Prices to remain high through the recessionary phase
Falling commodity prices during a recession lay the foundations for the recovery. First, prices of industrial metals and fossil fuels drop, along with falling overall demand. As input costs reduce, manufacturers cut prices, to stimulate demand all over again.
Industrial metal prices have fallen during the current global recession. But energy prices have not due to the Arab Spring and the consequent fear of disruption of crude and gas supplies. The civil war in Libya, which is a key player in crude, may now be entering its last phase. If we’re very, very optimistic, we could assume that a new government will take charge in say, the next 10 days, and immediately start repairing damaged infrastructure. Even in that best-case scenario, it will take months to stabilise Libya’s crude exports.
More realistically, it will take a few more months for a new Libyan regime to take charge. It may take another six months to a year before Libya’s oil infrastructure is back to normal. In a worst-case scenario, like Iraq, there could be an indefinite period of anarchy and violence.
In every case, energy prices are likely to remain expensive through the recession, unless global GDP drops drastically, and reduces demand. And, once a global recovery sets in, rising demand will ensure that energy gets even more expensive. This is a gloomy situation for India with its need to import crude, gas and coal. India’s policy-makers can come to certain logical conclusions about the future of the energy sector, based on the above chain of logic and a few undisputed facts.
One fact is that, as the Indian economy grows, the growth in energy demand will match or outrun GDP growth. Another fact is, the power sector is in dreadful shape. It lacks the capacity to service current demand. It is inefficient and suffers massive losses in monetary terms, as well as in units lost in transmission and distribution. A third fact is that the mining sector isn’t in great shape and mining policy hasn’t really encouraged investment or innovation.
India must institute reform across its entire energy sector to maintain GDP growth. It must improve efficiency. It must build capacity across every segment. At the minimum, it needs to double power generation and transmission capacities over the next five to seven years. If this is to be done in the face of high energy prices, the “asking rate” for reform climbs.
The additional stress actually makes it a little more likely that sustainable solutions will be sought, instead of stopgap measures. Efforts will be made to diversify the power generation mix and there will be more focus on energy security. Here’s a brief look at some possible solutions and the investment opportunities they may trigger.
There will be a lot of transmission and generation equipment sold. The major players are mostly listed and new players will also enter the game, especially in non-conventional areas. There will be a major emphasis on renewables. This trend is already evident. There’s already a certain amount of listed coverage and that will jump as more renewable projects develop.
There will also be some attempts to reform the mining sector. This is both to improve the extraction of thermal coal as well as to encourage exploration for new oil and gas finds. There will also be more rapid induction of the technologies required to exploit coal-bed methane and shale gas. This will create another value chain with new players and hence, new opportunities. There are two large grey areas. One is nuclear and the other is hydro. Both make sense from the energy security viewpoint. Both sectors carry obvious technological and environmental risks. Both face big political hurdles and opposition from local citizens. My sense is that projects will happen in the long run but maybe not within a meaningful timeframe for the secondary investor.
None of the above will happen easily or quickly. All of it will require huge investments. Since the state lacks the funds to carry it out, it will have to alter policy to attract funding. We can take it for granted that there will be some huge scandals and scams along the way. That’s inevitable in an Indian environment.
This is a very long-term opportunity. Specific investment advice about energy plays is next to impossible. But the energy sector is really heading into crisis. Like it or not, all the possible solutions will force some major policy changes. Right now, the valuations of listed players across the energy sector are low. They will probably get even lower before the government deems it fit to do anything.
