The Hindu Business Line : Shedding complacency over oil

Though it is often claimed that if wars of the 20th century were centred on oil and that conflicts of this century would be over water, the trigger could well be both. With the euphoria generated by reports of strong economic growth, India has its work cut out to meet the ever-growing demand for energy, particularly oil, says V. Anantha-Nageswaran, looking at the issue of oil and its poorly-understood price dynamics.

THE World Bank released its economic report on Russia on February 18 (www.worldbank.org.ru). The report caught international attention because the Bank's researchers, adjusting for the mechanism of transfer pricing from industrial sectors to trading companies, found that the dependence of the Russian economy on oil was triple the official estimate. The share of the oil and gas sector rises from the estimate of 8.8 per cent based on official data to around 25.2 per cent, adjusted for transfer pricing.

The report correctly then warns Russia that such excessive dependence on one sector renders the economy vulnerable to any correction in oil price. However, it may well be a stroke of luck for Russia. Its heightened dependence on oil and gas could be a bonanza if, contrary to consensus expectations, the price of oil and gas rises in the years ahead or stays at high levels. The Russian economy, notwithstanding appropriate calls for diversified strength, may thus be counting itself lucky for its excessive oil and gas dependence!

This paper is not about the Russian economy but about the issue of oil and how its price dynamics remains poorly understood. Although it was often claimed that wars in the 20th century centred on oil and that wars this century could be over water, it might well be possible that wars this century could be due to both oil and water, thus raising the unwelcome possibility that there could be more and not less wars.

Despite the euphoria generated by recent reports of strong economic growth, India has its work cut out. Indeed, sustained higher economic growth would bring in its wake higher demand, more generally for energy and particularly for oil.

Consensus is sanguine about oil supply, prices

The Energy Information Administration (EIA) of the US Department of Energy, in its International Energy Outlook published in May 2003 (www.eia.doe.gov/oiaf/ieo/index.html) presents a sanguine picture of the outlook for the oil price in the decades ahead. This is despite the fact that the developing world would consume nearly 86 per cent of the world oil in 2025 compared to 64 per cent in 2001 amidst rising total consumption. The report states that `limits to long-term oil price escalation include substitution of other fuels (such as natural gas) for oil, marginal sources of conventional oil that become proved reserves (that is, economically viable) when prices rise, and non-conventional sources of oil that become proved reserves at still higher prices. Advances in exploration and production technologies are likely to bring down prices when such additional oil resources become part of the reserve base.'

Peter R. Odell, Professor Emeritus of International Energy Studies at Erasmus University, Rotterdam, in a presentation on the Global Energy Outlook for the 21st century, also reiterates the optimistic case.

In his words, `sustainability, equated with the elimination of energy poverty for all the world's 9 billion people by 2050, can be achieved and that previously expressed fears of global energy scarcity have all proved groundless'. Most oil added to reserves since the 1970s remained unused and that oil reserves were at an all-time high.

He expects hydrocarbon fuels to remain the dominant source of world energy supply until the 2070s and oil supply to increase slowly to peak in the year 2050. Given this, he expects the geo-political significance of oil to be high only for the next two decades and that it would become `just another source of energy' in a competitive energy market this century.

Sceptics marshal forceful arguments

Well-known environmental and anti-globalisation activist, George Monbiot, in an article written for The Guardian in December 2003 (`The Bottom of the Barrel'), is at the opposite end of the spectrum.

In contrast to the optimism expressed by both Prof Peter Odell and the World Energy Outlook of the EIA that non-OPEC oil production would remain competitive, Monbiot cites geophysicist Kenneth Deffeyes who told the `New Scientist' that he was `99 per cent confident' of the year of maximum oil production being 2004.

The caveat added by the EIA to its optimism on supply that there could be a significant overestimation of both proven and ultimately recoverable reserves has become more important in the light of the recent admission by Shell Petroleum that it would reduce its `proven oil and gas reserves' by 20 per cent (January 2004). Even if one were to skirt the debate on the extent of reserves available, there is more agreement between pessimists and optimists that the price of oil would be influenced by economic, political and environmental considerations. The cost of extracting the oil could prove to be intolerable.

A recent article in The New York Times (`Forecast of Rising Oil Demand Challenges Tired Saudi Fields', February 24) makes this case based on interviews with experts in Saudi Aramco the state-owned oil company.

An internal Saudi Aramco plan estimates total production capacity in 2011 at 10.15 million barrels a day, about the current capacity. But to meet expected world demand, the US Department of Energy's research arm says Saudi Arabia will need to produce 13.6 million barrels a day by 2010 and 19.5 million barrels a day by 2020.

That may be a daunting task. Saudi Arabia, the leading exporter for three decades, is not running out of oil. Industry officials are finding, however, that it is becoming more difficult or expensive to extract it.

Separately, the World Energy Council (WEC) takes exception to the optimism on non-OPEC oil production prospects. In doing so, it bolsters the pessimists' case for declining oil supply and consequent higher prices. Its `Reflections on the Dynamics of Oil and Natural Gas Markets' (Statement 2004) leaves no room for ambiguity: "Despite new oil production in non-OPEC countries using new exploration and production technology (such as deepwater, Caspian oil and the accelerated depletion of Russian fields), it is WEC's view that oil production outside the Middle East started to decline at the end of the 1990s. It appears that natural gas production in North America has now also peaked, and this could soon be the case in WesternEurope as well."

Interestingly, the WEC reckons that world GDP could grow at significantly less than 3 per cent per annum in the next three decades owing to `demographic trends, higher real energy prices and the failure to address institutional barriers to energy access in developing countries'.

The WEC expects this to affect supply more than demand leading to higher real energy prices.

Morgan Stanley raises oil price forecast

As though to underscore all of these rising concerns, Morgan Stanley, one of Wall Street's leading investment banks, has revised its oil price forecast for 2004 and 2005 (Morgan Stanley Global Economic Forum, February 27).

Economists Eric Chaney and Richard Berner state that `since 2000, markets have been engaged in a painful process of upward revision of very long-term equilibrium prices.'

According to them, three fundamental factors are at work: `strong demand from China and India, constraints on supply reflecting 15 years of insufficient investment, and OPEC's improved grip on markets.'

Their forecast for the price of crude oil per barrel in 2004 is revised to $30.4 per barrel and for 2005 to $29.9 from the previous estimate of $26.9. In summary, it is clear that the odds of a higher oil price is greater than even.

India has no time to waste

For India, all of the above underscore the need for being vigilant about the oil and energy supply situation and start working towards energy security. India depends on the international market for 70 per cent of its crude requirements (80 million tonnes were imported in 2001-2002, and this year consumption is predicted to be around 85 million tonnes).

While two decades ago the country was able to meet around two-thirds of the needs of petroleum products domestically, the situation has radically changed today. India today barely manages to meet one-third of the demand for petroleum products indigenously. Even government estimates indicate that indigenous production would not exceed 32-33 million tonnes around the next few years (http://www.observerindia. com/analysis/A018.htm).

In recent months, India had begun work to building up its own strategic petroleum reserve. According to the Observer Research Foundation, India is planning to shell out Rs 13 billion in the next two years to build strategic storage facilities for 15 days consumption of crude and oil products. It will be expanded to 45 days by the end of 2006. However, this is to ward off any short-term supply constraint. It does not reduce the dependence of the economy on hydrocarbon fuels.

Indigenous alternatives deserve support

Research at the Indian Institute of Science (IISc), Bangalore, holds a lot of promise. `Sustainable Transformation of Rural Areas' (SuTRA) is a project of the (http://www.apdap.com/sutra/aboutus.htm) Department of Mechanical Engineering.

This project aims to generate electricity locally by the use of non-edible vegetable oils from the seeds of trees such as Pongamia grown around the village. Power can be generated by using generator sets powered by Pongamia oil to enable supply to small communities for lighting and home industries. The same oil can be used as fuel for cooking. Pumpsets can also be run using Pongamia oil to supply potable water from borewells, and for lifting water from tanks during the off-season to enable women's self help groups grow flowers, vegetables, short duration and economically remunerative crops such as oilseeds and fruits like melons to generate additional income. The project does not lay emphasis on using this oil for transportation purposes.

Priority for new govt: Highways and new cars need fuel

As the country feels excited by the prospect of growing at 7-8 per cent in the years ahead, it is imperative to lift the level of preparation for making available the resources to sustain such a growth rate. Energy comes at the top of the list. In the short-term, the anticipated depreciation of the dollar against global currencies and the rupee, in particular, would help mitigate the rising price of oil in dollar in the years ahead. In the long-term, that provides scant comfort. Investment in energy conservation, reduction in the energy intensity of the economy, improvement in energy efficiency (cutting electric power transmission and distribution is a case in point) and diversification into alternative fuels (SuTRA research shows a path) should be the immediate priorities of the new government.

(The author is Director, Global Economics and Asset Allocation, Credit Suisse. The views are personal. Address feedback to nageswar@singnet.com.sg)

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