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Asia must brace for volatile oil markets

Governments need long-term plans as well as short-term responses to sudden price swings

| India

Governments across emerging Asia face big challenges managing swelling foreign exchange outflows on oil imports and steering sensitive domestic fuel price liberalization policies.

The strains have been particularly acute in the larger oil-consuming countries including India and Indonesia.

It might be about to get worse. Crude's surge to four-year highs at the start of October and a more than 30% dive in November, coupled with the U.S.-China trade war creating uncertainty over global oil demand for the coming months, portends a period of extreme price volatility and unpredictability.

Benchmark global crude prices have nose-dived in recent weeks amid expectations of plentiful supply and waning demand due to slowing economic momentum.

However, energy ministers from the 15 OPEC countries and their 10 non-OPEC allies are expected to decide to curb production in 2019, when they meet in Vienna over Dec. 6 and 7. That would likely shore up crude prices from their current levels, which see Brent hovering around $60 and WTI near $50 per barrel. But the mix of factors influencing prices has made it harder than ever to say with a reasonable degree of confidence, what levels we will see next year, or how widely they might fluctuate.

That can pose a bigger problem for governments doing annual budgeting for oil expenditure, planning pricing and taxation policies at the pump, or advancing fuel diversification initiatives.

The low oil price years of 2014-2016 accelerated fuel price deregulation in several countries across Asia including India, Malaysia, Thailand and Indonesia. As OPEC and non-OPEC crude production cuts began to mop up the global overhang and push up prices, governments went into consolidation mode on those reforms in 2017.

This year, the twin stresses of crude's spike and sharply depreciating national currencies against the U.S. dollar saw pump prices surge to historic highs in a few countries, forcing some to revive state subsidies or reduce taxes in a bid to alleviate the consumers' burden and avert a possible drag on economic growth.

Indonesia began backpedaling on its fuel pricing reforms in 2017. Malaysia's new government, following general elections in May 2018, reintroduced gasoline price caps and subsidies as part of its election pledge.

India's central government cut excise duties on petrol and diesel by 2.50 rupees (3.5 cents) per liter in early October, which eased pump prices by about 3%. Some Indian state governments also lowered sales taxes on the fuels, at the behest of the central government.

Even South Korea, which has a fully deregulated market with full pass-through of crude costs to pump prices, slashed taxes on petrol and diesel by 15% for a period of six months starting Nov. 6, saying it wanted to ease the burden on households and small businesses.

While these measures, whether it be walking back price deregulation or adjusting fuel taxes, provide governments a quick fix and sometimes a way out of politically sticky situations, they should not be mistaken for a sustainable strategy.

If all that governments do is respond to high crude prices when they bite, they will always be at the mercy of the vagaries of the market, where boom and bust cycles are becoming shorter and more frequent.

Even if crude settles in a lower range in 2019 compared with this year, the currency challenges of major Asian oil-importing countries may not go away, as the U.S. dollar is expected to remain strong. That could maintain the pressure on fiscal balances.

It is not that Asia's energy consumers are not responding to rapid change. Most countries are diversifying energy sources, while also embracing environmental sustainability as their consumption spikes. Ambitious targets for replacing internal combustion engine automobiles with electric vehicles as well as the mandatory addition of increasing amounts of biofuels to refined oil products and policy support for wind and solar power projects are all steps in the right direction.

The big problem, however, is that these initiatives, even collectively, will not make a serious dent in oil consumption, though they are expected to slow down the growth in demand and lead to a plateau in a few decades. Electric vehicle numbers are growing fast, especially in China, the world's largest automobile market, but from a very small base. The same is true of the share of wind and solar power in total electricity generation.

Even a plateau in oil demand will leave the world consuming more than 100 million barrels a day, with the Asia-Pacific region accounting for more than 35% and increasingly dependent on other regions to satisfy its crude needs.

Biofuels such as ethanol and biodiesel, while helping displace some fossil fuel use in transportation, cannot go beyond a certain percentage in the blend. In any case, they are typically propped up by government subsidies, tax breaks and regulatory mandates. Asian countries, prominently China, India and Indonesia, are promoting first-generation biofuels that are made from food crops, raising concerns over deforestation, loss of agricultural land, and rising food prices.

It is time for developing Asia to double down on a solution that could actually help reduce oil use, is environmentally friendly, and an answer to urban traffic gridlocks -- efficient local public transportation. Urbanization in the Asia-Pacific reached a tipping point in 2018: For the first time, more than half the region's population lives in urban, rather than rural areas.

China has done well with the speedy development of its high-speed rail network. India and a few countries in Southeast Asia are looking at installing Elon Musk's Hyperloop, a superfast ground transportation system. But these are typically systems for long distances, providing an alternative to air travel and traditional railway connections between cities.

Building mass rapid public transportation system in densely-populated cities is complex, expensive, and time-consuming. But the long-term economic benefits outweigh the costs.

In the short to medium term, governments will have to continue to balance satisfying growing oil demand, moderating pump prices in the event of crude spikes, and containing the drain on foreign exchange when their currencies slump against the dollar. Going into 2019, they must be ready for more volatility. That means looking at a wider range of price scenarios and preparing in advance, rather than relying on ad hoc responses.

Vandana Hari is founder of Singapore-based Vanda Insights, which tracks energy markets. She has two decades of experience providing essential intelligence on the energy sector.

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