Reforming India’s Energy Policy

Sunjoy Joshi

OP-ED MAY 20, 2014

India’s policymakers are fond of defining the country’s energy security in terms of three As: availability, access and affordability. However, the three As appear at increasing risk in the face of four formidable barriers: energy subsidies, systemic management inefficiencies, competition from a resource-hungry China and climate change.

What makes these barriers even more daunting is the recent emergence in public discourse of a misplaced debate regarding the ownership of natural resources, which has hamstrung the country’s ability to frame long-term policies to help harness its energy potential.

Securing energy supplies for Indian citizens therefore is set to be a tall order for the new government.

ENERGY SUBSIDIES

India’s energy subsidies represent a significant portion of its budget. The government spends roughly $25 billion on fuel subsidies, $7 billion on electricity, and $10 billion on fertilizer. One of the justifications given for subsidies is to increase fuel availability to the least empowered. However, regardless of the billions spent on subsidies, modern fuels remain a privilege limited to a few. National Sample Survey data for 2011-12 reveal that despite claims of increased penetration of modern cooking fuels, such as liquefied petroleum gas, 70% of rural households still use biomass.

Guaranteeing access and affordability are also arguments advanced for energy subsidies. However, price controls have failed to expand supplies and services, and rather ended up diminishing both access and affordability. Diesel-fuelled sport-utility vehicles of the super-rich romp on city roads while farmers struggle to run their pumps. Access to electricity remains directly proportional to per capita spending—the poorest decile, constituting 40% of all households, still use kerosene to light their homes. Rather than enhancing energy security, subsidies, by interfering with markets, are putting the three As at risk.

SYSTEMIC INEFFICIENCIES

Contrary to popular perceptions, India is not a resource-poor country. It contains the world’s fourth-largest coal reserves, its thorium supplies are practically limitless, potential solar power is particularly abundant, and its 3.14 million sq. km of sedimentary basins have not been even moderately explored, though most of these are deep offshore. India’s problem is one of management rather than scarcity.

The management challenge is best understood by the deficiencies in the coal sector. Coal is India’s single biggest fuel source, accounting for half of the country’s total energy use and producing two-thirds of its electricity. Estimates are that the country has enough coal to last for the next 100 years. However, environmental clearances, land availability and evacuation constraints restrict access to huge swaths of coalfields, halving its extractable reserves. Meanwhile, the state-owned Coal India Ltd, which supplies over 80% of India’s coal needs, has struggled to raise output and meet supply commitments. In 2012-13, coal shortages of 165 million tonnes affected the availability of power. Power plants dependent on imported coal suffered because of highly volatile international prices.

India’s 12th Five-Year Plan focuses on means to curb the country’s coal dependence, but alternatives also have issues. Gas price controls, dismantled in 2002, were reintroduced and extended in 2007 to encompass private producers of domestic gas. A complex system of quotas and allocations has returned to haunt the sector. Simultaneously, gas imports are limited by lack of infrastructure. India has yet to build its first transnational gas pipeline, and with the Indian gas market at the mercy of policymakers, investors are wary of investing in liquefied natural gas facilities or pipeline infrastructure. Hydroelectric, nuclear and other renewable energy sources comprise one-third of the current installed power capacity, but numerous issues limit their contributions. Hydropower plants have low load factors, for example. Wind capacity grew by only about half the targeted amount after the government withdrew accelerated depreciation and generation-based incentives. Although the US-India civil nuclear agreement boosted the capacity of nuclear plants, the sector’s growth has been held to ransom by what’s commonly known as the nuclear liability law. Foreign equipment suppliers are worried that this law places a disproportionate legal burden on them in the case of an accident.

GREAT WALL OF CHINA

At about the middle of the past century, India and China were at identical points along their development and demographic trajectories. In 1965, China’s primary energy consumption was about two and a half times that of India’s. But an explosion in China’s heavy manufacturing capacity fired by its export-led growth made it the world’s largest energy consumer by 2011.

India’s growth over the same period skewed towards services, so its demand for energy rose at a far more moderate pace. Still, it needed to scour the world for resources—and increasingly hit the Chinese wall.

China acquired assets from under India’s nose in locations as diverse as Angola and Kazakhstan. China also diversified its supplies to encompass Central Asia, Russia, and Latin America. To insure against the risk of supply disruptions through the Strait of Malacca, China committed to developing the Gwadar Port in Pakistan and a gas pipeline in Myanmar. And China put a substantial offer on the table for the development of Iran’s Chabahar Port, for which India has also committed $100 million. By moving far more effectively to rationalize its price policies, China today is far better integrated into global energy markets while India meanders through repeated policy flip-flops.

CLIMATE CHANGE

From 1996 through 2006, India was one of the 20 countries in which emissions intensity (carbon dioxide emissions per unit of gross domestic product) had declined during the first half of the period as well as the second half. Obviously, the reason for this drop during India’s boom years was growth led by services rather than manufacturing.

Can the pattern be sustained? The business process outsourcing industry, the poster boy of India’s growth, accounts for a mere 2 million jobs in a country where 12-15 million enter the workforce annually. Over the next few years, the only way to employ millions of youths is to create more jobs in the labour- and energy-intensive manufacturing sector. If India succeeds in achieving this necessary goal, however, it would be hard to maintain the intensity of its emissions. Yet it has pledged to reduce emissions by 20-25% under the Copenhagen Accord of 2009.

OWNERSHIP OF RESOURCES

Under the planned economy model adopted post-independence, India gradually arrogated the responsibility for guardianship, extraction and conversion of fossil resources to the state. Thus the energy sector came to be dominated by gargantuan state companies and a host of smaller public-sector undertakings. Policy, legislation, rules and regulations were devised exclusively for state-led operations, leading to an incestuous relationship with parent ministries or departments of the government.

In the 1990s, lending institutions forced structural adjustments, which initiated a process of piecemeal reform in certain segments of this superstructure. However, a lack of fairness and transparency eventually led the Supreme Court to uphold the public trust doctrine. In short, this doctrine states that natural resources belong to the nation, and the government holds them in trust, in a fiduciary capacity, for the public good. Unfortunately, despite its intention to bring transparency into the allocation and use of natural resources, this principle has now become an excuse to stall much needed reforms.

India cannot discover, extract, convert and distribute resources without investment, technology and competition among companies in the private and public sectors—three things that only reform can bring.

WAY FORWARD

If there is any lesson to be learned from the piecemeal reforms that culminated in the Supreme Court’s rulings, it is that governments are poor and inefficient allocators of resources. Resources are best allocated by markets, rather than doled out through policy guidelines, which, straddling half a dozen ministries and a Planning Commission, can at best be suboptimal compromises.

To that end, policymakers must direct their support to consumers and not waste time on administering subsidies by interfering with markets. Some experiments with direct transfer schemes have begun, however, a quicker pace and far more efficient processes are needed.

Over the next 20 years, India’s dependence on coal will continue. Therefore, it is necessary to expand production capacities by allowing private participation. Given the right mix of incentives, market forces will usher in new capital and technologies for fuel extraction, carbon sequestration, and gasification.

Natural gas has been and is expected to continue to be available at a significant discount to oil. Therefore, government policy should allow market-led substitution of oil by gas. As for renewables, given low plant load factors, policy emphasis and incentives must shift to generation rather than the addition of capacity.

Although renewables will play an increasing role, they will have limited utility for base-load generation. Therefore, nuclear energy must be a viable option. The ambiguities with regard to equipment supplier liability that have crept into the Nuclear Liability Act must be resolved. Although the executive may issue ingenious guidelines to clarify the law, Parliament is the only constitutional body that can amend the legislation. India’s energy landscape may continue to be dominated by strong national energy firms, but an efficient and technologically robust public sector is best created through competition with a strong private sector. That can happen only if the government ensures a level playing field when it comes to policy and regulation.

A public sector that is expected to pick up the tab for the government’s redistributive largesse can never be competitive or have the financial ability to develop solutions to India’s unique challenges. The treatment of state-owned companies as patronage distribution networks that work to stall reforms must cease. With the expansion of energy markets imminent, India must become the nerve centre for innovation rather than a mere market for others.

Finally, a key failure of India’s half-hearted reform process has been the lack of strong and independent regulatory institutions. Organizations such as the Petroleum and Natural Gas Regulatory Board, the Central Electricity Authority, and the Tariff Commission have been unable to cut themselves loose from the apron strings of parent ministries. Regulatory authorities must be given the autonomy that ensures it is they who become the standard bearers of reform.

Sunjoy Joshi is the director of the Observer Research Foundation in New Delhi.

This is adapted from a chapter in the upcoming book Getting India Back on Trackedited by Bibek Debroy, Ashley J. Tellis and Reece Trevor. It will be published in June by the Carnegie Endowment for International Peace and Random House India.

This article was originally published by Mint.