India Widens Its Oil Basket As US Begins Exports, But Energy Security Still Hinges On West Asia

On October 2, as the nation celebrated Gandhi Jayanti, a cargo of 1.6 million barrels (about 225,000 tonnes) of US crude oil was received at Paradip port, making it the first import of American oil by India. The political importance of the occasion was underscored by the presence of senior Indian and US officials at the port and the circulation of a press release by the Ministry of External Affairs that highlighted the significance of the event for bilateral relations.

The press release spoke of “a new chapter in the history of Indo-US trade” emerging from the “strategic partnership of global significance” that was shaped during Prime Minister Narendra Modi’s visit to the US in June 2017.

 The contracts to supply Indian refineries were signed within a month of the visit and involve the total supply of 7.85 million barrels (about one million tonnes) to three Indian government companies in the coming months. The statement recalled that Indian companies have invested $ 5 billion in acquiring assets in the US’ shale oil and gas industry and will also be buying US shale gas to be delivered early next year. The release felt that these imports would promote price stability and India’s energy security.

The supply of US crude oil to India is part of larger convulsions in the global hydrocarbon industry caused by the shale revolution in the US which has led to the extraction of unconventional oil and gas through fracking i.e. cracking shale deposits deep underground with a combination of highly pressurised fresh water and chemicals. Though this technology is over seventy years old, it became commercially viable only early this century when oil prices went over $100 for a barrel, since the cost of production of shale oil was around $ 85-90 a barrel in those early days.

Turmoil in energy markets

Shale oil made the US, its largest producer, self-sufficient, leaving the global oil market with a huge surplus. US domestic production went from a low of 5 million barrels per day (mbd) in 2008 to 7.7 mbd in 2013, and reached 9.4 mbd in 2015, just short of its peak of 9.6 mbd in 1970.

 In December 2015, the US Congress also removed the 40-year ban on exports of oil by the US. This, coupled with an economic downturn in the US and Europe and reduced imports by China, due to shifts in its domestic economy from manufacturing for world markets to a new focus on improved quality of life for its people, meant that the global market had a surplus of about a million barrels per day of crude oil. This brought about a dramatic plunge in oil prices that went from over $ 100/ barrel in June 2014, to $ 60/barrel in June 2015, and hit a low of $ 26.55/b in January 2016.

First responses to these developments were equally dramatic: member countries of the Organisation of Oil Producer Countries (OPEC) decided to maintain production to defend market share and ease high-cost producers (i.e. shale oil producers) out of the market. While prices continued to fall through 2014 and 2015, several rigs producing shale oil ceased operations.

But, over the months, the OPEC strategy did not seem to work since shale operations had become much more efficient, bringing cost of production down quite significantly. Again, even shale operators in relatively uneconomical fields thought of continuing operations in anticipation of higher prices, since shutting down and then re-starting would have been much more expensive.

This situation, in November 2016, finally led OPEC to work with major non-OPEC producers that were badly hurt by low prices to cooperate to reduce production. This agreement has withdrawn about 1.8 mbd of oil from the market and has boosted prices: in August this year, the price of Western Texas Intermediate (WTI), the US benchmark, was $ 52/ barrel, four dollars more than the price in July. Analysts project that prices will average $ 51/b in 2017 and $ 52/b in 2018.

Indo-US energy cooperation

This upward swing in prices has boosted US shale oil production and made the US a major competitor for traditional West Asian producers for different grades of oil. The US has maintained production at around 9 mbd, and is expected to reach 9.3 mbd in 2017 and 9.9 mbd next year.

 The US is also steadily increasing its exports. Thus, even as OPEC and its non-OPEC partners withdrew 1.8 mbd from the market, the US exported a record 1.3 mbd at the end of May this year. Since US producers are comfortable with prices at around $ 50/barrel, they have emerged as strong competitors to West Asian producers in the Asian market with 40 percent of US exports finding their way into Asia this yea.

This thrust towards Asia has a political dimension as well. At the end of June this year, Trump declared, with characteristic rhetorical flourish, that his administration would make the US “energy dominant”, a variation on the consistent presidential theme of making the country energy independent.

Energy Secretary Rick Perry explained this new concept thus: “An energy dominant America means self-reliant. It means a secure nation, free from the geopolitical turmoil of other nations who seek to use energy as an economic weapon. An energy dominant America will export to markets around the world, increasing our global leadership and our influence.”

This statement makes it clear that, on par with defence purchases, buying of US oil and gas will the route to earn the goodwill of the Trump administration. The president conveyed this quite clearly to Modi during their meeting in June, when the two leaders agreed to pursue “a fair and reciprocal trading relationship”, with special focus on the energy sector.

Modi responded with the three quick contracts in July. As the first oil cargo was loaded in August, Trump called Modi to welcome the first shipment and to assure the prime minister that the US will “continue to be a reliable, long-term supplier of energy”. US officials have gleefully announced that the value of the bilateral oil trade could be as much as $ 2 billion. Indian diplomats have spoken of “new vistas” being opened in bilateral ties.

Market forces at play

However, regardless of the political significance of the deal and the accompanying enthusiasm of diplomats, Indian oil executives have emphasised that they are only motivated by economic considerations. It should be noted that the crude being imported from the US is not shale oil, which is sweet and light and expensive, but conventional sour, moderate sulphur crude, Mars and Poseidon, that is similar to crudes imported by Indian refineries from Gulf sources.

This US crude has for now become competitive vis-à-vis the Gulf crudes due to the prevailing market conditions: production cuts by OPEC (with some non-OPEC partners, including Russia) have boosted the benchmarks, Brent and Dubai, in which Gulf crudes imported by India are designated; in fact, the price gap even makes up for the higher cost of shipping the crude from the Gulf of Mexico to the Odisha coast, so that the price differential, with a possible discount, made the landed cost of the US crude comparable with the cost of the Gulf crudes.

This situation could continue for a little more time: Hurricane Harvey knocked out about 4 mbd refining capacity in the Gulf of Mexico coast; though this capacity is slowly being restored, crude stocks have been built up, leading to a price differential of as much as $ 6/b between WTI and Brent, making US crudes quite economical for Asian (and Indian) buyers, despite the transportation cost factor.

Not surprisingly, Indian oil executives see purchase of US crude as a “trial run”, with purchases only to be based on competitive tenders rather than long term contracts of the kind they have with established Gulf suppliers.

Prime Minister Narendra Modi being greeted by King of Saudi Arabia Salman bin Abdulaziz Al Saud in April 2016

India’s energy security

India is the third largest consumer of oil globally, and imports most of its requirements: in 2016-17, India imported 214 million tonnes, 5.4 per cent more than last year. The International Energy Agency (IEA) has said that by 2040 India will be at the centre of the world energy scenario, with its energy demand being close to that of the US, mainly on account of surging demand for new infrastructure, electricity and transport.

In terms of the country’s long-term scenario, the draft national energy policy document recently circulated by the Niti Aayog indicates that, despite the focus given to renewables in the report, the share of fossil fuels (coal, oil and gas) largely remains the same in the period under consideration: it moves from 81% in 2012 to 79.4% in 2040 (Ambitious); its share is higher at 85% in the “Business as Usual” (BAU) scenario in 2040. The share of coal hovers between 46-50% for most of the projected period, becoming 44% only in the “Ambitious” projection for 2040. The share of hydrocarbons (oil and gas) also remains the same through this period, hovering around 35%. 

The report sets out the country’s fossil fuel demand over the review period (2012-40) as follows:

(i) Coal moves from 282 million tonnes of oil equivalent (mtoe) to 725 mtoe in the “ambitious” scenario;

(ii) Oil moves from 166 mtoe to 420 mtoe; and,

(iii) Gas moves from 43 mtoe to 112 mtoe.

 More importantly, with all the effort being made at increasing domestic energy production, pursuing conservation and efficiency policies rigorously, and increased use of renewables, India will remain import-dependent in respect of fossil fuels, with hardly any difference in the present and the scenarios in 2040:

(i) oil imports will be between 81-90%, with 86% in the “ambitious”  2040 scenario

(ii) coal imports are between 15-51% in different scenarios, with 26% import dependence in the “ambitious” 2040 projection, and,

(iii)gas imports range widely between the BAU and Ambitious projections, standing at 20% in the “ambitious” 2040 scenario.

West Asian supplies will be central to India’s quest for energy security. OPEC suppliers, dominated by West Asian producers, account for 40 percent of world production, as against the US share of 14 percent. As US shale production will start reducing from the mid-2020s, OPEC producers will expand their share in the world market, and will account for 70 percent of supply growth by 2035 (9 mbd to a total of 48 mbd); US supply growth during this period will be 4 mbd, largely in the early period.

In 2035, the share of West Asian producers in oil supply will be 35 percent, as against 18 percent for the US and 11 percent for Russia. It should be noted that the cost of production in the Gulf is about $ 7-10/b; in the North Sea and the Arctic it is between $ 21-45/b, while shale oil production in the US is $ 51/b.

In 2015, the IEA, in its India Energy Outlook for 2014-40, had projected the following:

(i) India’s crude oil demand in 2040 would stand at 7.2 mbd;

(ii) India would import over 90 percent of its requirements, mainly from the following sources (reflecting its attempts at diversification of supplies):

(a)  West Asia: 63 per cent

(b) Africa: 11 per cent

(c)  Latin America: 11 per cent

(d) North America: 10 per cent

(e)  Others: 6 per cent

The conclusion is unavoidable that supplies from the US represent an attempt at diversification based entirely on market conditions and have little to do with India’s energy security interests. The latter will remain tied to the Gulf, and India will continue to have an abiding interest in Gulf security and stability. In fact, India’s stakes are so high in terms of its long-term well-being that it should be a role-player in promoting regional security through its diplomatic effort. This is more important and urgent than seeking engagements with marginal suppliers 25,000 kilometres away.

(The author, a former diplomat, holds the Ram Sathe Chair for International Studies, Symbiosis International University, Pune.)