Global Markets_ Financial Crisis and Resource Security.doc

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					                           FOR ‘ONE INDIA-ONE PEOPLE’
                  Energy Policies for India a changing Global scenario

                                           S.L Rao

Since the first oil well was struck in 1859, we have consumed 1.5 trillion barrels of oil
equivalent. In the next 25 years, the world will need the same amount. The U.S.
Department of Energy says we will reach “peak oil” by 2025. Some experts think oil
supplies will fall even earlier. The concept of “peak oil” is one that is relative to prices. If
prices rise high enough, even oil that cannot be reached and sold at prices now available
in the market might come to market. Demand might also be lower at those prices, thus
reducing supply. Virtually every product we buy, own or use requires oil directly or
indirectly. Gas usage will also rise as coal comes under pressure because of the emissions
caused by it burning and the consequent climate change.
        We face four major challenges. The first is the credit fuelled financial crisis
resulting in tighter liquidity and less available capital for investment and trading. The
second is now globally recognised; accelerating climate change. It will increasingly
restrict the world’s ability to use cheap coal. The third is the long-term trend of soaring
energy prices and our growing dependence on energy imports (oil, gas, coal, uranium).
Fourthly, fiscal stimulation to overcome the economic crisis caused by liquidity
constraints and reluctance of banks to lend have made governments pump money into
financial institutions and the economy, reducing interest rates and raising fiscal deficits.

Oil Power
Producing countries have in the last three decades discovered their power to halt the
world. This power is also used as an instrument of foreign policy, and to discipline other
countries to follow their will – for example, in October 1973, when West Asian oil
exporters decided to punish the US and the West for supporting Israel in the Yom Kippur
War. Prices quadrupled when supplies were cut. Power of oil producers was further
established when the US under President Reagan went all out to destabilise the Soviet

Pressures on Oil Producers
Oil and Gas exporting countries are almost all authoritarian states. Their prosperity
depends on high oil prices. The oil producing countries now go all out to get maximum
prices. They need oil revenues to keep rising. Surpluses are largely invested in dollars.
         In recent years the large American deficits on budgets, trade and external
payments, have resulted in a declining dollar. Since the dollar is the international reserve
currency and oil and gas prices are in dollars, a declining dollar means lower realisation
by oil exporters. This has added to their pressures to raise oil prices. The rise in prices in
2008 led for the first time to a decline in petrol buying in the USA, the largest user of
world crude oil. Decline in demand, liquidity problems due to a financial meltdown and a
strengthening dollar brought prices down. They have remained lower than the peak level
of $ 145 per barrel with the growing recession in the global economy.

The Russia Effect
Russian foreign policy appears to concentrate its oil production and exports in the hands
of a national company—Gazprom, whose turnover in 2007 was US$ 91 billion, with
432000 employees, and which pays taxes that are 20 per cent of the Russian budget.
Gazprom supplies one fourth of Europe’s gas. Russia has demonstrated in recent years
that it will use energy and arms exports to exercise its influence. Of course, Russia is
vulnerable because of the overexploitation of its fields, lack of expertise in getting more
oil out of old wells, lack of investment in developing new wells, and likely future
dependence on the West for such technology.
         From India’s point of view, the lesson is that we need to nurture past close ties
with Russia, to assure supplies of arms and influence, and of oil. At the same time we
need to diversify suppliers since the new Russia is unlikely to be as favourably inclined
towards India as it has been in the past. India learnt a lesson that Russia will seek
maximum prices on arms purchases when it unilaterally raised the contracted price for
refurbishing its old aircraft carrier Admiral Gorshkov, and similarly on signed contracts
for sale of the Sukhoi aircraft.
        It is clear that European countries in their foreign policies towards Russia are no
longer as united as they were. It is clear that the policies are influenced by their present or
anticipated dependence for oil and gas supplies on Russia. Russia controls the pipeline
that supply Europe gas from Central Asia. It is therefore in a position to disallow
alternatives to these pipeline routes from appearing. Russia’s relationship with Central
Asian dictators gives Russia an advantage, in addition to its geographical location. As
Russia tries to restore its old imperial power, oil and gas are welcome tools in their
armoury. Any intrusion into the Russian sphere of influence will see strong reactions as
we have seen in Ukraine and Georgia.
        However, we must note that supplier countries like Russia also have restriction
son their freedom to use their control over supplies for influencing other countries as it
seems. Major buyers like the European countries, have a strong negotiating power.
Russia’s freedom to use supplies against its old vassal states is limited because of its
heavy dependence on revenues from Europe. Russia cannot afford to antagonise Europe
beyond a point. Declining oil prices reduce Russia’s revenues and the global financial
crisis has put pressure on its banks and financial institutions. Although Russia’s foreign
exchange reserves are substantial, it will need cooperation from other developed
countries at this time of declining income.

Other external influences on a country’s policies
As oil prices have risen, many oil-rich countries have become very rich. Some of them
have created Sovereign Wealth Funds (SWF). So have some major net exporting
countries like /Singapore and now China as well. Abu Dhabi and Dubai for instance have
stated that they will not use their SWF as foreign policy instruments. The IMF has
recently said that international regulation is necessary to ensure transparency of SWFs.
Countries must also be watchful that any SWF does not place itself in a position to
influence that country’s policies.
India-China Supply Competition
India is far behind China in the competition for oil and gas resources overseas. India has
been slow and has lost in most cases where China has been interested. India must settle
on strategies for succeeding in the competition. India’s experience in Burma where
Burma withdrew from an agreement to supply gas to India and instead handed the project
to China demonstrates India’s inability to take speedy decisions. China has been quite
uninterested in issues like dictatorships, human rights violations, genocide, etc, in
countries like Burma, Sudan or Nigeria and others, in order to ensure its energy supply
security. India has been quite confused in its response to such countries. Perhaps India
should play down its moral opposition to the internal situations in such countries while it
builds up a secure supply position and then tries to exert some influence. A similar
situation could arise in the future with the new republican government in Nepal. Nepal
has been for long an important hydro electric power supplier to India. For India it is
essential that it moves quickly to make relations with Nepal so strong that Nepal
voluntarily chooses to be in the Indian rather than the Chinese sphere of influence.

Global Markets: Supply and Demand
Oil prices have been volatile with rising prices of oil and gas since 1973. After every
short-lived decline, the equilibrium is at much higher levels. In sympathy with oil and gas
prices, there have been sympathetic rises in coal and uranium prices as well. If coal had
not gone up by as much as oil and gas, it might well be because the emissions from coal
keep coal lagging oil and gas prices. However, with the push towards nuclear energy
which has no climate change effects (only unsolved safety and nuclear waste disposal
issues), uranium prices may also catch up, though the fuel costs are a small proportion of
nuclear energy costs and might not have much effect on end prices of energy. In the
foreseeable future, India and China will continue to prefer using coal for generating
power. It is cheaper, it is easier to use, and there is ample domestic and foreign
availability of coal, as well as reserves in these countries. Clearly, we need to move fast
into generating more nuclear energy. India has vast thorium reserves but the use of
thorium needs the initial use of uranium and then reprocessing the used material to enable
use of thorium. India must give priority to developing thorium as a fuel source. The
acceptance of India by the Nuclear Suppliers Group (NSG) after the agreement with the
US will help India move towards greater use of nuclear energy. India must find domestic
and overseas energy resources and increase supplies of all sources of energy.

Changing Global Demand
Six countries in the developing world will be the countries that will need to substantially
increase their use of energy in order to develop and reduce the number of the very poor.
These are Brazil, Russia, India, China, South Korea and Mexico, of which the only one
with substantial oil and gas reserves is Russia. These countries will be under increasing
pressure in coming years to reduce their carbon emissions. The blame game for emissions
has already started. The game does not deal with the need to reduce the stock of
emissions that the developed world has emitted over the last many decades.

India’s Needs
Although India has been using less units of energy for every unit of output, there is still
scope to improve efficiencies. Here again, the problem is of technology availability and
cost. Developing countries need to promote joint research projects, which might be more
relevant to them than depending on research in developed countries. For example, clean
coal research is mainly in the developed world where the local coal is of a different
quality than in India and China where coal is much higher in ash content.
       The basic problem in most BRIC (Brazil, Russia, India, China) countries is that
there is a cap on domestic power tariffs in order to support their poor. This makes it
difficult to pay rising prices for oil and gas in generating power. This leaves coal as the
only affordable alternative

Financial Crisis in 2008-09
In the last few years, world financial flows at over $ 55 trillion are larger than world GDP
and many times larger than the flows of trade and investment. Complex financial
products have been created and traded which were totally unregulated. It was the
unravelling of these complex financial products that led to the financial collapse of
September 2008.
        In this context, the Overseas Wealth Funds (OWF) have become very powerful as
saviours of companies and even economies. It is essential for India to understand their
influence and what they are investing in. Except for China and Singapore, all of them are
oil exporting countries, all authoritarian states, and with little domestic accountability.
The influence of OWFs, if they dominate any sector of the Indian economy, would be
undesirable. Although, except for Russia and Venezuela, none of the other oil exporters
have used their oil power to influence economic and foreign policies in the countries they
have invested in, the possibility cannot to be ignored.
          In considering the financial crisis, we must recognize that one major financial
institution that declines is a domino that could lead to a general collapse. There is an
interconnected chain of relationships in the world economy. High oil prices are also due
to the weak dollar, resulting from the hit on the dollar caused by the enormous and long-
lasting American budget deficits, very low savings rates in the American economy, and
the unravelling of American financial institutions. There is however as yet no currency
that could substitute the dollar as a reserve currency for the world. The dollar will
therefore continue its central role and will continue to cause economic global economic
India is vulnerable because its economy has had weak fundamentals over the past two
years. (A high fiscal deficit, high and growing deficit in the balance of trade and on
current account, high dependence on FII flows, NRI deposits, external commercial
borrowings and not on foreign direct investment and export surpluses as in China). These
have resulted in a highly volatile rupee with a collapse in its exchange value, and the
worldwide shortage of liquidity. This has led to a decline in foreign exchange reserves
while external borrowings have slowed down. India has high dependence on imported oil
and gas, and increasingly on imported coal, with imported uranium soon to follow. Rising
oil prices and these weak economic fundamentals are a double whammy for India.

Gas pricing
Gas in India, like many other natural resources, belongs to the nation under the New
Exploration Licensing Policy (NELP). Gas must be used for power generation - domestic
gas must be available for power at a price that keeps the price of power within the capped
limits. Since the main user industries for gas in India are power and fertilizer, whose
prices are regulated, their tariffs cannot easily be raised, without hurting the revenues of
distribution companies, which are already short of revenues.
       We could also have ‘free market’ pricing for domestic gas as contracted under the
NELP. Government could then reimburse the cost difference between cost of fuels and
power tariffs to the power distribution company. Given the precarious nature of state
government finances, this might not happen. Government could also tax the excess
profits made by the gas supplier companies after allowing them adequate returns for
exploration and production. An excess profits tax could move up the surplus and use the
revenue to defray the cost of reimbursing power distributors for their losses. The present
differentials in pricing public sector gas and gas from private lessees of gas fields, to the
disadvantage of the former, therefore need to be reviewed.

What India Needs to Do
      We need to move towards a rational tariff system for electricity that takes account
       of costs of service. Subsidies should not be at the cost of distributor companies.
       Ownership of distribution should have a strong private component t introduce
       commercial and enterprise cultures in them.
      Supercritical boiler technologies can make better use of coal with fewer emissions
       per calorie of energy. There are presently limitations on acquiring such
       technology, on its suitability, cost, and so on.
      India also needs to look at technologies that can use agricultural waste, natural
       plants like jatropha and other oil-bearing plants and examine how they can be
       grown without diverting land from food crops.
      We must initiate immediately a “Green New Deal” to embark on a renewable
       energy revolution. A policy to enforce the introduction of measures to construct
       green Buildings must be enunciated and implemented. We must go all out to
       promote wind and solar energy as also selected bio-fuels but ensuring no adverse
       effects on food production.
      We must aim to begin a conscious reduction in the use of fossil fuels. This will
       demand incentives and penalties, enforcement agencies, research, and efficiency
       and conservation measures.
   We must impose tough emissions targets. However there must be no international
    commitment to reduce emissions because of the undue pressures of the developed
    countries that need to do a lot more in this area.
   India and China must cooperate in capturing energy resources around the world.
   We must recognise the power of oil exporting countries. Our foreign policies
    must react accordingly to avoid their undue influence on our country. We must
    also make ourselves important to them, as for example, by building roads,
    railways, providing support on education and health. It is essential to nurture close
    ties with Russia. Terms of joint ventures or exploitation of assets in other
    countries must be fair and respect host country interests even if country seems
    weak. We must do everything possible to gain entry into oil and gas resources of
    Central Asia. India must pursue its “blue water” naval strategy to safeguard the
    supply routes in the oceans. India needs to do all in its power to nurture relations
    with Nepal and Bhutan to ensure hydro supplies in the future.
   Joint R&D with BRIC countries, Mexico, South Korea on clean coal
   International regulation for transparency, with restrictions on the international
    finance sector so that uncontrolled movement of novel financial products across
    borders is curbed. Financial flows need global regulation; as do complex financial
    products. India needs to be careful while opening up to global finance. Tough
    domestic financial regulation need to be in place, especially for off balance sheet
    commitments, regulating derivatives and other complex products. India needs to
    regulate overseas funds flows to prevent debilitating effects on Indian stock
   We must relate domestic tariffs for domestic gas (and coal) to their end use prices
    as is allowed to major end uses, through appropriate regulation or excess profits
    tax. There must at the same time a realistic user charge for fossil fuels and power,
    and a relationship between the two. Subsidies remove flexibility from energy and
    foreign polices and must not be at the cost of the distributor, but paid for by
    government to the targeted beneficiaries.
   We must go all out for nuclear energy and continue giving top priority in R&D to
    the ultimate use of thorium as fuel. (2926)

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