Energy security 2.0

Published: March 29, 2016 - 12:32 Updated: March 29, 2016 - 12:35

Are strategic reserves the answer? 

Noor Mohammad Delhi 

Sheikh Mohammed bin Zayed Al Nahyan, Crown Prince of Abu Dhabi, visited India along with a high-level delegation from February 10 to 12. A key achievement of the visit was the deal struck by the two sides under which the Abu Dhabi National Oil Company (ADNOC) will store crude oil in India’s 1.5-million tonnes Mangalore strategic petroleum reserve and sell to the Indian refineries whenever needed. Commercial details of the agreement are yet to be worked out.

Besides, certain taxation, VAT and revenue-related issues also have to be resolved.

Indian Strategic Petroleum Reserves Ltd (ISPRL), a government agency, is setting up strategic crude oil reserves with a storage capacity of 5.33 million metric tonnes (MMT) at Visakhapatnam, Mangalore and Padur in the first phase. After the first phase is completed, India will have a crude oil import cover of 13 days.

India imported 189 million tonnes of crude oil in 2014-15, about 80 per cent of its total requirement. With domestic production stagnating, India’s crude oil import dependence could rise to a staggering 90 per cent in two decades.

What is perhaps reassuring is that another 12.5 MMT storage capacity will be built in the second phase. The government plans to finally have 90 days’  import cover by 2019-20, including capacities available with refineries for storage of crude oil and petroleum products.  

However, storage may have to be further increased later when consumption and imports rise.

Debasish Mishra, Partner, Consulting, Deloitte Touche, sees the strategic reserve as an innovative way to address India’s energy security concerns. “The petroleum ministry is doing some out-of-the-box thinking towards achieving energy security for the country. Creating a strategic reserve in India with the product ownership of supplying countries like UAE and Saudi Arabia will provide physical security of oil reserves within the country without significant investment,” Mishra said.

The stated objective of building Strategic Petroleum Reserve (SPR) is to insure against possible disruption of oil supplies in case of war or any other eventuality. But does it make economic sense too remains the moot question.

For example, India made a first purchase of two million barrels of crude oil last March for filling  the Visakhapatnam SPR when Brent crude was ruling at $55 per barrel. But since then, the oil price has come down to $30  per barrel. So it is obvious that there is a price risk in storing crude oil.

But there is enough merit in the argument for maintaining strategic reserves to meet the eventuality of  supply disruption  given that India consumed about 3.8 million barrels of oil per day in 2014, a figure that will reach 9.8 million barrels per day in 2040, according to the International Energy Agency.

Anyway, India is not the only country to have strategic reserves. The US, Japan, Germany and several other  Organisation for Economic Cooperation and Development (OECD) countries have much bigger strategic reserves than India. For example, America keeps the highest reserves of 727 million barrels and plans to increase it to one billion barrels.

Japan keeps strategic reserves of 323 million barrels and Germany has 184 million barrels. Spain, Sweden and South Korea too maintain strategic reserves. Meanwhile, China which already has strategic reserves of 31 millions barrel wants to increase it to 600 million barrels.While OECD countries’ decisions to build strategic petroleum reserves were triggered by the Arab oil embargo of 1973, India was jolted by the supply disruption caused by the 1990 Iraq war.

India was staring at an unprecedented energy crisis at that time, with oil reserves  left for only three days. Although India managed to escape the crisis then, it is still haunted by the threat of energy supply disruption.

 To bolster India’s energy security, the Atal Bihari Vajpayee government in 1998 mooted the idea of strategic petroleum reserves.

What is more, the bulk of India’s crude is sourced from the Middle East, a region which has seen growing political instability in recent years. That should be a wake-up call for India, energy experts say.

Apart from supply security, another key advantage of strategic reserves is that when stocks are drawn down, international oil prices cool. This is especially true in the case of the US which maintains the world’s largest strategic petroleum reserves.

A case in point is the March 2014 test sale of five million barrels of crude oil from the US strategic reserves when global prices were surging above $100 per barrel. Following that, oil prices dipped by two dollar.

Analysts say oil being such an essential commodity, suppliers can impact the price by just stating their intention to control supply. The global oil cartel, the Organisation of Petroleum Exporting Countries, has been using supply curbs as a tool to jack up prices.

Recently, Saudi Arabia, Russia and some other oil exporters agreed to freeze crude supply to the January 2015 level. If this deal is implemented successfully, oil prices could rise. A big oil importer like India cannot remain immune to such risks and it must have a cushion of strategic reserves. It has been a late starter. But, finally, the country has taken the right decision.

But building storage is an expensive proposition. For example, building storage capacity for 10 days of imports would need `4,000 crore for infrastructure and subsequent storage costs work out to $17-18 per barrel. It also takes time to build reserves. For example, building a stockpile of 12.5 million tonnes can take more than five years.

 Experts say that India can benefit from closer access to the commercial reserves while reducing the cost of access. This can be done by inviting investment in the stockpile programme, and through tie-ups with Gulf producers. In 2005, Saudi Aramco had mooted a similar plan but it could not take off.

In that context, the India-UAE agreement on cooperation ifor the  strategic petroleum reserves assumes added significance.

Experts suggest that beyond such commercial engagements, India can also sign oil-sharing pacts with other countries for emergencies to bolster its energy security.

Countries like Japan, South Korea, Germany and France have forged bilateral or regional oil-sharing pacts to deal with possible supply disruptions.

For example, South Korea and Japan have agreed to share their oil reserves in the event of an emergency. Meanwhile, negotiations are underway between Japan and New Zealand for an oil-sharing deal whereby Japan will sell part of its strategic reserves to New Zealand in the event of an emergency. New Zealand will pay the market price and negotiated option fees for the amount of oil previously held for it
by Japan.

The US has agreed to renew an existing pact to provide emergency oil supplies to Israel. America had signed the agreement with Israel following the Arab oil embargo of 1973-1974 as an exception to its oil export ban policy at that time.

France, Germany and Italy have an oil-sharing agreement in place that allows them to buy oil from each other in the event of an emergency. In 1968, the six members of the then European Economic Community – Belgium, France, Germany, Italy, Luxembourg and the Netherlands–agreed to maintain a minimum level of crude oil stocks and oil products corresponding to 65 days’ worth of domestic consumption which was raised to 90 days in 1972.

Luckily for India, the crash in international oil prices has come at a time when it prepares to topup its strategic reserves. But the billion dollar question is, can India move fast enough to maximise its gains from low oil prices?

Are strategic reserves the answer? 
Noor Mohammad Delhi 

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