Cheap oil and strategic reserves

The government should capitalise on current low prices to enhance energy security

December 07, 2014 10:12 pm | Updated December 04, 2021 11:29 pm IST

The Bryan Mound strategic petroleum reserve in Texas, one of four such storage facilities in the U.S. File photo

The Bryan Mound strategic petroleum reserve in Texas, one of four such storage facilities in the U.S. File photo

The sharp slide in global crude oil prices has raised the spirits of the country’s policymakers. Sticky economic problems ranging from ballooning subsidies to unbridled inflation have all been solved by the 40 per cent fall in Brent crude prices between June and now. The cheaper oil prices now present an opportunity for the government to reform and revamp the energy sector; it is also an excellent chance to build up our strategic storage, which is now next to nil. India relies on imports for almost 80 per cent of its oil needs.

To provide a bit of background, India had conceived of a strategic petroleum reserve as far back as in the late 1990s and after several committees and studies, the project to build a strategic storage for crude oil was given the go ahead early in 2004 by the NDA government. The plan was to build storage capacities in three places — Mangaluru and Padur (near Mangaluru) on the west coast and Visakhapatnam on the east. With a total capacity of 5 million tonnes, this storage was estimated to cover two weeks’ requirements. A special purpose vehicle — Indian Strategic Petroleum Reserves Ltd. (ISPR) — was floated under the Oil Industry Development Board to implement the project. So far, so good.

The problem started when the UPA government, which assumed office soon after, decided to review the strategic storage plan and precious time was wasted in further studies by the Planning Commission. To cut a long story short, a decade after the project was initiated, not one of the three planned storages has been completed till now. Costs have, meanwhile, escalated and the opportunity to secure the country’s energy supplies has been squandered.

Petroleum Minister Dharmendra Pradhan announced in Parliament in August that the first of the three, at Vizag, will be ready for filling by the end of this year with the other two expected to be ready by mid-2015. Taking the strategy forward — and rightly so — Mr. Pradhan has said that four more strategic storages would be built in Bikaner, Rajkot, Padur and Chandikhole in Odisha. These will have a combined capacity of 12.5 million tonnes and take the storage to 90 days’ equivalent of consumption by 2020. This is in addition to commercial storage of crude and petroleum products of about 30 million tonnes (about 70 days’ needs) available with the oil companies at any given point in time.

It is heartening to see that the strategic storage idea is receiving fresh attention under the new government. Yet, the challenge of implementation is stiff. These storages are built in underground natural rock caverns through excavation. Funding and building these caverns is a relatively easier challenge than filling them up. Remember, the oil stored in these reserves will be stocked and not consumed which means that the cost of financing will be huge. Only the government can conceivably fund this storage as there is unlikely to be a viable commercial model for private developers to exploit.

This is where the falling oil prices come in. The cost of filling up these caverns is 40 per cent lower now at $68-70 a barrel compared to just six months ago when Brent crude averaged $115 a barrel. If the project had not been delayed, the country could have benefited by filling up the caverns now at the prevailing cheaper prices. But the opportunity is not lost yet. If analysts and experts are to be believed, the low oil price regime is projected to continue well into the next calendar year. With demand well short of supply and the OPEC in no mood to cut back on output, oil prices appear headed further south. A recent study by consultancy IHS of new shale oil producing wells in the U.S. shows that they will be competitive even at oil prices as low as $55 a barrel which means that this will be the new base for the market to test.

The government still has the window to exploit if it is able to complete the ongoing three storage projects expeditiously and starts filling them up. But the wall that it will run into is: how to fund the crude oil purchase? A quick calculation will show that filling up the entire 5.3 million tonnes capacity at current prices will cost about $2.73 billion.

That is but a fraction of the $143 billion that the country spent on oil imports in 2013-14.

Yet, how does one fund this? And what about the upcoming four new storages that are being planned which will mean another 12.5 million tonnes of crude oil? That will cost another $6.43 billion at current prices.

Innovative thinking will help

This is where some innovative thinking will help. With supply running well ahead of demand in the global oil markets and producers, notably OPEC countries, reluctant to turn off their taps, the capability to store crude oil will be an important factor in determining the resilience of oil producers in riding out the current price slump.

There have been instances in the recent past when some producers such as Iran commissioned very large crude carriers (VLCC) to act as floating storage to ride out temporary market difficulties.

With some shrewd thinking, the government can strike a deal with one or more oil producers on mutually beneficial terms to offer the newly built caverns for storage. Indeed, Mr. Pradhan did recently hint of such a thought in government when he said that a part of the storage capacity could be leased out to a couple of Gulf producers.

In addition to this, the government could weigh a special cess on petrol and diesel or impose a small import duty of 5 per cent on crude oil to fund the reserve build-up. This is easy to do in the current environment of soft prices without inflicting pain on consumers.

To be sure, building up the reserves is not an exercise that can be completed tomorrow. The United States built up its 727 million barrels of strategic reserve gradually over two decades.

China, which boasts of 170 million barrels of strategic reserve, has been at the exercise for a decade now and is expanding it further. What is required though is planning and shrewd execution. The present low oil price regime presents the government with an excellent opportunity that should not be missed.

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