<b>Suman Bery:</b> Pricing energy in an era of volatility

In his excellent recent book The Turn of the Tortoise, T N Ninan reflects on India's chronic difficulty since independence in remaining a major manufacturing power despite its success in the first half of the 20th century. He notes that manufacturing as a sector has been consistently hobbled over many decades by confusion over the goals of policy. As a result, the sector as a whole has not achieved employment, scale, domestic vibrancy or global competitiveness despite excellence in certain pockets. That this is a failure primarily of policy rather than national character is revealed by the success of India's services sector, where policy has been supportive in a more indirect fashion.
 

I was struck by the relevance of this approach to the area of energy pricing, a topic explored in a forthcoming book on Indian energy of which I am a co-author1. Of course, the term 'energy' is itself an abstraction. It is used to refer to what specialists refer to as 'primary energy', the core fuels of coal, crude oil, natural gas, renewables, nuclear as well as the enormously important category of firewood and animal dung for domestic use in rural India. It is also used to refer to 'energy services', the form in which these fuels are finally applied: as electricity; as refined transport fuels (motor spirit, diesel, aviation turbine fuel); as sources of direct heat in industrial applications (coal and natural gas) or in a range of applications (cooking, lighting, cooling and occasionally heating) in the household sector.

In each of these spheres and for many of these fuels (except traditional biomass, where the research focus has been on environmental and gender dimensions) there have been vigorous academic and policy debates on pricing. Occasionally, as with the 2006 report of the Expert Committee on an Integrated Energy Policy convened by the erstwhile Planning Commission (with Kirit Parikh as chairman) an attempt has been made to address important cross-fuel issues. No doubt the forthcoming National Energy Policy being prepared by the NITI Aayog will also take an integrated view.

Our book takes a long-term view (till 2050) of the evolution of India's energy system. It discusses the role of pricing in the design of an energy system that is flexible, resilient and fit for purpose over this time-scale. It does so by acknowledging four transitions which are near inevitable - but also considerable uncertainties, particularly with regard to the advance of technology. These four transitions are the shift from traditional to modern fuels (acknowledged in the proposals for rural cooking gas in the 2016 Budget speech); the growing importance of urban areas as shapers of energy demand; the deeper integration of Indian energy with global sources of supply; and the challenges and opportunities of a world increasingly committed to reducing greenhouse gas emissions especially from the energy system. In this regard, the book loosely follows in the tradition of scenario analysis which takes certain trends as largely given, but then explores the impact of key uncertainties and branching points. Indeed, where the global energy system is concerned, the book draws upon Shell's New Lens Scenarios, first published in 2013.2

The book notes the multiple considerations that have driven energy pricing in the past: affordability; industrial competitiveness; financing expansion of domestic supply; control of measured inflation; need for revenue; pricing of economic externalities such as road congestion, local pollution and more recently the need to put an appropriate price on carbon. In virtually all societies, rich or poor, energy pricing is deeply political because distributional issues are involved. So India is not an exception. Nonetheless, in light of the multiple transitions noted above, the book concludes that the core goal of energy pricing in the decades ahead should be to stimulate energy production and distribution by encouraging a much more diverse group of investors and actors to participate.

In essence the book embraces the logic of a well-known theorem of economics, namely that each economic policy instrument should be dedicated to achieving a single goal. The shift in the subsidy on cooking gas (LPG) to a direct cash transfer is a courageous and appropriate demonstration of this principle. Widening the debate, the book argues that many of the other benefits expected from a reliable, resilient energy system (such as universal household access, even industrial competitiveness) are more likely to be served by a financially viable system fully capable of recovering costs. As a recent headline in this paper put it, 'Having no energy is costlier than the cost of any energy'. A rather different tack on the same issue is to compare India in the next three decades with Western Europe, Japan or South Korea at various points in their evolution over the last half century. All three are examples of successful industrialisation and increased prosperity in resource-poor environments.

This finally brings me to the theme of volatility. In his impassioned address at the launch of our book, Railway Minister Suresh Prabhu noted the extraordinary challenges faced by domestic policy makers in reacting to sharp changes in global energy prices. These entail adjustment at all levels: in macroeconomic balances; at the level of the energy industry; at the level of consumers; and indeed governments themselves both as users of energy and as revenue earners. There is little comfort that I, or the book, can provide. Resilient economies are those where price signals are promptly transmitted down to the end-user. Indeed, the uncomfortable message from Shell's New Lens Scenarios is that there is little reason to believe that volatility is likely to subside, and plenty of reason to expect it to remain a prominent feature of the global economy. Allowing for volatility in energy markets while creating a stable policy environment for investing will be a difficult but vital challenge for the present government and those to follow.

---

The writer is Chief Economist, Royal Dutch Shell
These views are his own
1 Energizing India: Towards a resilient and equitable energy system, Sage India (2016); forthcoming
2 www.shell.com/scenarios