The Hindu Business Line : Regional market, key to Asian oil security

The Union Petroleum Minister, Mr Mani Shankar Aiyar, is quite correct when he says that the accident at ONGC's Bombay High North will not compromise India's energy security. But the question is whether the country's level of energy security is satisfactory in the first place.

THE FIRE at ONGC's Bombay High North (BHN) platform, which accounted for approximately 15 per cent of the oil company's annual production of 28 million tonnes is, above all, a human tragedy. However, it has other dimensions as well.

The Union Petroleum Minister, Mr Mani Shankar Aiyar, is quite correct when he says that the accident will not compromise India's energy security. According to him, it will immediately impact ONGC crude production of 1,10,000 barrels a day, but it will take the company only about four weeks to make up 70 per cent of the crude production lost as a result of the fire. Further, the BHN platform is insured for $195 million and ONGC's multi-support vessel (MSV), `Samudra Suraksha,' under Shipping Corporation of India operation, for $60 million under the ONGC's offshore package insurance policy. If this cover proves inadequate, the Centre may prove sympathetic to a request from ONGC for a concession on the gas subsidy, now borne by the company.

All of the above constitute perfectly acceptable components of a plan to restore normalcy to ONGC's operations. If implemented efficiently, the accident may not impact India's energy security — at its current level: But the question is whether the country's level of energy security is satisfactory in the first place.

The answer to this question, given the current realities, would have to be in the negative. It is in this context that a paper titled `Cooperation among the region's countries will help guarantee a steady supply of oil and natural gas' by Ivo J. H. Bozon, Subbu Narayanswamy, and Vipul Tuli published in The McKinsey Quarterly (2005, Number 2) is of considerable interest.

In their paper, Ivo Bozon, a director in McKinsey's Amsterdam office, Subbu Narayanswamy, an associate principal in the Mumbai office, and Vipul Tuli, a principal in the Delhi office, predict that as Asia's appetite for energy surges, the desire of the region's leaders to ensure a reliable flow of reasonably priced oil and natural gas will also intensify. If they fail, Asia's fast-growing economies could stumble. A race is now under way — between China and India, in particular — to buy energy reserves in such far-flung places as Iran, Russia, and Sudan.

"The magnitude of Asia's future energy needs explains this urgency: the region's share of global consumption will nearly double in the next 20 years, to about 48 per cent for oil and 22 per cent for natural gas. By 2010, the region's oil consumption will surpass North America's. Such rapid growth has led world energy markets to their most critical juncture in more than two decades: today's tight supply and hefty prices could conceivably spark an energy boom and bust like the one that shook the world economy in the 1980s... " How, according to the authors of the paper, might this scenario come about? "If, in response to the tight supply, oil-producing countries that don't belong to the Organisation of Petroleum Exporting Countries were to add significant capacity, thus increasing their market share, OPEC might in turn attempt to boost its production, generating a global oversupply. The price volatility inherent in this kind of situation would be damaging to both producing and consuming countries."

They argue that Asian governments and their national oil companies can do much to promote stable prices and reliable supply in the region — but only if they work together.

"The first step is for countries to acknowledge the challenges: Asian oil and natural-gas markets are currently neither as deep nor as transparent as are those in Europe and North America. Buyers can't hedge risks, and sellers get less for their products than they would elsewhere because of the relatively inefficient and volatile markets. Moreover, Asia has limited strategic reserves, which can soften the impact on prices in the event of a sudden supply shortage."

Further, they write, Asia lacks the infrastructure to transport large quantities of natural gas from the well to the consumer — even though the cost of pipelines continues to decline, making them a viable option over distances of thousands of miles.

"Since pipelines cross borders, the difficulty is that nations must work together to secure funding, agree on routes, and set equitable transportation tariffs. Even projects to transport liquefied natural gas by ship often require both the supplying and the consuming countries to invest in infrastructure." They make an interesting point here: "It may sound unlikely, but many of the world's big oil-producing countries don't have sufficient resources to expand their production in order to meet Asia's future energy demand. Capital investment in Africa and the Middle East alone will need to increase to $45 billion a year over the next three decades, up from $8 billion a year during the past one. That amount is more than Middle Eastern countries can spend and still provide education, health care, and other social services to their rapidly growing populations. Foreign partners will likely be needed to bridge this funding gap and spread the investment risk."

Elaborating on cooperation among the region's countries, the authors recommend several concrete measures that Asian governments should take.

"As a crucial first move, they need to create a regional market for petroleum products — one that attracts the backing of key buyers and sellers and has the financial sophistication to enable risk hedging. They also need to establish a regional benchmark crude oil (similar to Europe's Brent blend) that can serve as a pricing yardstick for other types of crude. Major buyers (such as China, India, and Japan) and big sellers (such as the OPEC producers) should commit themselves to using a single exchange in order to ensure that the market has the necessary volume and financial liquidity to be efficient." Further, they suggest that Asian countries should help the market build storage facilities equal to about 30 per cent of its daily volume to smooth physical delivery. In addition, all parties should agree on standard contracts and common regulations for the settlement of transactions and on arbitration to resolve disagreements.

Governments should also move to improve energy security in the region, taking steps to ensure an adequate supply of oil and natural gas in the event of a major refinery fire or other supply disruption.

"For starters, governments in Asia and the Middle East will need to begin sharing detailed information on demand, supply, and inventories. The International Energy Agency's role in compiling detailed statistics to help reduce price volatility and avoid market panics for its member countries in Europe and North America demonstrates the benefits of such cooperation."

In addition, buyers and sellers should jointly increase the strategic reserves for Asian countries. These reserves currently stand at 25 days of demand or less — but should ideally be closer to the United States' 60-day supply or Europe's 90 days. The region's governments should establish contingency plans for opening the reserves' spigots in case of an emergency.

The paper takes note of the fact that cooperation between buyers and sellers could include investments in each other's energy infrastructure, "a trend that has already begun."

This cooperation could include investments in each other's energy infrastructure — another trend that has already begun in a small way. The authors of the paper concede that none of these tasks will be easy. "Aligning disparate priorities and forging common goals can take months or years of painstaking negotiations. Cultural differences and historical rivalries can often overrule common sense..."

They point out that the way for Asian countries to overcome such hurdles is to focus initially on areas of shared interest that are relatively uncontroversial and inexpensive, such as promoting greater transparency. "To make progress, leaders need a regular forum where they can address sensitive geopolitical issues. The inaugural Asian ministers' energy roundtable, in New Delhi, in January 2005, represents a promising start."

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