The Hindu Business Line : Strategies to meet oil demand

With the world oil demand this year set to spurt the highest in a quarter century, the natural limits to production and the increasing impact of depletion and disruption in West Asia, it is vital that India develops an oil strategy for the medium term, says S. Narayan, describing several approaches.

THE recent decision by the Organisation of Petroleum Exporting Countries (OPEC) to raise output has cooled down the high crude prices to some extent. Immediately after the decision, Brent Crude fell to $36.40 a barrel in the London market. This has given Indian oil companies some respite, though they continue to struggle with uncovered margins at the current prices of petrol and diesel. There are, however serious doubts whether this agreement to lift output will have a deep or lasting effect on oil prices.

The key price driver may continue to be the rapidly increasing demand due to economic recovery in several parts of the world. The International Energy Agency (IEA) estimates that increase in demand in 2004 could be as much as 3 million barrels per day (mbd), a figure that is very close to all the world's new capacity and additions to production combined.

Demand growth is led by China, where current year's growth estimates could be as much as 1 mbd over the previous year. Demand growth in India (11 per cent) and in the US, where sales of gas-guzzling SUVs continues to grow, feed to this demand growth.

Predictions are that the world oil demand in 2004 will rise the most since 1980, as higher than expected use in Brazil, India, China and South-East Asia compounds economic growth in these countries. The IEA predicts increase in demand of diesel and other fuels by 2.3 million barrels to 81 million barrels. The US demand is projected to increase by 3,30,000 barrels a day or 1.7 per cent and an additional 4,20,000 barrels a day in 2005.

On the supply side, though actual production figures are notoriously difficult to come by, the total output is well under 80 mbd. In terms of non-OPEC capacity, production appears flat out with little or no new additions to capacity this year. Looking at total OPEC production, the first quarter averaged 31.22 mbd, reaching 32.22 mbd in March and 31.81 mbd in April.

The last time OPEC production approached these levels was in 1979 — the second oil crisis. Saudi Arabia appears to be the only major oil producer capable of increasing capacity in the short run.

There is also the increasing impact of depletion. The IEA has no standard data for recording depletion, and for many years it made little difference. Now depletion has started to have a significant impact and one that is likely to grow. Total production in 2002 was 74 mbd and 29 per cent of global production was from areas where production is in decline.

In the absence of reliable statistics, a reasonable guesstimate for average decline rates is 4 per cent, and the declining group's production is likely to go down by around 0.85 mbd. The under-recognised impact of this is that to meet this year's projected demand growth, the required new production will have to be close to 3 mbd. The real average growth rate needed will not be the 2.1 per cent reported by the IEA, but a more aggressive 4.1 per cent. This would seem to be a key factor in the continuing strength of oil prices.

There is also no significant increase in refining capacity in the US. Differing environmental and emission standards in different states has fragmented outputs from refineries to an extent where the considerable investment that has taken place over the last few years has helped only to meet these output requirements.

There is no appetite for fresh investments in refineries at present, in view of the ever-emerging changes in product requirements. With new refinery capacity across the world unlikely to grow in the next few years, refining margins will continue to remain high, with a high level of product prices.

The world's major oil consumers remain dependent on West Asia. Recent violence in Iraq and Saudi Arabia has again raised fears about disruption in supplies. Iraqi exports have been cut by sabotage attacks on oil facilities. The reduction in supplies has been relatively modest but has caused doubts about Iraq's long-term prospects of becoming a large and stable oil exporter.

Any attack on Saudi oil facilities would be a major factor for world oil markets. Analysts also view the political tension in Nigeria and Venezuela as having the potential to disrupt exports and drive up prices

Thus oil prices are likely to remain high, at least in the medium term. The era of $24-28 per barrel is definitely gone. How big the fluctuation will be would depend on China's ability to moderate growth as well as the degree of stability in the Gulf region. Some countries have factored this into their strategies.

Recently, China called for tenders for the installation of three very large nuclear power stations, to reduce dependence on fossil fuels. Other countries are also looking at alternatives to oil-based energy consumption.

India is heavily dependent on imported crude. Indigenous oil production peaked at around 34 million tones in FY 1989, but has been in a gradual decline since then. In the last few years, significant gas finds have been reported, particularly in the Krishna-Godavari offshore basins, but very little oil.

New gas pipelines are being planned, which will deliver, over a grid system of 11,500 km, 120 million cubic metres of gas per day. ONGC's efforts at offshore equity in oil in Vietnam, Sudan and Sakhalin will bring some relief to supplies.

The attempt to correct the prices of petroleum products through price increases and rationalisation of tariffs has to be viewed against this backdrop.

The argument that current prices understate costs to the oil marketing companies is, no doubt, true. The current corrections may afford some temporary relief, and it is equally important that a strategy be developed for the medium term as well.

Some approaches come to mind. First, there is a need to examine urgently the dependence of the power sector on liquid petroleum products. Accelerating the exploitation of gas reserves and additional LNG capacity would relieve the pressure, and prove efficient and economical.

Gas pricing policies, tariffs and clarification on roles of gas carriers needs to be put in place on a priority basis, so that investments in gas-based projects can be accelerated.

Second, there is a need to look at efficiencies of use. After the first oil shock, considerable work was done in oil conservation. It is time to revive and put in place conservation measures that should cover the entire gamut of product use, including transportation, generation and feedstock fuels.

Third, some kind of market competition should be introduced, even among the public sector marketing companies, through price differentiation (which now exists in lubricating oils). This would better reflect production and cost efficiencies.

Finally, there is no alternative to aggressive exploration strategy — both offshore and onshore, as well as looking at equity oil stakes overseas. Resources and energy must be thrown into this with greater vigour.

(The author is a former Petroleum and Finance Secretary.)