Rising Fuel Prices: Clearly, A Sound Energy Policy Is What India Needs Today

As Indians scrimp and struggle to deal with rising fuel prices, it is vitally important that we lift the lid off the dynamics behind our most important daily torment. Not for nothing did Union Finance Minister Arun Jaitley state recently, that rising crude oil prices constitute one of the gravest challenges to our nation’s economy. It is, therefore, just as crucial to fact-check a few myths, establish a few fresh premises, and understand how the Indian government is trying to mitigate the situation:

• The US economy is booming because its domestic oil sector is booming
• A base crude oil price in the range of $60/barrel is necessary for domestic US oil production to boom at the current scale
• Global oil supply capacity far outstrips global demand, and will continue to do so for the next generation or so
• Ergo, following basic laws of supply-demand economics, the crude oil price should either fall to the level of genuine profit, or, producers should cut volumes to demand higher rates
• But in the current scenario, as will be explained in this article, the global oil price is being artificially maintained at a high level, by preventing selected major producers from operating to full capacity and capturing the market
• Doing this is in the American national interest, since her domestic oil sector generates substantial employment and revenues in direct correlation to the global oil price

Readers would be aware that global oil production is around 92 million barrels per day (MMbopd or mbpd, 2018 BP data). The majority comes from a handful of nations:

Large producers like China and Brazil are not included since they are net importers. The balance is made up of two dozen-odd countries who produce in the 1-2 mbpd range, mostly again for domestic consumption.

But what is most interesting is the American oil production data:

From the above chart we see that American oil production had been in decline for decades, until around 2005, when a remarkable upswing took place. This turnaround took place on the back of new and innovative technological developments, which permitted oil companies to drill deep, and then horizontally, to extract oil from hitherto-uncommercial geological formations (often mistakenly called shales). This revolution was also facilitated by a concurrent, long plateau of very high oil prices:

At first everyone rejoiced. Russia, and the Organization of the Petroleum Exporting Countries (OPEC), cheered as their budgets gushed into surpluses. A number of new oilfields were brought on stream. A number of deep-water exploration campaigns were very profitably undertaken, establishing new petroleum provinces, and unlocking vast volumes of black gold. Canada too capitalised on this, increasing production by around 40 per cent. Even in India, a relatively large discovery was monetised by this price-spurt. The biggest beneficiary though, of course, was America:

But then, as with all gluts, and on the back of the 2008 recession, the oil price fell with alarming swiftness. From a high of over $130 a barrel in July 2008, the price crashed to $40 a barrel by Christmas that year (2017).

How the price was revived forms the crux of our tale, and the clinching evidence may be found in a rarely-used graph: a plot of the price differential between Brent (a global benchmark) and WTI (West Texas Intermediate, a domestic US benchmark). For decades preceding the ‘shale’-oil boom, Brent had historically traded marginally below WTI along a narrow band, meaning that foreign crude was slightly cheaper than American crude. But once the ‘shale’-boom was on in full force, wild fluctuations in the differential between Brent and WTI began to manifest themselves:

Now the picture becomes clearer. As oil exporting countries began to ramp up volumes on the price surge, and a situation of over-supply began to form, it became necessary that production levels be cut to keep prices above the production costs of American ‘shale’ oil. The problem was that if prices fell globally, American refiners would drop orders for domestic crude and source their needs from abroad. That in turn would mark the death of the domestic oil boom, generate widespread unemployment, and severely impact the American economy. This is what the wild fluctuations of the Brent-WTI price differential curve reflect – an effort to ensure that global oil prices were kept high enough to keep the new, huge volumes of domestic US ‘shale’ oil competitive to US refiners.

But who was going to cut production, and why? Not America, of course, because they were one of the largest importers of crude in the world. Then who else? Oil exporting nations balked; everyone had budgets to balance, mega infrastructure projects to fund, and tomorrow to think of. Naturally then, if a cut by consensus could not be achieved, then someone would have to be forced to volunteer. They found their patsy in Iran.

In hindsight, Iran was the perfect choice – rebellious enough, contrarian enough, interfering enough on Middle Eastern affairs, independent enough, anti-American enough, and professing a dangerously proud national desire to build an atomic bomb. It had all the necessary qualifications, so to speak. But, some readers may wonder, was Iran actually capable of upsetting the apple cart? Did it have so much oil? Wasn’t Saudi Arabia the real big brother, steadily producing 10-11 mbpd annually, with the capacity to up production by a couple million more? The simple answer is that the oil bounty of Iran is one of the least-addressed topics in the general discourse of oil politics.

To jog memories, to erase incredulity, to disprove accusations of outlandish statements being made, and in detailed answer, the chart below shows that as far back as the mid 1970s, Iran was already, and regularly, producing around 6 mbpd (even 7, in one month in that period):

Since then, through a revolution, a long and useless war with Iraq, and decades of isolation, Iran has continued to expand both reserves and capacity. Indeed, it is one of the few oil provinces in the world where super-giant oilfields will still be found, meaning that prospective areas still await exploration (and this is in addition to what has already been discovered and established as extractable volumes).

Today, if permitted, Iran can swiftly expand production levels from the presently restricted 4 mbpd to 10 mbpd, matching Saudi Arabia and Russia, and reach 12 mbpd a few years thereafter. One does not need to be a genius to figure out what the appearance of an additional 8 mbpd on the global market would do to the oil price. Of course, the price would fall. Saudi Arabia would follow suit to capture market shares, and Iraq, the United Arab Emirates, Kuwait and the Russians…you get the picture. Importing nations would benefit, and the American ‘shale’ oil boom would end (along with that of Canada). Hence the efforts to control Iran, to prevent a very different sort of domino effect from the ones Americans feared in the 1950s and 1960s.

In effect then, nothing changes. The daily vituperations over Persian perfidy reflect only one more chapter in the efforts to control the oil price. Once upon a time there was a Carter Doctrine, which stated that any efforts by any nation to seek predominance over the Middle East would be treated as an act of war. Unfortunately, after two Gulf wars and an interminable global war on terror, the Carter Doctrine wasn’t exactly the flavour of the day – nor its progenitor either. So in that sense, the world had changed, but only in terms of texture; the underlying dynamics, as ever, continue to be about oil. Still, Russia is awake. China has grown to unrecognisable dimensions from its emaciated Mao days. Europe, with its overweening dependency on Russian gas, and a befuddling migrant problem, doesn’t quite know whether to run with the hares or hunt with the hounds. India too, has a new government in place. A post-Cold War unipolarity centered on America is fraying vigorously at the edges.

At this point, readers must mark two issues: first, that one reason for Republican anger within America against Barack Obama and the Democrats, was because they felt he had lost control of the Middle East, and with that, America’s traditional ability to fix or set the global oil price. This is probably true to some extent (see the oil price chart: its fall in the last years of the Obama presidency, along with the Iran nuclear deal, did profit margins of American oil companies no good at all).

Secondly, if Donald Trump has been able to build up the oil price since his swearing in, Indians hurt by soaring fuel prices should be objective enough to admit that the man has acted well in his country’s interests. You may detest his boorishness, his hairdo, or his lack of oratory; you may think him crude, vacillating and undependable, but it cannot be denied that the American economy has grown in the past two years; and, that much of that growth has been propelled by domestic economic activity stemming from rising crude oil prices. There is a lesson in that for us.

And it is here, finally, that we come to India, and the weariness with which its citizens fill their petrol tanks each week. There was a time of many decades, when both crude oil production and consumption were low. Required imports were managed via a barter triangle, with India shipping pharmaceuticals and shoes to the USSR, the Soviets giving arms to Saddam Hussein, and Iraq completing the triangle by dispatching oil to India. But that cozy arrangement ended with the Cold War. The ensuing 1990s saw instead a huge jump in Indian oil consumption. Unfortunately, production didn’t keep pace; over the past two decades, our domestic production has hovered slightly below the 1 mbpd mark:

In a sense then, Indians are being forced to shell out more rupees per litre of petrol or diesel, as a function of America seeking to bolster its own economy. The livid amongst us (a full 100 per cent without doubt) may rightly ask why we are being forced to subsidise America’s prosperity? True. Very true. And that is precisely why many months of laborious talks between the Indian and American governments have resulted in India being able to buy oil from Iran – in rupees. This situation of surviving on the sufferance of another nation should not happen in the ideal world, agreed; America is no one to dictate to us. But that is a moral position. The reality is that they have the will, need and strength to enforce limited sanctions on Iran to create an artificial shortfall of crude oil in the global market – and there is very little we can do about that. They do so because they can, and because it is in their national interest.

If anything, the takeaways from this episode should be multifarious. First, that more Indians should be made aware of the wider dynamics which cause fuel prices to rise here. Second, that with the probability of India discovering giant oilfields within its borders being abysmally low, a reasoned debate on a new energy policy must be undertaken. Third, some recognition must be given, that this government appears to be learning that old game of playing strengths against strengths to achieve national goals. And fourth, that as this nation grows, it becomes all the more important to make a clear distinction between politics and policies.

India has its own set of national interests, which span the spectrum from trade, security, energy to the environment – all of which must be met with a degree of success; for which, a sector-by-sector approach must be initiated, to slowly reduce dependency on states which may be friendly today, and not so friendly tomorrow. Bottom line: we may never become self-sufficient in needs, but we can aspire to be self-reliant.