Have plan in place, oil to hit $100 per barrel

Have plan in place, oil to hit $100 per barrel

There is no simple explanation for the factors behind the world energy crisis

Representative Image. Credit: AFP File Photo

As US benchmark oil crossed $80 per barrel on October 8, a level last reached in November of 2014 and is likely to climb to $100/b, the Union government has to develop both short and medium-term plans to face the potential energy crisis. Already, the world - including the energy affluent US - is dealing with a global energy crisis. Intensity depends on countries and regions. But in India, if the government shows any urgency, public is not aware of it.

One day we read that we have more than adequate quantity of coal to meet any likely power demand. Then we read the next day how coal inventories are much below the minimum level in many power plants. While this is one facet of the energy crisis, the other facet is the unexpected huge price rise of imported LNG and crude oil prices. Managing this huge import bill as we recover from the pandemic will not be easy.

There is no simple explanation for the factors behind the world energy crisis. Unlike the earlier crisis, there is no geopolitical event this time. There was considerable uncertainty about how pandemic will affect the overall energy demand. While some were preparing for the economy to revive and thus increase in energy demand, most were expecting the third or fourth wave and oil demand to be lower. In the event, optimists seem to have been right so far.

Some blame it on less than predicted power supply from renewables like wind and solar. Though International Energy Agency strongly refutes the argument that it was the energy transition to be blamed, the facts argue against such a thesis. Developed countries rightfully showed urgency to bring about the energy transition. This was also helped by the dramatic fall in solar energy prices in recent years. However, as we can see now, every country seems to have failed to do much needed prior planning to manage with known-unknowns of variable power supply to the grid.

For example, in the UK, a closed-down coal power plant was started to supplement the power. In some countries because of the shortage of coal and higher natural gas prices, oil power plants have been started. In February this year, a monthly poll of 50 experts by Reuters predicted Brent price to average $54.47/b in 2021. In all likelihood, it may turn out to be around $75/b. Currently, Goldman Sachs is predicting oil prices to reach $90/b before year-end.

It is useful to take a look at why oil pundits missed with a huge margin. Most of us had assumed that as oil prices go above $50/b, US shale producers will have the economic incentive to increase production. However, it did not materialise. This is because of several factors as we know now.

Having lost money, banks were not willing to lend money to shale producers. Second, not knowing how long higher prices will last oil producers and investors were also not keen on investing. Finally, those mega oil companies with deep pockets were interested to increase free cash flow to reward their shareholders by increasing dividends.

Spare capacity

The even bigger unknown factor was the real ‘spare capacity' of the OPEC-plus. Based on IEA’s assumption spare capacity of 9 million barrels per day (mmbd) at the beginning of 2021, some have estimated to be just 6 mmbd. In the event, it appears to be even less. OPEC+ is not known for maintaining quota discipline. Despite demand exceeding supply and excess oil inventory declining, OPEC was not in a hurry to open the tap. They stuck to their original decision to increase production. Not only did most members maintain quota discipline, some could not even meet their allowable limit.

Despite the pressure/request by the US president to OPEC and especially to Saudi Arabia to increase supply, oil futures which always overreact to such political pressure, prices have been increasing. This is also another indicator that there are supply constraints. It is a well-known fact that oil production in old wells declines every year by 3-5% and much more for shale oil. IEA has been warning of this natural phenomenon as an investment in oil and gas has been declining in recent years and especially since the pandemic. This might be another factor for production capacity decline both in OPEC+ and also in other countries since investment in the oil industry has declined substantially during the last six years.

It was IEA that had urged the oil industry not to invest any more in new oil and gas exploration just a few months back. Now IEA is suggesting that OPEC+ needs to produce more. Such mixed signals create even more uncertainty and problems as energy transition gets momentum. Currently, we are just in the beginning stage of the energy transition with renewables meeting a small percentage of the power requirement. As renewables start dominating as is predicted in the latest IEA world energy report, the problem will get even worse unless we prepare better to balance the electrical grid.

For India, where energy transition is only in its infancy, there is even greater urgency to have the best experts to prepare to manage future energy crises. In fact, in the current situation of a considerably smaller role for solar and wind (less than 4%), India should not have faced an energy crisis of low coal stock. The current crisis is the result of mismanagement by the government at the Centre and states. To avoid a more complex future energy crisis, the government should seriously consider merging all energy-related ministries like petroleum, coal, renewables, and power to have just one energy ministry.

(The writer is a former governing council member of Manipal Institute of Technology, and an international oil expert)

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