The Organisation of Petroleum Exporting Countries (OPEC) meeting on 12 April 2020, proposed a cut in oil production by 9.7 million barrels per day. This is unlikely to alleviate the ongoing turmoil in the energy market. Energy analysts estimate that world oil demand has dropped by 30 million barrels per day and Market recovery should begin after the Coronavirus pandemic is controlled, and major economies (including India) reopen for business. This is a reminder for all oil-exporting nations to worry about demand security, a very different scenario from decades prior when oil-buying nations worried about supply security.
India has been a major beneficiary of low oil prices since 2018, as it is a large oil importer at 1.4 billion barrels. Can the country leverage the current scenario to cement its own energy security? How can India seize the moment to lock in these low prices for future benefit?
With cheap oil flooding the world, typical strategies to secure energy supplies include buying stakes in listed oil companies or filling up a country’s Strategic Petroleum Reserves (SPR). Neither is advisable in this environment. Buying stakes in foreign listed companies by India’s national oil companies will appear predatory while filling India’s existing SPR of 6.5 million tonnes (enough to cover 11.5 days of oil consumption) amounts to only a small financial gain. Besides, it is unrealistic to expect the government to create large volumes of storage at this time with so many other demands on its resources.
In this atypical era then, India can use market mechanisms to reset the global energy trade in its favour. For example it can catalyse oil trade in Indian currency through a Petro-Rupee. This will allow the participation of the Indian private sector and retail investors to the country’s advantage.
This is how it works, in a three-step process.
First, through the regulators’ encouragement, mutual fund houses can set up a Crude Oil Exchange Traded Fund (ETF) – similar to gold ETFs which are popular in India. Retail and institutional investors can buy units in such funds, which will represent physical barrels of oil kept in purpose-built storage in India. Construction will take time and it may be too late to fill it up with $20 per barrel oil this time, but India won’t miss future cycles. The oil stored in this ETF can be used in an emergency thereby significantly expanding the state’s SPR at no cost to the exchequer.
On oil storage: Worldwide, investors are buying and stockpiling cheap crude oil as they expect prices to return to normal. This is evident from the rising cost of renting storage facilities and the booming charter rates for supertankers, which are now being used to store oil instead of moving it. Indian investors are likely to follow the same pattern. India can use this increased oil storage, owned by private domestic investors, to push for a greater role for the Indian rupee in the world oil trade.
Second, is the creation of long-term (three, six, 12and 24month) futures and options for crude oil, either on the existing or a specially built exchange. These trades should be in the Indian-basket (the crude that India uses) rather than on the NYMEX (New York Mercantile Exchange), which trades in U.S. crude, and which MCX uses currently.
This will help eliminate a singular problem of catalysing the trade in India: the absence of sellers. Just three companies produce most of India’s domestic oil, whereas creating a market requires multiple participants. The U.S. has thousands of oil producers and sellers – from single well operators to global super-giants. The owners of crude oil ETFs will be a natural pool of future sellers and option writers, providing the market with the liquidity that traders, brokers and speculators can build additional volumes, on. Adding to that community will be oil users in India such as transporters and airlines, which can use the exchange to hedge their risk to oil price fluctuations. Oil refiners such as Indian Oil and Bharat Petroleum can also lock in their margins by buying crude futures and selling product futures, thus making earnings more predictable.
To secure demand the national oil companies of Saudi Arabia, Abu Dhabi and Kuwait – for whom India is a major buyer, can sell a part of their exports to India on this exchange, for better price discovery and transparency. Oil brokers on global exchanges will also be able benefit from arbitrage opportunities, thereby creating a global exchange and marketplace in India.
Third, the Indian government can hedge its own exposure to crude oil. With commitments to its many subsidies such as cooking fuel and electricity, India can protect itself against sharp spikes in oil prices.
The energy industry in the world is undergoing a transition and now is the time for India to position itself for a more central role in the global oil trade.
Amit Bhandari is Fellow, Energy & Environment Studies Programme, Gateway House.
This article was exclusively written for Gateway House: Indian Council on Global Relations. You can read more exclusive content here.
For interview requests with the author, or for permission to republish, please contact outreach@gatewayhouse.in
© Copyright 2020 Gateway House: Indian Council on Global Relations. All rights reserved. Any unauthorized copying or reproduction is strictly prohibited.