Flaring oil

Rising crude has left PSU oil marketing companies bleeding from the high under-recoveries. IOC, India’s largest refiner-marketer, recently had to sell government bonds worth Rs 2,464 crore at a discount of 12%. IOC, BPCL and HPCL are amongst the top five Indian companies in the list of Fortune 500 companies, yet they are so vulnerable to high crude oil prices.

The rising crude oil price enhances the price competitiveness of diesel more than petrol and natural gas, and through that, restricts the economy’s ability to be more energy efficient and clean-energy friendly. Further, the high import dependence leads to sharply rising import bills, which impacts the current account deficit and weakens the rupee.

The fears elicited above become relevant only if this price rise is fast and sustained over a long period. So, what is the likelihood of crude oil having a sustained price rise?

Tracing the history of crude oil prices will show that two periods – first from 1973 to 1980 and second, from 2002 to 2008---have shown significant and sustained price increases. Interestingly, both these periods have been preceded by high world GDP growth.

Global annual economic growth, in ten years preceding 1973, was recorded to be 5.3% (at PPP). This was the highest economic growth for any ten-year period on record. Riding on the back of high incomes generated by growth, oil demand increased, leading to rising prices. For the period 2002 to 2008, the average per annum growth up to 2007 was 4.6%—the highest for any five-year period on record, barring the very period leading to the 1970s price rise.

The global recession in 2008 brought demand down and hence also the prices. The coordinated effort of major economies of the world, through expansionary policies, led to increased purchasing power and it is largely felt that the world has come out of the recession. Recently, the World Bank reported that the world GDP grew at 3.9% in 2010 and the outlook for 2011 is 4.3%. So once again a strong income effect is fuelling the crude oil price rise.

Since Industrial Revolution to around 1950, the rich countries grew much faster than the poor ones. Thereafter, the trend began to change slowly and the contribution of poorer countries increased gradually. In fact, the contribution of non-OECD countries to the global economic growth has almost doubled after the 1990s and is today more than 40%. Comparison of data series on ‘growth in GDP’ and ‘growth in primary energy consumption’ shows that the two variables have high positive correlation.

Increasing consumption has evidently led to an increase in the price of crude oil. Though the strong energy efficiency measures being advocated in OECD countries work against the correlation, the relatively high energy intensity exhibited by the developing countries outweighs the efficiency gains of the OECD countries. The energy intensity in non-OECD countries is still around three times more than in the OECD countries.

BP Statistical Review 2008 shows that the developing countries consumed 4.4boe to produce $1,000 worth of GDP, but, OECD only used 1.4 boe. Aided by their strong output growth in 2008, the non-OECD countries’ primary energy consumption surpassed the OECD countries’ primary energy consumption for the first time.

BP Statistical Review of World Energy 2009, reported that non-OECD countries accounted for 51.2% of global commercial energy consumption. The same Review for 2010 shows that in the last ten years OECD economies have grown by 18%, while the non-OECD economies have grown 75% and primary energy consumption increased by 57%.

Today, India and China make up for the fall in demand caused by slowing western economies. High growth coupled with high energy intensity is a perfect recipe for increasing energy prices.

The Mexico oil spill is changing the way oil exploration and production industry works. It would create a tougher regulatory environment which is expected to considerably slow down exploration. Geologists say that new discoveries are expected to come up largely in difficult terrains. Harsher the terrain, riskier the exploration---tougher would be the regulations. Many small and mid-cap companies may exit the industry. Difficulty in obtaining permits, more monitoring and compliance and reduced number of players may together tend to reduce the supply of crude oil and hence stimulate a price rise.