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14 December 2016, Gateway House

Three tiers of energy security for India

India imports 80% of its oil and 80% of the imports are from vulnerable regions. This high-cost, high-risk approach is not sustainable, and the current low price of oil offers India an opportunity to secure its long-term energy needs by taking three concurrent steps: diversifying supply sources, investing in oil fields, and using financial instruments

Fellow, Energy & Environment Studies Programme

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The following article was part of The Gateway of India Dialogue 2016 compendium ‘Where Geopolitics meets Business‘. This piece has been published separately.

The Gateway of India Geoeconomic Dialogue will happen on 13-14 February 2017.

India has a large and growing oil requirement, over 80% of which is currently met through imports.  Although prices have fallen over the last few years—during 2015-16, the country imported 1.25 billion barrels of oil at an average price of $46.2 per barrel, [1] as compared to an average of $105 per barrel in 2013-14—the cost of imports is not a sustainable long-term approach for India.

But the country’s need for oil will only keep growing, and India must adopt a three-tier strategy to secure its long-term oil availability at a reasonable price: diversify supply sources, acquire oil fields, and use financial hedges. It is important that these measures work together; none of them in isolation can entirely protect India from price fluctuations and supply hiccups.

The current scenario of low oil prices, low prices of energy assets, and new oil supplies coming into the world market offers India a rare opportunity to put this strategy into practice, and reduce the country’s vulnerability to price spikes and supply disruptions.

Diversifying supply sources is one part of this strategy. Apart from the fluctuating or high price of imports, India faces another risk—80% of its oil comes from countries facing severe problems or located in unstable regions. West Asia accounts for 58% of India’s oil imports. [2] This region is vulnerable to terrorism, internal political upheavals, and a possible confrontation between Saudi Arabia and Iran. Libya and Syria, also in the same region, are collapsed strife-torn states.

India’s biggest non-West Asia sources of oil are also vulnerable. Venezuela and Nigeria, together provide 22% [3] of India’s oil imports—but Venezuela is dealing with economic collapse, while Nigeria is facing persistent terrorism.

Taking note of these uncertainties, India must look to other sources: it currently imports less than 1% of its total oil from Russia and Canada, [4] both of which are major oil producers with big reserves. The U.S. too is going to become an exporter, with its growing production of shale oil. [5] These are politically stable countries and India can channel more of its imports from them.

However, such a shift will only account for a fraction of India’s oil needs. And it will still leave India vulnerable to a spike in global oil prices, which can go up irrespective of where India is buying oil from.

This is where the second tier of the strategy can come in: India must become more proactive in acquiring oil fields in other countries. The ownership of oil fields will allow India to accrue some of the value of rising oil prices; it will also offer a measure of protection against rising oil prices.

The public sector Oil and Natural Gas Corporation has been acquiring small stakes in oil fields in several countries for over a decade. In recent years, other government firms such as Indian Oil, Oil India, and Bharat Petroleum have done the same. However, the total oil production from these assets is less than 5% of India’s oil imports. [6] The low price of oil offers these companies a chance to buy more oil fields cheaply—the share prices of many listed oil companies have fallen by 70-80% in the past two years.

ONGC and the other three Indian companies have, since September 2015, signed agreements with Rosneft of Russia to acquire stakes in large oil fields. [7, 8] India needs to identify other hydrocarbon rich countries where it can invest safely. Venezuela, Ecuador, Bolivia, and Argentina are all rich in hydrocarbons, but not necessarily good destinations for India’s investment diversification. All four countries have a poor track record of respecting the property rights of foreign firms. All have, in the past decade, in a move driven by high oil prices, nationalised oil fields owned by foreign firms. [9] ONGC also has oil fields in South Sudan, which have been shut down due to the deteriorating security situation.

Any investment has to consider the political stability of the host country.  Here again, the U.S. and Canada offer an opportunity—there are hundreds of listed companies in both countries that can be acquired. Both however place some restrictions on the acquisition of hydrocarbon assets by state-owned firms, which India will have to follow. [10]

Since only a few states rich in oil are safe for foreign capital investment, this option too will cover only a fraction of India’s oil needs.

India must therefore also put in motion the third tier of its energy security strategy: turn to the financial markets to protect itself against price spikes.

The Indian government bears a direct risk from rising oil prices. In the past, it has had to share the burden of high petroleum prices by reducing the taxes on petroleum products and by giving direct subsidies to vulnerable consumers—of as much as $15 billion during 2013-14. [11]

Hedging is therefore strategically necessary. There is a precedent for governments hedging their energy risks: Mexico, which relies heavily on oil revenues, spent $1.09 billion to hedge its oil sales for 2016, in order to ensure that it gets a floor price for its oil. [12] As oil revenues are important for the Mexican government, the expenditure is deemed worthwhile.

But India sits on the other side of the oil trade, and must act accordingly to protect itself. The best way to do this is to use call options, which give the holder the right, but not the obligation, to buy an asset at a predetermined price. Crude oil is one of the most highly traded commodities globally, and such options can be purchased years in advance for large quantities.

For instance, the call option to buy oil at $70 per barrel in December 2017 can be currently purchased for $2.12 per barrel. [13] This contract allows but doesn’t compel India to get oil at $70 per barrel, irrespective of the market price. This is similar to buying insurance—pay a small premium upfront to protect against a potential disaster.

It is these three steps together—diversification of supply sources, acquiring oil fields, and financial hedging—that can help cap India’s oil import bill.  This cost has been a major worry for planners, and the low energy prices since early 2015 have resulted in an annual saving of $75 billion. The time is clearly right for India to reduce its long-term vulnerability to the cost of imported oil and close one critical source of financial uncertainty.

Amit Bhandari is Fellow, Energy & Environment Studies, Gateway House.

Kunal Kulkarni was a Senior Researcher, Gateway House. 

The Gateway of India Dialogue was co-hosted by Gateway House and the Ministry of External Affairs on 13-14 of June 2016. The 2017 conference, The Gateway of India Geoeconomic Dialogue will be held on 13-14 of February 2017.

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 2016 Gateway House: Indian Council on Global Relations. All rights reserved. Any unauthorized copying or reproduction is strictly prohibited

References

[1] Petroleum Planning & Analysis Cell, Ministry of Petroleum & Natural Gas, Government of India, Ready Reckoner, March 2016, <http://ppac.org.in/WriteReadData/Reports/201604191010304216675SnapshotofIndia’sOil&Gasdata-March2016.pdf>

[2] Lok Sabha, Government of India, Starred Question Import of crude oil, Annexure I, 7 December, 2015, < http://164.100.47.192/Loksabha/Questions/QResult15.aspx?qref=25281&lsno=16>

[3] Ibid

[4] Ibid

[5] Egan, Matt, ‘After 40-year ban, U.S. starts exporting crude oil’, CNN Money, 29 January 2016, <http://money.cnn.com/2016/01/29/investing/us-oil-exports-begin/>

[6] ONGC Videsh, ‘O+OEG Production’, <http://www.ongcvidesh.com/performance/production/>

[7] Oil and Natural Gas Corporation Limited, Press Release pursuant to Regulation 30 of the Listing Regulations, 17 March 2016, <http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/469EF225_B82C_497C_AB10_0C0EB1E0F628_103944.pdf>

[8] Bharat Petroleum Corporation Ltd., Press Releases, Corporate Announcement, 16 March 2016, <http://corporates.bseindia.com/xml-data/corpfiling/AttachHis/9E2371DC_9C0D_4374_A3F5_D966C7D8CD54_152008.pdf>

[9] Ellsworth, Brian, ‘Venezuela seizes operations from oil majors’, Reuters, 1 May 2007, <http://www.reuters.com/article/us-venezuela-nationalization-idUSN0149302220070501>;  Valencia, Alexandra, and Alexandra Ulmer, ‘Ecuador to pay $980 million to Occidental for asset seizure’, Reuters, 13 January 2016, <http://in.reuters.com/article/ecuador-occidental-idINL2N14X0U420160113>;  ‘Bolivia sends military to oil fields in Chaco’, Reuters, 16 April 2007, <http://uk.reuters.com/article/bolivia-naturalgas-idUKB28786320070416>; Bronstein, Hugh, ‘Argentina nationalizes oil company YPF’, Reuters, 4 May 2012, <http://www.reuters.com/article/us-argentina-ypf-idUSBRE8421GV20120504>

[10] Bhandari, Amit, and Kunal Kulkarni, ‘North America: petro state’, Gateway House: Indian Council on Global Relations, 13 April 2016, <https://www.gatewayhouse.in/petro-state/>

[11] Ministry of Finance, Government of India, Reduction in Subsidy, 11 July 2014, <http://pib.nic.in/newsite/PrintRelease.aspx?relid=106437>

[12] ‘Mexico wraps $1.1 billion oil options hedge to lock in $49 floor’, Reuters, 20 August 2015, <http://www.reuters.com/article/us-mexico-oil-idUSKCN0QP0X020150820>

[13] Crude Oil Options Quotes, CME Group, ‘American Options, Dec 2017, All’, <http://www.cmegroup.com/trading/energy/crude-oil/light-sweet-crude_quotes_globex_options.html?optionExpiration=Z7#strikeRange=ALL> Accessed 3 May 2016

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