Energy crisis: Let prices adjust for a sustainable long-term solution

The West Asia crisis has created a global shortage of crude oil as well as liquefied natural gas (LNG). Given India’s exposure to imported fuels, the crisis has affected it as well. In response to the shortage and the perceived uncertainty over availability, the prices of crude oil and LNG internationally have been highly volatile. The price of Brent crude has gone up from $70 per barrel on February 26 to a high of $106 per barrel.

 

The cost of the Indian basket, however, has increased more sharply to over $156 per barrel due to disruptions in supplies from West Asia. Two challenges are emerging therefore — a shortage of supply as well as an increase in the cost of procurement. Efforts are being made to diversify the procurement of both ingredients of our energy basket, but these are likely to augment supplies only in a few months, given the logistical challenges. What does this crisis mean for India?

 

Any shortage in availability can be addressed either by allowing prices to adjust to eliminate the shortage or by rationing supply among competing users.  Currently, the crisis is being managed by drawing down reserves of crude oil and by rationing liquefied petroleum gas (LPG) usage. Clearly, there are limits to managing the situation only with these tools. There are two emerging concerns with this policy response. 

 

Perceived shortages create a black market for LPG along with hoarding behaviour.

 

The choice of rationing mechanism can have extended consequences — the government initially elected to protect consumers while partially withdrawing supplies to commercial users, including industry. Apart from the restaurants and hospitality sector, a number of industries are reported to be scaling back production or temporarily closing units. While fertiliser has been designated as a priority sector with assurances in supply of gas, tile manufacturing, tea, textiles and aluminium are reporting cutbacks. These, in turn, would cause second- round effects through reduced employment and lower production for these goods.

 

Perhaps it is time to consider price-based mechanisms to manage demand. Increase in price in the context of this sector in India can be considered in two ways — an increase in the cost of procurement can be passed forward as a higher price or, alternatively, an increase in price could be introduced to manage demand. Given that prices of imported fuels respond to global rather than local demand and supply, there could be a difference in the price change required in these two scenarios.  In the presence of adequate supply, price management can address a number of alternative priorities. However, price plays a significantly different role of moderating demand in cases of shortage of supply. Given the current milieu, the demand-moderating impact of price increases should be the focus.

 

To explore this option further, an assessment of the persistence of the crisis is called for. While it is hoped that the crisis would be a short-term one with a return to “normalcy” soon, the repeated nature of dispute between Iran and US-Israel suggests that the disruption could be long drawn or recurring in nature. In other words, uncertainty in the availability of crude or LNG, as well as in associated costs, remains. In this context, can we use this crisis as an opportunity to trigger structural change in the composition of our energy mix, with reduced reliance on imported fossil fuels?

 

How can the government support/nudge such a transition? The transition would have two components — first, on the supply side of energy, identifying alternative energy sources where India could have a comparative advantage; and second, on the demand side, nudging and supporting transition from one form of energy to another. On the supply side, the government has a number of initiatives in place to encourage the expansion of capacity under renewables such as solar. There are announced initiatives for coal gasification and carbon capture technologies. Ethanol can be another substitute energy source to explore. A suitable product mix which augments energy sustainability and self-sufficiency might require support not just for investment, but also for undertaking research & development for long-term efficiency in resource use.

 

On the demand side, households have been encouraged to move from solid fuels such as biomass to LPG. Automobiles are being encouraged to shift from diesel to CNG, and now further to electric. Similar support would be required for industries that use LPG or other forms of crude oil derivatives to move to electricity as the primary energy source. The nudge can be sector-specific to begin with. All of this requires resource commitments from both the government and the private sector.

 

Fiscal impact: Consider the alternative scenarios. The current approach of rationing and price controls remains in place, or, alternatively, price is used as a tool to moderate demand. In the first scenario, if the energy supply is lower, it would have an adverse impact on gross domestic product (GDP) growth. With higher costs of imported fossil fuels, if the costs are not passed forward, the balance would have to be met through budgetary support.

 

In the alternative scenario, if prices are adjusted to moderate demand, there would once again be an adverse impact on GDP growth, along with an increase in inflation. The fiscal balance might be better since revenues would be augmented both from higher petroleum taxes and implicit inflation taxes.

 

Clearly, the cost of borrowing for governments would be higher, but the government would have a nest egg to manage the new demands placed on it. The resources so mobilised could be earmarked for supporting the transition on both the demand and supply sides as discussed above, in addition to supporting the energy requirements of low-income households.

The author is director, National Institute of Public Finance and Policy. The views are personal