Arguing against insurance

The Economic Times editorial argues that it is too costly to set up strategic oil reserves while conveniently ignoring the motivations behind the project and without suggesting alternative (cheaper) solutions.

In the modern world, with its sophisticated hedging instruments, the purpose of reserves cannot be primarily to protect against price shocks. Presumably, therefore, they are addressing the possibility of an actual physical disruption of supplies. Quite apart from the fact that this is less likely today than in the past, this contingency too could be better dealt with by diversifying sources of supply across different parts of the globe.[Economic Times ]

Security perspective
India is hopeful that its economy is poised for sustained growth. Along with an improved energy infrastructure, a growing economy needs a stable supply of oil. Now, given our geographical location, the primary source of oil will come in over sea routes from the Gulf region. Overland routes from Central Asia need to pass through Pakistan which despite all the smiles and handshakes does not yet look like a smart thing to do. The only other source of oil is South East Asia which anyway is not a major producer.

Given the supply environment, it is not too prudent to dismiss the possibility of physical disruption of oil supplies. A strategic oil reserve is necessary to help cushion some of the effects of a supply disruption. The Economic Times argues that the current capacity of 15 days reserve is insufficient, but that does not mean it is ineffective. Neither does insufficiency constitute a good reason for dismissing the rationale behind the idea. If anything, it may mean that the capacity of the strategic oil reserve has to be upgraded over a period of time.

Shock absorption
Financial hedging is a useful complement to a physical oil reserve. It involves taking and managing risks, but even the most highly educated professional risk managers can sometimes go horribly wrong (ever heard of Long Term Capital Management ?). To argue that hedging is a substitute for a physical oil reserve is to argue investing in the stockmarket is a substitute for taking insurance or putting money in savings accounts.

Russia, China and Britain have access to stable supplies of oil and do not need an oil reserve. But the United States, Japan, Germany and Israel like India, dont. And that is why they have set up strategic oil reserves, and that is it is necessary for India to do so.

Related Links: Two counterpoints from T N R Rao and Devinder Chawla who think the Strategic Petroleum Reserve makes good sense