Background

The world has seen many energy transitions: from human to biomass energy; from biomass to animal energy: from biomass to wind and water derived energy; from wind and water to energy from fossil fuels.  These transitions offered improvement in efficiency, cost and ease of use and were primarily mediated by the market. The current transition from fossil fuels to renewable energy (RE) is different in many ways.  It is mediated primarily by government policy response to market failure to correct negative externalities (climate change) of fossil fuel use.  The transition is much more than a mere substitution of one fuel with another at the supply end but one that will demand a complete transformation of the energy delivery system. 

There is no dearth of technical and economic modelling studies on scenarios for global and national RE diffusion and the required policy inputs, but these are mostly designed to promote RE rather than objectively discuss the geo-political, economic, social, and structural challenges that the transition is likely to entail.  The limited corpus of literature on the geopolitics of RE is generally optimistic.  According to most projections, scarcity of fossil fuels will be replaced with the abundance of renewables and the widely dispersed availability of RE will eliminate problems associated with geographic concentration of fossil fuels.

Some of the studies see the de-centralised nature of RE democratising access to energy and offering a substantial peace and security dividend to the world.  Current responses to China’s leading role in producing and using technologies for harnessing RE, particularly solar energy technologies, suggests otherwise.  A recent report on solar PV (photovoltaic) supply chains from the IEA (international energy agency) cautions that “the level of concentration of global PV supply chains in China is creating challenges that governments need to address”.  To take on the challenge of solar supply chain concentration in China, the West is encouraging developing countries to invest in domestic manufacturing and also invest in alternative supply chains. 

India’s Geo-strategic Vectors

Despite the ongoing energy transition, there is continuity in key domestic values such as self-reliance for strategic autonomy, economic progress for material power asset maximisation and social justice for domestic coherence that have informed India’s energy policy.  These key values, embedded in the internal dimensions of India’s energy policy have influenced India’s strategic vectors for external projection that include but not limited to dependence, resilience, and identity.  India’s domestic values and strategic vectors will continue to inform energy policy even in the low carbon world.

Dependence

The low carbon era is likely to be far more material intensive than the fossil fuel era. Effectively, generating 1 terawatt of electricity from solar energy could consume 300-400 percent more material input than generating electricity using natural gas or coal as fuel.  For example, if global solar energy generation capacity increases to 630 GW (giga watts) by 2030 as required by the net zero goal for 2050, production of polysilicon will have to double. India set itself a target of increasing RE power generating capacity to 500 GW by 2030 (this goal is not part of India’s recently updated NDC (nationally determined contribution to the Paris agreement on climate change). Even if the goal is not met, India’s RE power generation capacity will increase substantially given the tremendous policy push and financial incentives offered to private sector investment in RE. 

India is also incentivising domestic manufacture of RE equipment, but it is not likely that this effort will reduce import of key minerals and technologies for production of solar modules and batteries.  However, mineral supply disruptions may not have the dramatic impact that oil supply disruptions have had on oil importing economies like India.  Oil is a primary source of energy that required continuous growth in production; minerals are part of the equipment that harness RE, and they do not require continuous replacement and growth in supply.  The value of global mineral trade even in a scenario where RE dominates is likely to be an order of magnitude lower (billions of dollars) than that of oil trade (trillions of dollars).  If mineral rich countries hold up production, alternative higher cost mining sites can be developed to fill in the gaps as mineral resource endowment is not highly concentrated. Minerals from older devices can also be recycled and reused.

In this light, India’s decision to “make” rather than “buy” RE equipment raises some issues. Both in mineral mining and RE equipment production, cost competitiveness matters.  Investment in relatively high-cost domestic manufacturing will effectively increase the cost of reducing carbon emissions and may misallocate scarce capital that may be better employed in adaptation measures for climate change.  Overall development and social justice through energy access (among other things) may also suffer as capital is diverted to the production of carbon mitigation goods.  

Resilience

Electricity is the main vector for RE and the economics of electricity is shaped through physics.  Electricity is a heterogeneous good across space and time (electricity at 12 noon and 12 midnight are different goods as are electricity produced in a densely populated city and that produced in unpopulated desert.  In both cases the former is far more valuable than the latter).  The nature of electromagnetism that produces electricity makes storage, transmission, and flexibility difficult and expensive.  These properties make intermittency the primary risk in the low carbon era just as scarcity was the primary risk in the fossil fuel era.  In a scenario where RE dominates energy supply, flows (that counter intermittency) will matter more than stocks (as it was in the case of fossil fuels). Control over strategic reserves of energy and control over pipelines and sea lanes will have to be replaced with control over the grid that facilitates flow of electricity. 

The grid network will require not only storage but also require flexible and interrelated power systems that can balance supply and demand in real time. RE is much less geographically concentrated and any country can specialize in those aspects of RE trade in which it has a comparative advantage based on factors such as technology, relative price, and cost of transport. Surplus production of low carbon electricity such as hydropower or solar power from one country could be exported to cover deficit in another country.  This means that a resilient grid will have to be regional rather than national. Cooperative relationships with neighbouring countries will matter more than relationships with far away resource rich countries.  For India control over the grid network will become vital for resilience in energy supply for national security and for projecting influence, especially in the South Asian region where it will be the largest producer and consumer of low carbon electricity. The grid network will include physical assets such as power lines and storage facilities, and virtual interconnections that will multiply as the number of decentralised suppliers and consumers increase.

Electrifying everything including transportation with electric vehicles will compromise diversity, one of the key attributes of energy security.  When there is compromise on electricity supply due to technical, natural, or manmade causes, economic and social life will come to a standstill.  Investment in alternative low carbon sources such as Hydrogen that do not rely on the electricity network will increase diversity but the high cost of redundancy that has to be built into the low carbon energy system will remain a matter of concern for India that has vital development needs.

The reliance on the private sector that dominates the RE sector in India accounting for over 96 percent of capacity may also compromise resilience.  The primary motivation for private investment in India and elsewhere is private profit maximisation not the production of public goods such as energy security.  This was evident in the recent past when private thermal power generators in India reduced the import of coal because of high international prices contributing to an “energy (coal) crisis” in late 2021 and early 2022.  When oil prices increased private refiners preferred export of refined products to maximise profit rather than provide energy security to India.  In both cases the government had to intervene to protect national security. 

Identity

The gradual shift in India’s positions in multilateral climate negotiating platforms reflects the change in its identity from that of a non-aligned ‘leader of the poor’ (G77) to a ‘member of the affluent club’ that is aligned mostly with the interests of industrialised nations (G20). India is attracting investments for low carbon energy sources from industrialised economies, and it is also developing domestic manufacturing capacity in RE technologies. In the process India is emerging as the primary ‘adjustment variable’ in the effort to counter the dominance of China in RE supply chains.  But in the domestic context, millions of impoverished Indians are the ‘adjustment variable’ in the addressing climate change.  India can facilitate these millions to industrialise, develop and urbanise using traditional fuels like most of the world did or India can marginalise their needs in its quest for a global role in the geopolitics of the low carbon world.       

Source: International Energy Agency

Background

On 1 July 2022, the government announced windfall tax of ₹23,250/tonne (t) on domestic crude oil production, ₹6/litre(l) on export of petrol and aviation turbine fuel (ATF) and ₹13/l on the export of diesel.  Three weeks later, the government reduced the export tax on diesel and ATF by ₹2/l and removed tax on petrol. The tax on domestically produced crude was reduced to ₹17,000/t.  Another two weeks later the government removed the export tax on ATF and reduced the tax on diesel by half to ₹5/l and increased the tax on domestically produced crude oil to ₹17,750/t.  The economic rationale for imposing windfall taxes was that India’s trade deficit had increased to record high levels and a weak rupee had increased the value of India’s imports. 

In 2008, when oil prices increased to about $100/barrel (b) some sections of the Indian government demanded imposition of windfall tax on oil companies.  But the government refused saying that there was no economic rationale for such a tax. This week, UN Secretary General Antonio Guterres commented that it was “immoral” for oil & gas firms to profit from the ongoing geopolitical crisis and called for oil & gas companies to face special (windfall) taxes. Is profit, especially unexpected profit, a sin that must be taxed away or is it a sin to tax oil company profit?     

The Economic Logic  

Production of scarce depletable energy resources such as oil and natural gas command an ‘economic rent’ which is central to natural resource valuation. Economic rent is defined as the return to any factor of production over the minimum amount required to retain it in its present use. It is broadly equivalent to the profit that can be earned from a factor of production (for example, a natural resource stock such as oil) beyond its normal supply cost.  Discovered reserves of mineral resource such as oil and gas gain value over time as depletion increases their cost of replacement.  In theory, it is natural for the current price of oil and natural gas to reflect their current marginal cost. 

A price that exceeds long run marginal cost is ‘monopoly profit’ which can only be achieved through collusion between producers or by government decree.  The distinction between ‘economic rent’ and ‘monopoly profit’ is not merely semantic.  Economic rent provides the incentive and cash flow necessary to simulate new supplies at ever rising replacement costs.  The consequence of disallowing economic rents associated with depleting resources is future shortages of the resource.  Economic rent is by no means limited to energy fuels, but the social and economic significance of energy instigates public antipathy towards economic rents that accrue to the energy industry in general and the oil industry in particular.  The oil industry is singled out for attack as it is seen to be the beneficiary of both economic rent and monopoly profit, with collusion with OPEC (organization of the petroleum exporting countries) contributing to the monopoly component. 

According to some interpretations ‘windfall profit’ is distinct from that of both ‘economic rent’ and ‘monopoly profit’ and is defined as the ‘profit earned unexpectedly, through circumstances beyond the control of the company concerned’.  As the profits are neither expected nor the result of efforts of the firm, it is assumed that taxing the firm  would not harm the firm’s incentives to maximise future profits.  A finer distinction could also be made in terms of whether the windfall profits arise out of the cyclical nature of the market or structural features of the industry.  Studies have found that a tax on windfall profits arising out of the structural nature of the industry does not affect company behaviour while a tax on profits arising out of short term or cyclical factors affects company behaviour resulting in resource misallocation and distortion and are best avoided. 

The empirical relevance to the case of oil depends on the question whether or not the supply of oil is given and limited for all times as is that of land. If the supply curve for oil is responsive to prices and therefore indicates that more oil is supplied at higher than lower prices, then the taxation of the windfall profits induces the misallocation of resources in the economy and leads to a reduction in public welfare.

American Experience

The American example of imposing windfall taxes in the 1980 is widely quoted.  When the Carter Government came to power, price decontrol was the only available instrument to curb growing demand for oil amidst the supply crisis set off initially by the OPEC embargo against America and its allies in 1973 and later in 1979 by the Iranian Revolution.  Removing controls on domestic oil prices was expected to produce additional revenue of $1 trillion translating into more than $300 billion of additional profit for oil companies.  ‘Windfall profit tax’ was designed to capture this additional profit. 

Unlike the ‘excess profits tax’ collected during the World Wars which was a supplementary tax on corporate income, the crude oil windfall profit tax collected in the United States had nothing to do with profits.  It was a tax on oil price and was paid before profits made by an oil company were calculated.  The price of oil in 1979 was assumed to be a reasonable price and any price above that was taxed at rates between 15 and 70 percent.  When the windfall tax bill was being debated in 1979 the Washington Post observed that the proposed tax was merely ‘an excise on every barrel of oil produced’.  When the bill was passed the Wall Street Journal described it as the ‘the Death of Reason’ which had ‘sacrificed the nation’s security to its thirst for revenues’. 

Most analysts who studied the US crude oil windfall profit tax have concluded that it was not a great success.  Against a revenue projection of over $300 billion over ten years only $80 billion was generated.  Oil prices did not increase as anticipated through the 1980s but the base price which was indexed to inflation continued to rise.  In addition, administering the tax proved to be more complicated and expensive than originally thought.  During the period of the tax’s existence, America’s reliance on foreign oil increased from 32 percent to 38 percent and this increase was partly attributed to windfall profit tax that inhibited domestic production. 

The Indian Case

In the upstream sector production sharing contracts (PSC) allow the government to get a higher share of profits when oil prices increase. If windfall tax is levied, oil companies would pass the cost to the government by way of reduced profit. Royalties levied by central and state government under PSC are on ad-valorem basis which means that government revenue increases with increase in oil prices. The downstream sector (refining) is a ‘margin’ business and gross refining margins do not necessarily follow crude price fluctuations. Given the competitive nature of refining business and the fact that there is global shortage of refining capacity, improvement of margins is attributable to enhanced productivity and not to high oil prices.  Based on these fundamentals, it is possible to stay at the granular level and illustrate, balance sheet by balance sheet, that Indian oil companies do not make ‘windfall profits’ on account of high oil prices.  But a more useful exercise would be to look at broader questions: What purpose would an additional tax on oil companies serve? Would it contribute to India’s energy security?  Would it improve redistribution of wealth and improve quality of life for the poor? 

The Chaturvedi Committee Report treated windfall profit as resource rent and recommended that revenue from windfall taxes could be used for supporting the subsidy mechanism as a ‘short term measure’.  The report treated the government as the rightful owner of ‘resource rent’ and argued in favour of using the revenue for bridging budgetary gaps and for supporting redistributive policies. While this may sound reasonable, introducing subsidies with new revenue streams would only increase inefficient consumption. It is known that subsidies drive up energy consumption by middle class & rich households rather than facilitate consumption by the poor.   

If windfall profit taxes are used to sustain price distortions or make up for budgetary shortfalls, even in the short term, it would comfort policy makers that they can always tap on this new revenue source to sustain their policies. In addition, windfall profit tax will reduce the incentive for domestic exploration and production of crude oil which in turn will increase import dependence.  By skimming off profit streams of oil companies, the government will not only compromise India’s energy security but also sustain its own inefficiency. 

Source: Petroleum Planning & Analysis Cell (PPAC)