nigeria, Chad, Angola, Ghana and Cameroon, Congo and Gabon are currently under way.

India has inked six agreements, mostly dealing with energy trade with Venezuela during the recent first-ever visit by its President in March 2005. But India's recent diplomatic overdrive and policy of source diversification are fraught with several complications. The politics of the global energy sector has seen the US attempting to dominate it for the past few years.

Washington has expressed its displeasure at New Delhi's new-found bonhomie with countries that the US has declared non grata in the context of our pipeline diplomacy with Iran. Though energy engagement with such states could be a risky strategy in terms of safety of our investments, it appears to be a more secure arrangement than no energy security at all.

Such developments make it absolutely necessary for India to push for restructuring the US-dominated international energy web and work towards creating a pan-Asian oil and gas grid to foster greater Asian energy security.

The search for energy sources has put India on a whole new path, the contours of which are uncertain and outcomes not known.

This requires a careful crafting of policies — domestic and international — that reduces the economy's thirst for imported oil and consolidates our nascent international oil alliances in the quest for securing energy security.

(The author is Deputy Secretary, Finance, Government of Tamil Nadu. The views are personal and do not reflect the policies of the Government.)