“We are among the world’s most inefficient producers and users of oil”

Last week, Mr Vikram Singh Mehta, CEO of Shell India, spoke on ‘Changes in the Oil Scenario’. Introducing Mr Mehta, PP Arvind Jolly noted that he had a BA in Mathematics from Delhi University, an MA in Economics from Oxford University, and also an MA in Energy Economics from Tufts and Harvard University, USA.

“Vikram started his career in the IAS, worked there for a year, went abroad and joined Phillips Petroleum, USA. He returned to India and worked four years as an advisor in the Oil Ministry of the Indian government before joining Shell abroad,” said Arvind.

“The past 18 months have been a period of unprecedented strain for the global oil and gas market. Demand has grown sharply, especially in China, and supplies have not kept pace,” began Vikram. “The combined impact, reinforced by geopolitical uncertainties and market speculations, has pushed oil and gas prices to levels that we have not seen in real terms since the early ’80s.

“There are varying views for the longer term outlook. Some like me believe that sustained increase in oil prices will, over time, slow down demand and release new supplies, thereby reversing the current tightness in the market. Others argue that the current levels are but a prelude to another sharp jump — that $100 a barrel of oil is not an unreachable level.While we can only conjecture at the longer for us in India, because, short of a miracle, India will remain dependent on oil import in a foreseeable future.

India’s oil gap

“In the early 80s, India imported 30% of her crude oil requirements, and domestically produced the balance 70%. Today we import 70% and produce only 30%. The widening gap between demand and indigenous supply is because of two reasons: one, the limited success of our public sector companies in finding and developing indegenous reserves. And two: a steep growth in demand.

“ONGC and Oil India have had limited success in oil exploration. Since the discovery of Bombay High in the mid-70s, there have been no comparable discoveries. We are recovering only a fraction of the limited reserves that have been discovered — about 28%.

The comparable figures internationally for fields of similar geology is upto 60%. Imagine the loss of value of this low recovery rate; it runs into billions!

“The second reason for this widening gap is growth in demand. A decade ago, India consumed 67 million tonnes of crude oil per annum, but today it consumes over 120 million tonnes. The compounded annual rate of growth (CARG) of our demand has been 5.9%, which is next only to China’s growth rate of 7.5%. More importantly, we are among the world’s most inefficient users of oil. For every $1000 growth in GDP, we consume an additional 1.5 barrels of oil. The comparable figure for France, Italy, UK and Germany is half a barrel, and for US, three-quarters of a barrel. That means that France etc., generate wealth using one-third and the US half the fuel used in India.

“In fiscal year 2004-05, India will spend $40 billion on oil imports. While we have the foreign exchange, and our economy has shown the resilience to manage the inflationary consequences, this is clearly not a sustainable situation. We cannot remain exposed to the vicissitudes of a volatile crude oil market. That is why energy security is uppermost in the agenda and priorities of the government.

The quest for oil security

“The word security is often used loosely, like the word ‘strategic’. The lack of clarity often leads to misdirected resources and policies. Take for instance ONGC’s current policies to scout for oil and gas fields abroad — in Latin America, and in the Far East. To make these acquisitions, it is argued that a strategic oil security premium must be paid. I have no quarrel with the principle of diversifying one’s portfolio of assets, but I wonder how acquisition of a minority shareholding in a producing field in Latin America will enhance our oil security.

“What would happen if the shipping routes were clogged because of an outbreak of conflict in the Middle East. How would we access our equity oil molecules in the Far East, if the Strait of Malacca were choked because someone had sunk a supertanker or two in the middle of the Strait, where it is only five to six kilometres wide. On the other hand, if it is financial return through ownership rather than physical access that we want, then why don’t we buy stakes in well-known oil companies? The fact is oil is tradable; it can be bought on the open market by anyone who pays the international price!

“I do think that some of ONGC’s current purchases have been very sensible and well-timed. The purchase of oil equities in Sudan and Russia a few years ago will give ONGC a very high return, because they were bought when the oil price was relatively low. But overseas acquisitions should be justified on commercial grounds, not on strategic or security grounds.

Historical supply crises

“One could counter this view by arguing that in the event of a major supply disruption, ownership of even these far-flung assets is better than no ownership whatsoever. After all, the price of a portfolio diversification has been a tool for hedging against price volatility for many years, and for most companies. But I would advise caution against that on the basis of historical fact.

“Since 1951, there have been 18 significant supply disruptions. Six were on account of international conflicts such as Suez Canal crisis in 1956, the Yom Kippur War of 1973, the Iran-Iraq war of 1980, the Iraq-Kuwait conflict in 1992, and of course, more recently the US invasion of Iraq.

“Seven supply disruptions were consequences of internal civil wars, such as Biafran war in Nigeria in the 80s, the Iranian Revolution in 1979, the civil conflict in Lebanon and so on. The remaining five were because of accidents, such as the Exxon Valdez shipping accident along Alaska, and the blowout of Piper Alfa rig in the North Sea.

“Each of these 18 events took a significant percentage of the world’s oil supplies out of the market. But not all had a proportionate impact on oil prices. In fact, some relatively severe disruptions like the Biafran conflict caused no more than a minor hike in oil prices, while others of shorter duration, i.e. the Iranian Revolution in 1979, resulted in a sharp price hike.

“Ultimately, disruptions in prices have depended on the availability of surplus capacity in the international oil market, and the willingness of the suppliers to make supplies available. I have made these points because I want to stress that: one, ownership of assets acquired by paying a strategic premium is possibly an expensive route to pursue and does not guarantee physical access; and two, given that countries in the Middle East are the dominant resource-holders of gas, physical access can be better assured by strengthening ties with those countries.

Energy Security Strategy

“So the first prong of our energy security policy must be oil diplomacy and building of a better relationship with the resource-rich countries in the Middle East. What are the other prongs? The second obvious prong is the enhancement of domestic production.

“Minister after minister has travelled across various countries to tap international companies to explore hydrocarbons in India. But for one reason or another, none of the majors have actually entered. Smaller, private companies have responded, with some notable successes — Reliance’s discovery of an offshore gas field in Eastern India, Gujarat State Petroleum Company’s discovery in the Krishna-Godavari basin, and Cairns oil and gas find in Rajasthan.

“Without detracting from these successes, the fact is that these discoveries will make only a marginal dent in our oil supply-demand balance. The problem is that our hydrocarbon reserves are not easily accessible, being located in complex geologies, or in deep waters or Himalayan foothills.We cannot tap these reserves without using leading-edge technologies, which are largely proprietory.

“In my own view — which I hold not because I work for an international major, believe me — is that the probability of successfully locating hydrocarbons in these difficult locations and, once located, successfully developing and producing them on a commercal basis, would be best enhanced by A Full Day partnering large international majors who have the operational experience and the technology for working in such difficult terrains.

“The next prong of policy should be to access international gas. India is an island in a lake of natural gas. It is surrounded by natural gas in Myanmar, Turkmenistan and along the Caspian Sea, Iran, and Bangladesh. It can access this gas, either as liquified natural gas or through pipelines. The difference between looking to securing gas from these countries around our region, as against, say, oil in Latin Americas or in the Far East, rests partly on the proximity of these countries to India, but more in the umblical tie that a pipeline connection creates; disruptions impact both the supplier and the consumer.

“I am aware of all the political, logistics and economic arguments against transnational pipelines, but I would argue that if the trans-Siberian gas pipeline to Western Europe could operate undamaged at the height of the cold war, then there is every reason to be optimistic. If at least one of these transnational gas pipelines in our region will come to fruition, there will be a certainty of benefits to supplier countries, because they have no other alternative other than pushing their gas to India if they wish to monetize their reserves. It will be a great benefit to India because it would help reduce our dependence on oil.

“A fourth prong of energy security policy could be the creation of strategic reserves. Now I say ‘could’ rather than ‘should’ for I am uncertain about its cost-effectiveness. I include it however, because it is a widely adopted measure. Japan and members of the International Energy Agency — comprising most of Europe and the US — have all access to the strategic reserves. The government of India has also approved investment to create one.

“My doubts spring from my economic training over the costs. I am sure that the costs of building the caverns, filling them with oil and then operating and managing those facilities, may not be cost-effective,. The benefits would outweigh the costs only if the supply disruptions were prolonged, i.e., for six months or more. So the decision to set up strategic reserves must rest therefore on the government’s perception of the probability of the of Spreading Awareness AIDS and disruptions occuring, the length of such disruptions, and the likelihood that consequences of shortage will not be made up from alternative sources.

“My own view is the probability of the disruptions is high, but in a globalized and connected world, disruptions will be relatively shortlived, and that alternative supplies will be made available.

So the four prongs of energy security policy are:
• oil diplomacy
• domestic production
• access to gas, and possibly
• strategic reserves. But none of these prongs, individually or collectively, will secure our future unless we will do something about our demand management and the development of alternatives to fossil fuels.

“I will conclude by focussing on the urgency of the need to alter the magnitude and the manner of our energy consumption, and of working towards a low-carbon future. One of the reasons that we are among the most inefficient users of oil and gas in the world is that our consumers have been shielded from the play of market forces. The price signal has been stifled.

“You all know about subsidies, which have led to all manners of distortions. Transportation fuel is adultrated because of the price differential between kerosene and diesel. State Electricity Boards have become bankrupt because they are unable to charge the full cost of power. Subsidies are diverted into the blackmarket. All this is known. When Petroleum Minister Manishankar Iyer was asked to take Awareness in the Slums Cleanliness politcs out of pricing, he replied he would do so if someone tells how to remove politics out of the polity. So the tradeoffs are made outside the market process.

“In my view, there is no doubt that in the absence of price induced demand management, we will find it increasingly difficult to balance supply and demand. In the process, we will throttle the stimulus towards non-fossil fuel future.

“Energy is the key to the development and the long-term health of our country, and we do have a need to secure that. And there is no one primary source of energy on which we can be dependent. And as we move away from oil, we will need to create a cocktail of fuels ranging from fossil fuel, nuclear, solar, and later on, hydrogen.

“Equally, we must not ignore the fact that today there is too strong a nexus between economic growth, energy demand, and ecological degradation. We have to now invest in technology that will weaken this nexus,” Vikram Singh Mehta concluded.

Q&A

Rtn Shanta Chatterjee:
What would you say the oil reserves are for the rest of the world? How many years? And what are the reasons for oil majors not coming to India for exploration?

Vikram:
Those who believe that we are going to run out of oil are being challenged by those who believe that with evolving technology we will be able to locate more and more fossil fuels. Past Slums about evidence supports the latter view. We have indeed been able to develop technologies that makes it possible for us to now find oil in very harsh terrains like the Arctic Sea, or very deep waters. We are able now to commercialize oil from shale, and are able to drill in terrains that were impossible earlier on. So I am of the view that we shouldn’t focus on the finiteness of fossil fuels, but more so on the ecological consequences.

As for why oil majors have not entered India: it is not because India does not have hydrocarbon potential, but in the order of ranking of preferences, they have better opportunities elsewhere in the globe than in India. India stands below their threshold of interest in relative ranking.

PP Ajay Kanoria:
Why is the rate of recovery in Indian oilfields only 28%, as against 60% globally. What can be done to raise our rate of recovery?

Vikram:
We need to apply the modern and efficient oil recovery technologies, which are used by a large number of big companies to raise their recovery rate to 60% or more. For ensuring energy security, we need to correctly structure our terms and conditions, and adopt the most modern technologies for enhancing the recovery level. It is very possible.

Rtn Poonam Kumar:
What is your opinion on disinvestment and privatization of the oil companies?

Vikram:
I support privatization, not because I critique the public sector, but because I believe that competition will enhance the efficiency of our companies.

Rtn Burjor Poonawala:
What does the process of developing oil reserves involve?

Vikram:
Fossil fuel is in the spongelike porous rocks; it is not in lakes underground. When you drill a well, pressure differentials are created and oil will flow toward the well. However, if there is impermeability that prevents the flow from one part of the rock to where the well has been drilled, you won’t have any recovery of oil. The challenge of the exploration is not just simply to locate the hydrocarbon, but also to ensure that you locate your wells in such a way that you will be able to extract maximum from the pores, and to ensure that you will not encounter these impermeabilities.