INDIA: Rapid growth drives global hunt for energy

Analysis

Venezuelan President Hugo Chavez is expected to sign a bilateral agreement on energy cooperation during his meeting in Delhi tomorrow with Petroleum Minister Mani Shankar Aiyar.

Chavez's visit follows Caracas's offer last year to India's state-owned Oil and Natural Gas Corporation (ONGC) of a share in the production and exploitation of five Venezuelan oil fields. It also underlines the growing overseas activities of Indian energy corporations as Delhi searches for ways to meet accelerating domestic energy demands.

Import reliance. Over the last 20 years, India's domestic production of oil has stagnated while its consumption of petroleum products has almost trebled. It imports 70% of the country's oil needs, which has had a significant impact on the balance-of-payments position. Indeed, last year's rise in international oil prices has taken the current account sharply into deficit after several years in surplus (see INDIA: Budget reflects Chidambaram's taxing imperative - March 2, 2005).

In the next ten years, even if the latest series of domestic oil exploration discoveries (for example, by UK-based Cairns Energy in Rajasthan) are fully exploited, India will still struggle to keep its imports down at current levels (see INDIA: Rate hike underlines energy fears - October 26, 2004). Domestic demand for petroleum products is increasing relentlessly at 5% per year.

Meanwhile, demand for natural gas, which stood at 0.6 trillion cubic feet (tcf) in 1995 had reached 0.9 tcf by 2002 and is expected to touch 1.2 tcf by 2010 and 1.6 tcf by 2015. Domestic sources of supply met over 90% of demand as late as 2003. However, despite the increased reserves discovered by recent exploration, the country will need to import up to one-third of its projected consumption needs by 2015. Moreover, volatilities in the international gas market threaten not only India's balance-of-payments position, but also the underlying growth rate of its industrial and agricultural sectors -- where gas is a fast-rising substitute fuel and is used extensively to produce chemical fertilisers.

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Securing energy needs. In 1998, when the Hindu nationalist Bharatiya Janata Party-led government conducted nuclear tests, it also inaugurated a new policy of securing the country's future energy needs. The government broadened its engagement with multi-national companies (MNCs), widening opportunities for them to participate in oil and gas exploration within India and proposed building up a buffer stock of oil to protect against market volatilities.

Overseas participation. Nevertheless, the foremost aspect of this strategy involved encouraging leading public-sector energy companies -- such as ONGC -- to secure energy resources overseas by participating directly in the global energy market (see INDIA: ONGC emerges as a global energy player - April 14, 2003):

• ONGC stakes. In recent years, ONGC has bought equity stakes in oil fields in Iraq, Sudan, Libya, Angola, Burma, Sakhalin in Russia, Vietnam, Iran and Syria.
• PSU activity. Other Indian public-sector undertakings (PSUs) have become involved -- not only in acquiring exploration and exploitation rights, but also in establishing sales outlets for Indian petroleum products and in offering a variety of technical services.
• Gas growth. In the gas market, the Gas Authority of India Limited (GAIL) has started to invest heavily in equity stakes in liquefied natural gas (LNG) plants in Oman and Iran, and is building port facilities and pipelines at home to handle large imports. GAIL is also pursuing plans for direct pipelines from neighbouring Bangladesh, Burma, Iran and even Pakistan.

Overseas constraints. However, the success of the new energy strategy has thus far been limited by two main factors:

1. Western competition. In more developed oil markets, it has brought India into direct conflict with leading MNCs and the policies of Western governments (especially those of the United States), which support them. Thus, while Saudi Arabia is by far India's largest supplier of crude oil, Indian companies have made little progress in acquiring rights in the Saudi oil industry.

   Instead, Indian companies have had to pursue opportunities in regions on the margins of the global energy market. This has led ONGC to pursue rights in countries such as Burma, Sudan, Libya, Russia, Iran and (pre-US invasion) Iraq -- where political instabilities and other pressures have often disrupted its activities. ONGC's investments in Iraq are now of doubtful value while cost factors have risen sharply for its investments in Sakhalin -- not least because it has had to make large loans to its failing Russian partners.

2. China challenge. Indian companies have also had to compete with other 'late-comer' national oil companies also seeking to improve their country's energy security. In particular, ONGC has faced stiff direct competition with the China National Petroleum Corporation (CNPC), which is much larger and more active (see CHINA: Energy-led foreign policy raises the stakes - January 27, 2005). Until 2003, India's international spending on oil rights was just 3.5 billion dollars, while that of CNPC was over 40.0 billion. Recently, in both Angola and Sudan, ONGC has lost bids for oil-prospecting rights to CNPC and, in Sakhalin, it was obliged to offer Rosneft a 2 billion-dollar 'loan' simply to keep its place in a market where CNPC had already offered Yukos 4 billion. These competitive pressures have pushed Indian companies ever further towards the peripheries of the global oil market -- in recent months, even towards Ecuador and the Ivory Coast.

Domestic problems. Three main domestic factors have constrained the oil industry's ability to secure investments abroad:

1. Bureaucratic inefficiency. The large amount of bureaucratic red-tape surrounding Indian PSUs has proved a significant disadvantage. One of the reasons why ONGC lost out to CNPC in both Sudan and Angola was because it had to wait to have the financing for its bids cleared by Delhi.

2. Political interference. Successive Indian governments have exploited PSU energy companies to fulfil their political mandates and to ease their own fiscal difficulties. Until recently, the government administered petroleum and gas prices to keep them at artificially low levels -- and, although these mechanisms have now been removed, pressures continue to be exerted on PSUs to hold down their prices and thus their profits.

   Even where PSUs make significant profits, they can rarely be kept for corporate investment strategies. In recent years ONGC and the Indian Oil Corporation (IOC) have had to declare very high dividends which -- because the Government of India holds more than 80% of their stock -- have disappeared into the public treasury.

3. Coordination problems. The public-energy sector is plagued by a lack of organisation and coordination. This has largely been because the government has encouraged energy companies to operate independently. Thus, they rarely cooperate and frequently compete against each other. For example, ONGC has recently been seeking to enter the domestic market for processed petroleum products, while IOC -- most of whose business is based in that market -- has started prospecting for oil rights overseas. This has led to duplication of functions and effort.

Nevertheless, to a degree this may prove advantageous because success in the international market for oil rights can depend on offering diversified services. This may explain why IOC has been successful at acquiring exploration rights in countries where it also provides petroleum products and distribution services, while ONGC has been unable to do the same.

Policy dilemmas. In response to this last problem, Aiyar has called for a restructuring of the industry through the creation of one or two petroleum 'giants' out of the dozen or so PSUs that currently occupy different segments of the market. However, his proposals contradict the government's policies of pursuing economic liberalisation and increasing the influence of market forces over corporate performance.

The implications of Aiyar's position came out most clearly at recent meetings with the Iranian authorities during which he convinced the latter to grant exploration rights to ONGC in return for signing a large LNG import contract, which will be administered by GAIL. Aiyar has now become central in coordinating policy among the supposedly autonomous corporations that make up India's oil and gas industry. In this respect, liberalisation and privatisation in the industry remain distant prospects.

Gas issues. In contrast, the gas sector has attracted significant private and foreign investment. This has largely been because its late development has meant that the state has struggled to retain its authority over the internal structure of the gas industry. Reliance Industries -- India's largest industrial conglomerate -- has made major gas discoveries, especially in the Krishna-Godavari basin. Furthermore, Shell has become an important player in the LNG market and British Gas in the supply of intra-state pipelines. These private interests have started to challenge the control of PSUs in several areas. For example:

• Reliance is threatening not to develop its holdings in the Krishna-Godavari basin unless GAIL concedes its current statutory monopoly on inter-state pipeline connections; while
• Tata Industries and GAIL are in open competition for access to neighbouring Bangladesh's gas supplies (see INDIA/BANGLADESH: Tata deal breaks integration inertia - August 25, 2004).

Energy diplomacy. However, as the competition between Tata and GAIL suggests, private-sector interests will have to find a means of compromise with the public sector. This is because the solution to India's energy problems lies overseas and thus can only be tackled through diplomacy -- a prerogative of the state. In this respect, India's neighbouring countries possess the resources to meet its energy shortages. However, Delhi's diplomatic relations with them have traditionally been difficult:

1. Pakistan problems. For more than a decade, Iran and India have agreed in principle to the construction of a pipeline bringing natural gas to India. However, the pipeline has never gone beyond the planning stages, largely because it has to pass through Pakistan, whose hostility to India has precluded construction.
2. Dhaka doubts. Bangladesh has been prepared to frustrate the development of its own gas industry rather than agree to selling gas to India, which is essential to justifying investment costs. Instead, India has been obliged to pursue an import strategy based on LNG, whose costs per unit of gas are at least 60% higher.

Recent progress. Nevertheless, over the last year, there have been breakthroughs on several fronts:

• Burma. With strong government support, GAIL has brokered agreement with Burma for a gas pipeline to India -- which Bangladesh has finally agreed to join, largely for fear of being left out. A network of pipelines around the northern Bay of Bengal is now in prospect.
• Iran. More significantly, the new climate of negotiation between India and Pakistan has promoted the revival of the Iran-Pakistan-India pipeline. While India remains cautious -- and thus far has pledged no active investment -- Aiyar has agreed (on behalf of GAIL) to take the gas on a cash-on-delivery basis, which will improve the prospects of financing the project.
• Pakistan. In other moves, Pakistan -- which faces its own energy problems -- has opened its domestic petroleum product market to international investors, including, in principle, Indian investors. Both Reliance and Indian Oil are considering bids in Pakistan's market.

Besides helping to solve India's energy shortages, if these projects come to fruition, they could significantly diminish tensions between the countries of the region. For example:

• Pakistan may hesitate to promote hostilities against India, which could see it lose potential revenues in excess of 1 billion dollars -- earned from transit duties from the Iran to India pipeline -- and, in turn, harm its own domestic petroleum market; while
• Bangladesh's traditional suspicion towards India could evaporate if Dhaka were to gain from several billion dollars per year in gas revenues through its cooperation over the pipeline from Burma.

Global impact? Energy projects have the capacity to exert much wider influence. While China and India have been in open competition for energy resources, there are signs that they are beginning to appreciate how far they share common interests against the MNCs and Western governments, who currently dominate the field.

Furthermore, leading energy suppliers, such as Russia and Iran, are also encountering deepening difficulties with the same MNCs and governments. An energy axis between Iran, Russia and China is already starting to form -- centred on the Caspian region. India's energy diplomacy is beginning to draw it towards this new axis where its PSUs have also been active in seeking investments in the Kazakhstan oil and gas industries. To this extent, India's quest to secure overseas energy resources could lead its future diplomatic trajectory even further afield.