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Beware of energy’s robber barons

Beware of energy’s robber barons
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First Published: Sun, Feb 08 2009. 10 28 PM IST

Illustration: Jayachandran / Mint
Illustration: Jayachandran / Mint
Updated: Sun, Feb 08 2009. 10 28 PM IST
India, in its quest for energy security, is leaving no stone unturned. It surely needs to consider all means for energy independence, but it should pause to examine the risks. Recent events involving Russia, the world’s largest supplier of natural gas, are an indicator of some potential dangers.
Illustration: Jayachandran / Mint
In early January, Russia’s giant energy company Gazprom suddenly cut off natural gas supplies to Ukraine. As a result, much of Europe shivered without heat because pipelines through Ukraine supply most of their gas. Moscow exercised its gas clout in 2008 as well, ostensibly over pricing and transit fees, but more likely as an assertion of its readiness to wield energy as a weapon. The Russian act has implications for two gas pipelines that concern India: TAPI (Turkmenistan-Afghanistan-Pakistan-India) and IPI (Iran-Pakistan-India).
At issue is the stranglehold both monopoly suppliers and transiting countries may have over energy security. Given that TAPI and IPI would transit through rough terrain with restive populations such as Afghanistan and Baluchistan, the chances of disruption are high, whether via blackmail by the Pakistani government or due to physical damage by insurgents.
Consider the Russia-Europe scenario. The Europeans are so concerned about Russian energy clout (the European Union gets 25% of its gas from Gazprom) that they have proposed several alternatives—for instance, the Nabucco pipeline to transport Central Asian gas through Georgia and Turkey to Austria, avoiding Russian supplies and territory altogether.
To counter this, the Russians have proposed the North Stream and South Stream pipelines that in turn bypass Ukraine. This has split the Europeans: Germany prefers the North Stream; Italy and Greece prefer the South Stream.
Such energy dependence can have wider ramifications. It is quite possible that Russia’s invasion of Georgia in August was a warning to the Europeans and Americans, who, in the Russian view, are getting rather too friendly with Georgia. In 2007, Georgia completed a section of a pipeline that passes from Baku in Azerbaijan to Erzurum in Turkey. This will connect to the Nabucco line, if it is ever completed. But Russia’s counter-proposal of the South Stream, to terminate at the same Austrian distribution point as Nabucco, has caused the Europeans to rethink.
The Georgian invasion may have been part of Russia’s strategy to lock in its customers by offering an unattractive choice: If they go with the Georgian option, the Russians could disrupt that pipeline at will, as it runs close to Russian-dominated South Ossetia in Georgia. A number of European countries are dependent on Russian gas (100% in the case of Bulgaria, Finland, Lithuania and Slovakia; at least 60% in the case of Greece, Hungary, the Czech Republic and Poland; and at least 40% in the case of Germany), and switching costs are high. Their bargaining power as customers is low.
The Russians have also induced their customers to build “co-specialized assets”—large capital investments that can only be used specifically with their product. The goal, from the point of view of a supplier, is to make their offering so attractive that their customers should be willing to put in large amounts of money to build infrastructure for that product, and only that product; the supplier also invests, and it is a win-win for both. Until, that is, the supplier shows its teeth. Technological changes may render co-specialized assets obsolete or non-optimal, thereby becoming a burden.
Russia has also created, in effect, a cartel of gas-exporting countries from Central Asia to West Asia to North Africa. In the 1970s, the Organization of Petroleum Exporting Countries (Opec) similarly held the world to ransom. By becoming a monopoly, Opec was able to increase prices by an order of magnitude, bring on the infamous “oil shock”, and transfer trillions of dollars from the rest of the world to themselves. We don’t want a repeat of that with Russia, or other gas moguls.
Clearly, overland pipelines create insecurity. Therefore, India must weigh the alternatives. What if, for instance, it used an offshore pipeline from Iran that skirted Pakistan’s coast and landed in Gujarat, or it used liquefied natural gas (LNG) shipped from Central Asia? The cost of building and maintaining an offshore pipeline is significantly greater than that of an overland pipeline, but the latter’s risk premium may justify the increased cost.
Better yet, India should consider new technologies. LNG terminals and refrigerated LNG tankers, for example, do not depend on geography. LNG terminals can accept LNG ships from anywhere. In other words, switching costs are minimized, and there is no threat of disruption by a transit nation. The cost of every stage in the LNG value chain has dropped so much in the last decade that its end-user price is now comparable with that of gas piped overland.
Nations can wield tremendous power by leveraging their natural resources. India, looking to make itself energy independent, would do well to imbibe these lessons. Otherwise, ironically, it will become even more of a hostage to others’ whims.
Rajeev Srinivasan is a management consultant concentrating on energy and strategy issues. Comments are welcome at theirview@livemint.com
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First Published: Sun, Feb 08 2009. 10 28 PM IST