From Business World of 11 May 2004.
The unrelenting rise in oil
prices
On the 5th of May,
2004, the price of Brent crude crossed $40 a barrel. This is the highest price
ever reached. Briefly in 1980, the price of Arabian light had crossed $36 after
Iraq invaded Iran. But after that it was all downhill for the oil price till
1998, when it briefly dipped below $10. From there crude price has quadrupled
in six years. This is in the beginning of summer, when global demand is
relatively low. What will happen in the coming winter? Will the price touch
$50? And what then? Are we heading for a period of high oil prices and a
scramble for supplies, such as was seen in the 1970s? The oil price surge in
1973-74 led to widespread strikes, unrest, and finally the emergency. At the
end of the turmoil, Mrs Gandhi lost power, and so did the Congress at the
center for the first time since Independence. So started the restructuring of
Indian politics which ended up in the ascent of the National Democratic
Alliance and the Prime Ministership of Atal Behari Vajpayee – which thirty
years ago would have been unthinkable.
The NDA has been unworried about
rising oil prices. It took the rise as just another occasion to play politics.
In 2001, the government abolished the administered price mechanism, with the
full intention of ushering in an era of market-determined prices. But as oil
prices rose, that determination also flagged. In the past two years the
minister of petroleum did not allow oil companies to raise the prices of
kerosene and liquefied petroleum gas; the result is that the refining companies
are making losses on these products. Without giving it the name, he brought
back the administered price mechanism. Whereas earlier there was rampant
cross-subsidization through the Oil Price Equalization Fund, now there is
cross-subsidization within each refining company.
Although this cross-subsidization
was an NDA policy, it was in the spirit of the Congress, which continues to
believe in using political patronage in the guise of redistributive policies.
It is a type of policy that is likely to find considerable support in the new
Parliament, especially amongst such backwoods parties as the Samajwadi Party
and the CPM. Hence unless the next government takes an early decision on the
principle, the policy of interference and patronage may well become permanent.
A government does not run on
principles alone; the political costs and benefits cannot be ignored. For this,
it is necessary to form some idea of what is happening in the oil market, and
where it is going to go. Clearly, the market has undergone a qualitative
change. From the mid-1980s, crude price ambled gently between $10 and $20.
Between the winter of 1998 and of 2001, however, it quadrupled. In the next
year it halved. Since early 2002 it has almost tripled.
Thus the oil price cycles have
shortened, and volatility has increased. It would be tempting to think that
this is the doing of OPEC. But by and large, the behaviour of OPEC in the past
five years has been anti-cyclical: it has increased production as prices rose,
and vice versa. Conspiracy theories may be appealing, but do not really give a
good explanation of the rise in oil prices.
An obvious factor is the rising
demand. After the oil shock of the 1970s, world oil demand fell 17 per cent and
took fifteen years to recover to the old level. But since 1985, demand has
risen 30 per cent in Latin America, 40 per cent in Africa and 50 per cent in
Asia. Currently, the transition of China from a self-sufficient to an oil
importing country is having a significant impact on the world oil market. Hence
it is on balance best to assume that we have entered a period of high and
volatile oil prices.
Such is just the time that will
tempt politicians to try and stabilize prices; but that would be the height of
folly. Subsidies are invariably given at the expense of producers; and since
the bulk of oil production and refining is still in government hands, it is
very easy to command the government’s obedient daughters to cross-subsidize.
But such a regime will be extremely unattractive to private investment.
Reliance today is the only private oil refiner; it is large and efficient. But
it is already having running arguments with the government-owned oil marketers
on account of the subsidies. Private investment will give us a more nimble and
efficient oil industry; and it will not come unless the government stops
interfering in the market. And it is important to get consumers used to actual
market prices; higher prices will lead them to find ways of replacing and
economizing on oil. And finally, only real prices will lead the government to
look for solutions – for instance, in import of gas and in improved coal
processing technologies.
