Energy Opportunity In India

Zerohedge recently posted an article titled India - Land of Energy Opportunity (http://www.zerohedge.com/news/guest-post-india-land-energy-opportunity). An investor forwarded the link to me for my comments.

India imports 80% of its energy needs. Energy security is a myth and is going to remain elusive. Energy producers need energy consumers as much as the other way around. In a world with complex supply chains for goods and services, geopolitical risk leading to energy supply disruption is hogwash. Extended geopolitical instability will lead to disruption in a lot of supply chains and will have large unintended economic consequences.

However, economically speaking, import dependence on energy is like an external tax on the economy. Countries (especially China) have tried to mitigate this tax by buying ownership in energy assets abroad.

In my view this is a really bad idea. Even large and extremely well run companies like Exxon have had trouble managing assets in unstable areas like Russia, Latin America and Africa. In my view Indian and Chinese companies will not be able to manage and execute assets in less developed economies. The ability to compete for energy assets in developed markets also remains suspect. Developed economies have stable, organized and competitive energy asset markets. Acquirers from India and China will more often than not get the short end of the stick when it comes to pricing of acquisitions.

So, in my view, it is best for India to stop worrying about energy security and to do what is most economically efficient i.e. develop energy resources that exist within its boundaries. Here, India's record has been poor.

The much publicized NELP (New Exploration Licensing Policy) has not taken off as expected because the government makes life difficult for people who own exploration blocks. NELP requires block holders to share profits from energy production with the government. The government allows block holders to recover exploration and production costs, but creates an impediment by forcing them to seek approval before any new expenses are incurred.

For a block holder that has completed exploration and has P1 proved reserves, approvals from the Director General of Hydrocarbon, Environment Ministry and others, for drilling production wells, can take up to 2 years (and cause tremendous frustration and heartburn). The government routinely interferes in the energy asset purchase and sale decisions between private parties and thereby denies them access to much needed capital.

Natural gas pricing and policy in India is a complete mess. The market is moving very quickly and the government's reaction time is 5 years behind. The fall in production in Reliance's KG-D6 offshore field can squarely be blamed on the government. While the government forces Reliance to sell gas at $4.2 per mmbtu, government owned companies are buying spot LNG cargoes at $15 per mmbtu.

Coal in India is an even bigger mess than natural gas. India has the third largest coal reserves in the world. However, most new power capacity is coming up in India based on imported coal from Indonesia and Australia. Since coal is regulated and does not have a market mechanism for pricing, the government continuously interferes in its pricing and production. Coal India has a virtual monopoly on coal production for market sale and is unable to produce even for current demand. The Indian Railways has a virtual monopoly on coal transportation and does not have enough rakes to transport even the coal that is produced by Coal India. The result is that 48% of India's coal based power generation capacity is idle and all new power plants are coming up near ports where coal can be imported.

Even when a coal block is allotted for a pit-head power plant, the government puts strict limits on production of coal and any excess coal production (since it could be sold in the market) is a criminal offense with potential jail terms for the CEO and Chairman of the concession owning company.

So, is it all grim and is there no opportunity? There is a lot of opportunity. The opportunity is in smart companies that have solid assets and have the resilience to operate in India. The opportunity is in specific assets and specific operators. Top-down, wishful macro-analysis of the India energy opportunity can land investors in a lot of trouble.
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