Jun 24, 2008

Towards Collective Solutions

Business Standard Column
Mr. Chidambaram's remarks made at the OPEC meeting over the weekend deserve serious attention. He emphasised the burden that the massive increase in oil prices was imposing on countries like India, which had been getting their economic act together over the past few years but now were in danger of having all their achievements eroded by energy prices. He also pointed the finger squarely at financial factors in explaining the price increase. As more and more money was being deployed in energy-related derivative products, he suggested, prices were being pulled further and further away from fundamentals. Finally, he proposed a solution involving a price band, which essentially requires oil producers to collectively increase production when the price went above the upper bound but left them free to cut production when the price fell below the lower bound.
No one can dispute the first concern. High energy prices have indeed moved from being a short-term irritant to a significant threat to macroeconomic stability and long-term growth. The second assertion, while it echoes a widely held view, is subject to deeper analysis. Those who believe that future prices are driven by supply-demand fundamentals, market outcomes are the consequence rather than the cause of current market conditions. This is a controversy that has impacted our domestic policies on agricultural products with, some say, disastrous outcomes. Let us await further analysis and evidence on this issue. However, the pricing proposal is, on the face of it, an attractive one. Assuming that a mutually acceptable price band between producing and consuming countries could be arrived at, it would give both sides an assurance of stability and sustainability. Significantly, the proposal is based on the entirely valid premise that the solution to the oil problem will necessarily have to be both collective and co-operative in nature. It is too large for individual countries to address, even the big consumers like the US and China, while any proposal that does not keep the interests of oil producers in mind is doomed to fail.
However, while the collective and co-operative approach needs to be encouraged, there are specific concerns about the viability of a price band mechanism. From the producers' perspective, they all have to agree to both the band itself, but more importantly to how the increases and decreases in production when the price moves outside the band are to be distributed. This was difficult enough to do when OPEC, a formal cartel, had a dominant share of global production. It will pose a formidable challenge in a situation in which Russia has emerged as a powerful free agent, with no need to comply with any agreement on prices, even as the socio-economic differences between OPEC members bind them to very different time horizons for realising oil revenues. From a domestic perspective, the objective of co-operatively reaching a sustainable supply-demand balance will be helped if consumers in all countries are actually paying the true price of energy. It is meaningless to talk of market solutions if large consumers like China and India continue to subvert market forces. In short, by raising the flag of collective and co-operative solutions to the problem at this forum, Mr. Chidambaram has initiated an absolutely necessary process. He would contribute even more significantly to it if he were to extend its logic to his government's approach to domestic pricing.

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