Prospects for energy integration

Regional energy integration has long been a pie in the Southasian sky. And like other grand visions that fail to materialise, the blame for this lack of success has fallen on geopolitics. But the traditional vision for energy integration was impractical, regardless of geopolitics or trade barriers. It was based on the premise that the very existence of energy resources in each of the Southasian countries provided adequate incentives for trading. The quantity of resources available in the Subcontinent, however, is not great enough to justify the costs of transportation within the region. In fact, it is in this very inadequacy of resources that the key can be found to regional energy integration. All the of Southasia's countries would benefit by combining their much-needed energy imports and distributing power through a common grid. Luckily, the new economic and political landscape of the Subcontinent today makes this a real possibility.

These are prosperous times for Southasia. Since 2000, regional economic growth has consistently averaged well over five percent, in spite of the political uncertainty and conflict in many parts of the region. India has set a blazing course at over nine percent for this fiscal year. Growth trends also reflect a deepening in the shift from agriculture to services and manufacturing. Increasingly, services and manufacturing sectors are driving economic growth. Sustained economic growth and the change in who is driving it have altered the political constituency of energy markets. Demand now pits increased energy security against increased energy access. Southasian countries have some of the lowest per-capita commercial energy consumptions in the world, reflecting both limited energy commercialisation and low levels of electrification (see Figure 1).

Policymakers have typically sought to increase energy consumption through increased electrification, and almost all of the region's countries currently have an explicit policy of improving access to electricity. Both India and Bhutan have ambitious goals of electricity for all by 2020. Bangladesh's poverty-reduction strategy seeks to extend transmission lines to all villages. Pakistan intends to reach another 40,000 households within the next year. And Sri Lanka intends to electrify 75 percent of households by 2010.

Policies on improving energy access were created at a time when economic growth was much more modest, oil prices were lower, and it seemed as if there was always going to be enough resources to simultaneously meet the dual objectives of growth and access. Now, the rising cost of energy, the vulnerability of supply links and the increasing scarcity of energy resources mean that somebody will have to do without. The trade-off between energy-for-growth and energy-for-access has now become visible.

Energy shortages are seen as the key impediment to sustaining today's high levels of economic growth – particularly in services and manufacturing sectors that require uninterrupted energy supply. The need to secure supplies and enhance supply-infrastructure has created a new political constituency for energy demands that rallies around the need for energy security. While an approach to energy that emphasised access could tolerate gaps in supply so long as the supply-infrastructure exists, energy security requires uninterrupted supply. The emergence of energy security as a national objective in Southasian countries has thus reshaped the demand for energy away from the focus on domestic supply-infrastructure for improved access, and towards an increased security of supply.

The emphasis on energy security is best reflected in India's current global grab for energy. ONGC Videsh – a wholly owned subsidiary of India's largest oil and gas producer (ONGC) and one tasked with the sole purpose of acquiring productive assets abroad – has secured several oil and gas 'blocks' worldwide. The company has a mission to acquire 60 million tonnes per annum of equity oil and gas by 2025. India's overseas investment in oil fields is projected to reach USD 3 billion within the next few years. Several Indian companies, including Tata and Jindal, have sought to acquire coalmines in Indonesia and Australia.

Energy-security concerns of other countries in the region are reflected in their diversification strategies. Sri Lanka is making a concerted effort to de-link its energy sources from oil prices, and has announced a venture with India's National Thermal Power Corporation (NTPC) to build an imported-coal-based plant in Trincomalee. Pakistan has been aggressively seeking to utilise lignite deposits in its Thar region. To reduce its dependence on imported petroleum, Pakistan set up a 100,000 barrels-per-day refinery in collaboration with Abu Dhabi in 2000, and two more are planned. A liquefied natural gas (LNG) terminal is planned for Karachi in 2009. Many of these various proposed diversification strategies will no doubt fail to materialise. The important point, though, is that energy-sourcing strategies that seemed outlandish even a few years ago during the era of low oil prices now appear far more feasible.

Limited trade options
The economic case for regional energy trade based on distribution of energy resources has always been exaggerated, and is even less meaningful under the current demand for energy security. Reserves of primary fossil fuels – coal, oil and gas – are located in Bangladesh, India and Pakistan, with much of it concentrated in India (see Figure 2). Other than the coal reserves in India, known fossil-fuel reserves in Southasia are too small to have any trade potential. Indian coal is of poor quality, and transportation over large distances remains uneconomic. In many parts of India, particularly in the coastal south and west, higher-quality coal imports from Australia, Indonesia and South Africa are competitive against domestic coal transported locally. Furthermore, Indian coal production is already overextended and unable to meet even domestic demand.

Prospects for regional energy trade have traditionally focused on bringing hydropower potential from Nepal and Bhutan into India and Bangladesh. After the success of the 1020-megawatt Tala hydroelectric project in Bhutan, which sells electricity to North India, the potential for crossborder hydroelectric trading has often seemed great. What Tala has illustrated is that trading opportunities do exist for isolated projects that add a few hundred megawatts. But the scope for a larger plan to systematically tap the vast hydro potential of the rivers of Nepal and Bhutan in order to meet India's energy demands remains limited, for reasons discussed below.

India's demand for energy, growing at over seven percent annually and facing worsening shortages, can be divided into the long-term 'base-load' demands – which include those for the electricity required to serve the high-growth services and manufacturing sectors – and more short-period 'peak demand'. The base-load demand will largely be met by power generation from coal, supplemented by gas and possibly nuclear energy, once the Indo-US nuclear agreement becomes operational. The government of India's so-called 'ultra-mega' power-plant scheme, which seeks to push through the construction of five to eight coal plants of 4000 MW each, is an effort to meet base-load demand.

Hydroelectric power from Nepal or Bhutan, because it is based on less-predictable river flows, is unlikely to provide the energy security needed for meeting base-load demand. This in addition to the fact that hydro will typically be a more expensive option for meeting that demand. The lack of generation reliability from run-of-the-river hydropower plants also makes them poor candidates for peaking purposes; in order to meet peak needs, a plant must be able to switch on and off efficiently as needed. Storage hydro plants with reservoirs to manage the variations in river flows can serve as 'peaking' plants. The environmental impacts associated with building large storage dams make them difficult to build, however, and practically impossible to finance.

The absence of a transmission grid with enough capacity to bring hydropower from Nepal and Bhutan makes crossborder electricity trading even more challenging. Tala survives because of a dedicated transmission line that connects the plant to demand centres in North India. Only 150 MW of inter-regional transmission capacity currently exists between India and Nepal, though four new lines are currently on the anvil. Creation of a regional transmission grid has long been a key recommendation for improving crossborder electricity trade, and was again raised in the context of the meeting of SAARC energy ministers in Delhi in early March. Such a recommendation, however, misses the dynamics of energy demand. There are many options for transmission expansion in India: east to west, east to north, east to south, west to north and Northeast to north. Without clarity on how hydropower from Nepal and Bhutan would integrate into the Indian supply mix, the case for a regional transmission grid remains weak.

More likely than not, the status quo will remain. Hydropower projects in Nepal and Bhutan will be opportunistically developed in limited number. Dedicated transmission lines will be built to wheel power from these plants to load centres in India. Large-scale development, whereby the hydro potential of Nepal, Bhutan, and north and Northeast India is integrated to serve regional demand, remains unlikely at this stage.

Integration, not trade
With limited fossil-fuel reserves and constraints on integrating hydro potential, Southasian countries are likely to remain significantly import-dependent. Energy demand has been growing steadily, at over five percent for most fuel categories, in line with economic growth. Dependence on imported oil is likely to worsen, thereby decreasing the cost-competitiveness of many industries.

The good thing is that, for the first time, these countries appear to have conceded that energy-import dependence is here to stay. This is the first – and most difficult – step towards a realistic energy-management strategy. The challenge that remains is to figure out how to manage supply vulnerability and price volatility. This is precisely where the new opportunity for energy integration emerges. By pooling together their primary-energy imports, Southasian countries can achieve the scale that they need in order to manage sourcing and supply in such a way as to minimise price volatility and disruptions. 

India holds the key to the strategy of regional energy integration. Though all Southasian countries are projected to have high energy-demand growth rates, the region's most populous country commands a major share of regional demand (see Figure 3). The region's other countries are individually too small to achieve any scale for efficiency in management or for leverage in bargaining.

The three proposed crossborder natural-gas pipelines are largely predicated on Indian demand volumes. The Turkmenistan-Afghanistan-Pakistan-India pipeline, covering over 2700 km and projected to cost upwards of US 7 billion, needs Indian gas markets to make it work. Similarly, the Iran-Pakistan-India and Burma-Bangladesh-India gaslines will be made feasible by Indian consumers. Without Indian demand, these pipelines will not be able to carry sufficient volumes to be economic. Spur pipelines to neighbouring countries that branch from these proposed trunk-lines would be an easy way to provide the energy security that these countries so desperately seek (See Himal February 2007, "Waiting for neighbourhood gas").

India's pivotal role in regional energy integration is consistent with its growing aspiration to be a global energy-processing hub. The country already has close to 140 million tonnes per annum of refining capacity, sufficient to meet domestic demand for petroleum products. The planned expansion of several existing refineries will mean the consolidation of India's position as a net exporter of petroleum products. Indian private-sector refineries offer better margins than do those in Singapore and West Asia, and are targeting exports as their key growth strategy.

An integrated Southasian energy market, with India as the hub, could afford member countries the opportunity to be more ambitious in their energy planning. Earlier recommendations – including those for a regional strategic petroleum reserve, a pipeline grid for natural gas and other petroleum products, and regional power markets – put aside previously for being too audacious, could well become a reality.

Geopolitics of liberalised markets
This is not the first time that an opportunity for regional integration has come to rest on India's actions. And, if it remains unexploited, this will also not be the first time that an idea is discarded for just that reason. But today, a new geopolitics makes it likely that this opportunity will not be passed over. Southasian countries have implemented significant structural and regulatory reforms to allow for private participation in energy markets. At the same time, Indian liberalisation has produced corporate players keen to tap into these new openings.

Indigenous energy markets are slowly taking root in all Southasian countries. Private participation in power generation is now allowed throughout the region. This has attracted both domestic and international investments in several countries. Fuel exploration, production and retailing have also opened up to private participation. Bangladesh, India and Sri Lanka have been regularly distributing exploration and production licences to private companies for development of oil and gas fields. The liberalisation of energy markets has also been supplemented by structural reforms in many regional countries, aimed at reshaping loss-making public energy companies. Many vertically integrated utilities have been unbundled into separate functional companies, and almost all countries have plans to institute such restructuring.

India remains at the forefront of this liberalisation; except for coal, all of its energy sectors have been opened up. In many sectors – especially refining, petroleum retailing, exploration, production and electricity – energy markets have matured considerably. Liberalisation has been matched by structural reforms aimed at disinvestment, restructuring and corporatisation of public-sector companies. India's status as the forerunner makes it easier for other countries to connect with it during the process of regional energy integration.

Many of the emerging indigenous energy markets are still nascent, and will take time to mature. Nonetheless, these markets provide the essential framework that can circumvent government engagement and make it easier to manage the geopolitics. Some of this has already translated into tangible crossborder engagements. The transmission line connecting Bhutan's Tala hydro project to North India was the region's first successful public-private partnership of its type. Indian Oil operates in Sri Lanka, and is one of the largest retailers of petroleum products in the country. India's National Thermal Power Corporation has signed an agreement with Sri Lanka's Ceylon Electricity Board to develop the country's first imported-coal-based power plant. Tata made a foray into Bangladesh to develop an integrated steel-and-power facility that would have utilised local gas and coal resources, with much of the electricity produced intended for export to India.

Liberalisation has not only made it easier for Indian companies to penetrate neighbouring markets, but has helped other countries to solicit Indian partners without having to rely on the patronage of the Indian government. When Nepal recently opened up three of its largest hydro sites for bidding, it was flooded with offers, mostly from Indian companies. Such linkages allow smaller countries to develop commercial relationships directly with companies that are relatively removed from the political pressures of New Delhi.
India's growth and emergence on the world stage has also transformed the way Indian companies operate. These companies have rapidly internationalised to take advantage of opportunities abroad. International companies have also 'Indianised' to do business in India. Most multinational energy companies are now active in India, and use that platform to do business elsewhere in the region. Today, a country in Southasia seeking to do business with India has a plentiful choice of partners. For that country, the differences between an Indian energy company and an international one will be difficult to spot.

This new corporate environment provides the most promising basis for regional energy integration. It offers corporate governance and business ethics more consistent with international standards. It provides Southasian countries and businesses an opportunity to integrate into an energy market without fear of Indian political influences, while those countries can also do business without having to be encumbered by geopolitics. Better still, it allows an opportunity for businesses to influence the making of a geopolitics beneficial to the region as a whole. And what does India get in return for making all of this regional energy integration possible? Simple: profits.

~ Bishal Thapa, Amit Sharma and Rashika Gupta are with ICF International, a global consulting firm, in New Delhi.