A look at India's oil vulnerability index

A look at India's oil vulnerability index
19 Nov, 2007, 0537 hrs IST,Mythili Bhusnurmath, TNN

With oil prices poised tantalisingly near the $100-a-barrel mark, the economies of oil importing, developing countries will be hit hard. The policy choices they make will be severely circumscribed by how vulnerable they are to soaring oil prices.

The UNDP’s Oil Price Vulnerability Index (OPVI) report (prepared when oil was ruling at $70 a barrel) lays out these choices in stark terms. The good news for India is that our OPVI is in the medium range, along with countries like Indonesia, Mongolia, Myanmar, Thailand and Vietnam. In contrast, Pakistan, Nepal, Bangladesh, Cambodia, Philippines and Sri Lanka have a high OPVI.

The bad news is that our big neighbour to the East, China (along with Iran and Malaysia), has a low OPVI, giving it an edge in coping with higher oil prices. Worse, many strategies to reduce vulnerability are unlikely to find favour since they call for a degree of political courage that has so far been singularly lacking in the present government.

So what are the broad policy prescriptions? Manage oil price risk, i.e., have proper pricing policies, targeted subsidies and use financial tools. Enhance oil supply, i.e., strengthen oil exploration and extraction, build refining capacity, diversify sources of supply and engage in barter. Restrain oil demand, i.e., increase efficiency in transport, industry and agriculture.

Prepare for emergencies ie build strategic reserves and plan for rationing. Diversify fuel sources ie use more coal, hydro, solar and other sources of renewable resources. The Report ranks these strategies in the context of four different possible scenarios that it calls baseline, supply shock, peak oil price and energy security scenarios. The ‘baseline’ scenario assumes future oil market developments are likely to be in two phases.

First, until 2010, high oil prices will keep the oil market broadly in balance, with incremental oil demand being met mostly by high non-OPEC production. From 2010, as non-OPEC production peaks, there are likely to be calls on OPEC to increase output. Subject to short-term reversible spikes, oil prices will range between US$65 and US$75 per barrel.

The ‘supply shock’ scenario considers an abrupt drop in oil supply as a result of which prices spike steeply to $100, plateau at around $120, and, in later years, decline to the initial level of $70. Over the medium term till 2011, as a result of the supply shortfall, countries reduce their oil intensities.

As supplies resume normal levels, they will probably increase intensities again, but not to the same levels as before, due to the greater substitution of oil by natural gas, coal, nuclear and renewable energy The peak oil price scenario reflects the Hubbert’s Peak theory, according to which, with no new major discoveries and the declining productivity of existing fields, world oil production will start to peak in 2007.

There will be a temporary supply plateau until 2011, resulting from a more efficient supply infrastructure, but subsequently, supply will decline irreversibly by 2.5% annually. In this scenario, oil prices will increase gradually from their current level of around $70 to $100 per barrel in 2011, the mid-point of the peak. Thereafter, prices per barrel will rise more steeply to $130 in 2015 and $190 in 2020.

Until 2011, the oil intensity of economies will remain constant or decline at current rates of substitution with natural gas and coal, but then decline at a faster rate as the impact of new fuels and technologies and structural changes begin to assert themselves. In the energy security scenario, concerns for both energy and environmental security lead to reduced oil demand, so prices fall back to a lower equilibrium at around $50 per barrel. In this scenario, the oil price will decline from its current value of $70 to $50 per barrel by 2015, and then remain constant at the new supply-demand equilibrium.

The report looks at different strategies for India in each scenario. In general, it suggests the following measures to meet the growing energy demand:

➢ Pricing: Move to a system of market determined pricing of petroleum products.
➢ Import pricing: The import parity pricing formula must be revisited to ensure that the Indian refining industry enjoys a margin that is rational and fair to producers and consumers.
➢ Excise duties: Duties should be based on a sliding scale that would fulfil the following objectives — ensuring revenue earnings for the government in a period of rapid changes in international prices; safeguarding consumers from the multiplying effect of an ad valorem duty; making the government responses to international oil prices more transparent.
➢ LPG: Since international prices of LPG are cheaper than those of kerosene, the production of kerosene could be phased out.
➢ Solar lighting: Since most kerosene in India is used for low-quality lighting, the government could provide highly subsidised solar lanterns to all unelectrified households.
➢ Energy efficiency: The government can promote energy efficiency measures across all sectors. This could include fiscal incentives for fuel-efficient vehicles, use of biofuels for public transport and greater use of rail for freight movement.

As a blueprint, it is unexceptionable. Unfortunately, the government is likely to ignore it as it has many similar blueprints in the past.

(UNDP Regional Centre, Bangkok: Overcoming Vulnerability to Rising Oil Prices: Options for Asia and the Pacific).