THE FAILURE OF SUCCESS AND THE FAILURE TO GOVERN: ‘REST OF THE WORLD’ AS CULPRITS FOR OIL INFLATION
Atul Sood
The claims of the mainstream media that India and China are culprits for oil price increase has little substance and attempts to hide the role of speculators and financiers on whose behalf the global economy is being run. The Indian government could easily cut oil duties and raise income tax and thereby share the burden of oil price increase either with corporate India or the large Indian consuming middle classes. The threat of bringing the government down in India, on oil price increase, mostly by the left parties, defies logic, especially when, bulk of the rural population and poor households still depend on their energy needs on solid fuels; the increase in oil and related product price is more of a concern for the upper income groups and that too in the urban areas. The real challenge then is to convert the fight against oil price increase to a fight for access to cleaner and efficient energy for the poor households.
Oil is skyrocketing in direct response to the basic laws of supply and demand, says Globe and Mail (Toronto) in its write up on June 24, 2008 in an article titled Oil has us under a barrel, and we’re not getting up. This is not a new story. On a trip to the Mideast over the weekend in early June, U.S. Treasury Secretary Henry Paulson said there is “no quick fix” to high oil prices because it is an issue of supply and demand. The New York Times in its June 10, edition tells us the same thing and puts the onus on anything other than the western world, exactly like the Globe and Mail.
This is a new dimension to India and China’s growth, so far there was talk of their large markets and how the growth was leading to rising incomes in these countries, how there was decline of poverty and therefore the new market mantra was panacea for the poor and so on. The current explanation for oil inflation (President Bush has also accused the changing food habits (read as eating better food) in these countries as a cause for the food inflation) implies that both the success and failure in the non western world is a problem. The failure of governance in Middle East and Africa, and for India and China it is the failure of their success. How far is this true? What does the reality of demand and supply tell us?
Production – Shares: The global oil production is dominated by OPEC and OECD, together they provide close to 70 percent of the global production. The data also shows that the shares of the OPEC and OECD have declined after 2000, and the share of former Soviet Union countries has increased. India and China are marginal players on the supply side. If we look at the changes to oil supply in the last 8 years it is clear that the largest decline has come from OECD countries, even though there are sharp year to year variation in the oil production from various sources. OPEC has marginally reduced its supply in 2007. Before that, for four years, it increased its production.
Consumption of Oil: What has happened to Oil Consumption? If we examine the world demand, it has not grown exceptionally in the last many years, except in 2004, when it grew at 3.86 percent. Other than that, the global demand in oil has grown on an average by around one percent. The 2004 consumption change, perhaps, did come from China, since its demand grew by 9.82 and 17.35 percent in 2003 and 2004 respectively. In the last three years, there is nothing exceptional that has happened that explains the doubling of oil prices.
So if the change in demand is not very significant in the last few years, has the source of demand changed? If we look at share in demand from different countries, it is clear that there is a decline in the demand from OECD countries, though they still consume around 57% of the global oil. The former Soviet Union, countries are producing more but consuming less. Their share has declined from 13 percent to five percent and the share of emerging economies has increased, by about five percent in the last 17 years. China’s share has increased from 4 percent in the early 90s to a little less than 10 percent. As a consumer India is still an insignificant player in the global oil market, consuming only around 3 percent.
To put the comparison in perspective, China’s oil consumption is little less than one third of the US consumption (7,855 and 20,698 out of a total of 85,220, 000 barrels/day (bl/day), India is sixth largest consumer of oil just above Canada (2,303 bl/d) and consumes 2748, 000 bl/day which is little 13 % of the US consumption. In per capita terms India is 149th in the list of 193 countries and China is128th. Canada is 13th and US is ranked the 15th largest consumer of oil in the world, Singapore is the 3rd highest ranked.
It is quite unclear on the basis of production statistics, consumption share, growth in consumption, demand projections and per-capita oil consumption how India and China’s growth is responsible for the price increase. Is there some other battle being fought here? The supply-demand debate stands thoroughly exposed in other ways. The OPEC has its 2008 global oil demand growth forecast unchanged at 1.2 mm bpd, as slowing economic growth in the industrialized world is offset by slightly growing consumption in developing nations.
Some people argue that by 2011, some 25 countries, will have reached the point at which further declines in production are essentially inevitable. This by no means points finger at the emerging economies, if the planet earth is living beyond its means, then the development paradigm itself has to be questioned, not the ‘relentless’ growth in emerging economies.
Oil Price and Oil Futures: It is interesting to note that over the last five years for which demand from India and China is used as an explanation for price increase, for the same five-year period, speculators demand for petroleum futures has increased by 848 million barrels. The increase in demand from speculators is almost equal to the increase in demand from China!
The key exchange in the game is the London ICE Futures Exchange (formerly the International Petroleum Exchange). Even, the June 2006 US Senate report, The Role of Market Speculation in Rising Oil and Gas Prices, hints at the role of speculators and financiers, ICE was focus of a recent congressional investigation. It was named both in the Senate’s Permanent Subcommittee on Investigations’ June 27, 2006, Staff Report and in the House Committee on Energy & Commerce’s hearing in December 2007 which looked into unregulated trading in energy futures. Both studies concluded that energy prices’ climb to $128 and perhaps beyond is driven by billions of dollars’ worth of oil and natural gas futures contracts being placed on the ICE.
Financial Times in its June 23, 2008 edition reports that ICE has been the target of criticism in the US in recent weeks, accused of enabling traders to manipulate oil markets and push up prices by taking large positions on ICE Futures Europe, its London-based subsidiary. About 15 per cent of all futures trading on the benchmark West Texas Intermediate contract takes place on ICE Futures Europe. ICE Futures Europe is regulated by the Financial Services Authority, the UK watchdog, rather than its US counterpart, the Commodity Futures Trading Commission. Last week, five US senators introduced the Close the London Loophole Act.
What these reports are hinting at is the role of futures markets in oil in the current price rise. The bulk of activity in commodity futures markets is typically concentrated on oil for delivery in the next three months. However, in the past five years, activity has increased substantially for deliveries much further into the future as more investors put money into commodity indices.
Bonds of Oil: The debate on “Subsidized’ Price of Oil in India: Contrary to the popular understanding oil products are not subsidized in India. The oil price scenario plays itself out quite differently than the rest of the World. The government imposes taxes on the retail selling of price of fuel that increases the selling price of fuels. But then the government intervenes in the market to artificially restrict the price of oil, to protect the consumer, and then compensate the companies financially, which have been compelled to charge a regulated price. The government borrows this money to pay the financial companies by issuing oil bonds that the government owned banks, LIC and UTI like public institutions are forced to buy. These public institutions compensate themselves, for being compelled to provide funds to the government, by either charging higher rate of interest for the loans they issue or by giving lower returns to investors who invest in these public institutions or by charging higher premium on insurance policies. So indirectly the burden of providing oil at less than the market prices to the consumers in India is shared by those who borrow from government owned banks, invest in UTI or buy insurance from Life Insurance Corporation. This is a peculiar way of taking the money from one pocket and putting it into another.
Tax on oil contributes a lot to the Central and State exchequer. The Report of the Committee on Pricing and Taxing of Petroleum products, Government of India, in 2006 identified customs duty, cess, excise duty, corporate tax, dividend, tax on dividend as major contributors to central exchequer from oil. For the State exchequer the main sources of revenue from oil are sales tax, royalties, dividends and Octroi duties. The committee reported that these collections were nearly 30 percent of indirect taxes collected by state and central government and more than 20 percent of the total tax mobilization by the government, something of the equivalent of about 3.5% to 4% of GDP is earned by taxing oil. Very recently the government of India has reduced the customs and excise duties.
If the oil companies were permitted to use the bonds to settle their tax dues, the subsidy would cancel out the tax receipts, bringing out the absurdity underlying the entirety of administered oil pricing. Also, the bonds issued by the government have few takers in the secondary market given the yield rates. The appetite for these bonds was particularly low among institutions as till recently the bonds were not eligible for Statutory Liquidity Ratio (SLR) status. SLR is the percentage of liabilities or deposits commercial banks have to park in approved instruments. SLR-eligible instruments like normal government bonds carry lower interest rates. Oil companies which have been experiencing huge losses have managed to remain in the black thanks to the oil bonds.
The Way Out from the Oil Bonds: What can the government do under the current situation? The Committee on Pricing and Taxation of Petroleum Product by Government of India in 2006 was formed exactly for this purpose. However, the Committee undertook decision based on some principles that completely ruled out its capacity to find meaningful solutions. Solutions such that the principle of protecting the poor from sharp oil price increase is fulfilled. After all, after the AMP removal 2002, the government had intervened in the market on behalf of the poor. The Committee followed the principles to minimize if not eliminate distortions and inefficiencies that result in misallocation of resources; minimize subsidies; ensure that the burden of subsidies should be borne entirely and transparently in the Union Budget; free oil marketing companies from the burden of subsidy and rationalize Custom tariffs on crude and products and adjust excise tariffs to protect the consumers from excessive volatility in prices. The framework of the committee was basically to sort out market distortions rather than think of alternatives to meet the oil price increase challenges in an environment where the growth experience of last 15 years in India has been highly unequal. The accelerated development is not leading to an improvement in the living conditions of vast majority of men and women. How else can we explain, that combined assets of our dollar billionaires being second to the billionaires in America. In August 2007, the Arjun Sengupta Committee reported the deeply disturbing figure of 836 million Indians – that is over 75% of our people, “the poor and the vulnerable” – surviving on a daily average expenditure of under Rs. 20 a day. This means we have hardly had inclusive growth. That there has been some improvement is undeniable but the rich have infinitely got richer and the poor have definitely got poorer (see Governance and Development Report India, 2007). It is such inequality that compels the popular governments to talk of inclusive growth, the ‘Aam adami’ ( a phrase used by the Indian Prime Minister while addressing the nation; it means common masses and has been used with some sarcasm! Ed.) and be compelled that they be seen intervening on behalf of the poor.
In the case of the oil price increase the government is intervening, in the name of the poor, but as argued above and established below, it is intervening in an ‘in effective’ way. The right intervention can be found if we are not obsessed with markets, with supply and demand, with correcting inefficiencies but be more upfront and direct about protecting the poor. There are a few directions in which the government could go in the current milieu where the oil companies are soon going to run out of cash in order to ‘protect’ the poor. To begin with the government could choose to do nothing and let the problem aggravate. Doing nothing is also something and it is a common occurrence. This would let oil companies’ losses reach other public sector entities, followed by an economy wide funding crunch, higher rates, and a slowing economy. Alternatively, the government can issue more oil bonds and continue to hide the actual level of fiscal deficit. Also, the government can cut excise and/or custom rates, something that it has marginally done in the recent weeks. Such tax cuts could raise the fiscal deficit, not hide it, and in one way solve one of the main problems associated with oil bond issuance for the ‘deficit obsessed’ economists. The efficiency obsessed regimes will not defend the last two actions for long, since they believe that increased fiscal deficits will universally cause future inflation, crowd out the private sector and lower return for financial sector. Finally, the government could cut oil duties and raise income tax to contain fiscal deficit. This would simply be a reallocation of higher oil price induced losses to corporate India and/or consumers with additional taxes of up to 10% to 20%. Affected parties’ tax bills would go up, which may slow growth.
It is the last option which is the most appealing and fair. It will at least ensure that the burden of oil price increase at least is being shared with either corporate India, which in the last ten years has benefitted a lot from the growth boom or the large Indian consuming middle classes, who in any case consumes a much larger proportion of energy compared to the other lower and poorer classes. The threat of re-regulation, that such an action may create, in any case is a misnomer because all market economies are regulated in spite of claims to the contrary. The slowdown in growth, I think, is the only negative outcome of choosing the fourth option, but then who cares about growth per se? Whose growth is it anyway? It is the nature of growth that is more important than just growth. It will not be wrong to say that growth has deepened disparities and divides in the last 15 years in India.
Economic Affluence and Energy Consumption: India and China, account for almost two fifths of the World’s population, but less than one-fifth of the world’s primary energy use. Despite their formidable growth in recent years, in both countries, poverty and lack of access to sufficient amounts of clean and efficient energy sources to meet demand in full remain serious concern and challenge in both countries. Both countries have experienced a tripling of primary energy consumption over the last twenty five years. However, per capita energy consumption still remains low in both countries, particularly in India. Given this unequal energy consumption between India and China on one hand and the OECD on the other hand, one wonders how fair it is to ‘accuse’ India and China for the current energy crisis.
Price increase in general affects the poor more adversely than the other social classes and therefore any price increase puts additional burden on the poor. However, given the singular opposition that the India left has adopted to oppose its partner in the government, the congress party, makes one wonder is something unique in oil price increase that makes the congress party more of an anti poor party, which it is anyway on hundreds of other parameters. What is unique in the consumption pattern of oil that makes a special issue for the poor? India and China are still far away from reaching global standards on energy consumption, including oil. And the pattern of economic affluence and energy consumption in both India and China reveal that bulk of the rural population and poor households still depend on their energy needs on solid fuels and battle against oil price increase is more for the middle and upper income groups and that too in the urban areas. This is true for both India and China.
(June 18, 2008)
(Atul Sood is a Visiting Fellow at Concordia University, Montreal and Associate Professor at Jawaharlal Nehru University (JNU), India; atulsood@mail.jnu.ac.in; atulsood61@gmail.com)