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The budget’s great game

The budget’s great game
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First Published: Sun, Feb 27 2011. 07 37 PM IST
Updated: Sun, Feb 27 2011. 07 37 PM IST
Arthur Conolly, an intelligence officer of the East India Company, coined the term “Great Game” to describe the 19th century fight for supremacy in Central Asia between Russia and Britain, made famous in Rudyard Kipling’s turn-of-the-century novel, Kim. In the 21st century, the New Great Game refers to a similar rivalry between NATO countries on the one hand, and Russia and China on the other. The game is now about oil and gas from Caspian Sea countries, which are expected to be the next Persian Gulf in terms of petroleum supply to the world.
But uprisings in several Middle East countries, and the threat of one in Iran, have started an upward spike in the price of crude. With Brent crude touching $120 a barrel last week, the Persian Gulf is still the great playground as far as global crude oil supply is concerned.
India’s economy is disproportionately affected by the price of oil. Since the country imports a majority of its oil needs, a sustained rise in oil prices directly affects the trade balance and current account. If the capital inflows that help balance the latter do not arrive in proper measure, then economic growth may suffer. In addition, oil prices feed through the economy’s supply chain, causing inflation. With several petroleum products still subsidised, this puts a burden on both oil marketing companies and the exchequer. High oil prices are thus poisonous for India’s macro-economy.
What should India do? What can we expect in today’s budget?
Almost exactly a year ago, the Kirit Parikh expert group report on “A Viable and Sustainable System of Pricing of Petroleum Products” recommended that petrol and diesel prices be “market determined both at the refinery gate and the retail level”. The government has partially implemented this by allowing the price of petrol, but not diesel, to gradually become market determined.
“Any ad hoc system of price fixation by the government may provide a semblance of domestic price stability in the immediate-to-short term, but give rise to serious long-term instabilities in the demand-supply conditions in the country, competitive functioning of oil companies, and fiscal soundness of the government,” the report had said. It is true that an increase in diesel prices will temporarily be inflationary. But in the longer-term interest, the Budget should announce a specific schedule to fully free all petroleum product prices, and convert the subsidies on kerosene and LPG into targeted cash transfer programmes. This is important, because energy security, especially in crude oil, cannot be reached until prices are free.
I also hope this budget will give India’s plan to build strategic petroleum reserves (SPRs) a shot in the arm. Think of SPRs as a publicly provided insurance policy against oil price shocks. The cost to build and maintain the SPR facility is the “premium”. The “benefits” are price reductions during periods of extreme prices. Many countries have developed SPRs to cushion against oil price shocks, among them the US, the European Union nations, Japan, China, Australia and South Korea. The US’ is the largest emergency facility in the world, with a capacity of over 700 million barrels, equating about 30 days of US daily consumption. China is on track to achieve a 90-day reserve by 2020.
India has plans to build 38 million barrels of SPR, equal to a little under two weeks of consumption. The Oil Industry Development Board, tasked with the country’s energy security, has created a special purpose vehicle called Indian Strategic Petroleum Reserves Ltd, with facilities to be built in Vishakhapatnam, Padur (Udipi) and Mangalore by 2012. Of these, the Vishakhapatnam facility is scheduled for completion in October. There is no publicly available report of progress.
The critique against SPRs is that they help—directionally, politically and in times of emergency—but they are not really effective in counteracting periodic spikes in oil prices such as the one we are seeing now. There is merit in this argument, but for India, with well over $200 billion in foreign exchange reserves, holding a portion of that as crude oil makes eminent sense. Building a meaningful SPR is not a simple (or cheap) project. Formulating rules for the use of this oil and its movement from storage to refinery is also a complex task. But it is one that India, as an aspirant to the permanent membership of the United Nations Security Council, must undertake.
India has not yet joined the New Great Game. For the moment, it must play the game within its borders, by freeing prices and building reserves. Let’s hope the finance minister listens.
P.S.: Raghuram Rajan once wrote, in a cautionary note that is relevant for India’s energy security, that buying minority stakes in opaque companies in poorly governed countries makes little business sense. Nor is it good strategy, I would add.
Narayan Ramachandran is an investor and entrepreneur based in Bangalore. He writes on the interaction between society, government and markets.Comments are welcome at narayan@livemint.com
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First Published: Sun, Feb 27 2011. 07 37 PM IST