The race for oil has just begun

India and China seem to be in a race to acquire foreign oil and gas reserves through their state-owned oil companies. This was dramatically exhibited in their competition to acquire a Kazakh oil company.

Though the Indian petroleum minister castigated the bidding procedure in which India's state-owned oil company lost to one from China, could this have been a blessing in disguise? This is the central question I want to explore in this column.

The first point to be made is that if a private Indian oil company was competing with one from China, there would be no need to discuss their respective commercial judgments. But instead, both India and China seem to be keen to use their burgeoning foreign exchange reserves to promote the acquisition of foreign oil assets by their state-owned oil companies in the name of energy security.

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Linking this to national security, as oil and natural gas remain the essential fuel for their burgeoning economies, suggests that merely economic considerations are unimportant in these strategic national decisions.

Acquiring these foreign energy assets and the means of their transportation (through pipelines) will provide assured and stable supplies of energy in the future. But is this valid?

In the 19th century liberal international economic order, one could reasonably expect that, if a state or its citizens owned foreign assets, then through the web of treaties the British had negotiated during their imperium, backed by the threat of "gunboats and Gurkhas", these international property rights would be fairly secure.

But that world has long gone. Starting with the Mexican and Russian revolutions and Attaturks' nationalist revolution in Turkey, most countries have abrogated international property rights to sub-serve the national weal.

Nowhere is this more apparent than for foreign-owned oil and gas fields. Beginning with Mossadeq's nationalisation of Western oil companies in Iran, most of the oil-producing countries nationalised foreign oil companies, while the US opposition to the Anglo-French Suez expedition to protect their international property rights finally put an end to any military means of protecting international property.

Why are India, China scrapping in Kazakhstan?

This implies that it is an illusion to believe that, if you own a foreign oil field, it belongs to you in the same way as one within your own territory. If, as is all too likely, a future Kazakh government was to nationalise the company owning oil in their territory in which foreign state-owned companies have a share, would the Indians and Chinese be willing to send in their troops to assert their property rights?

This could involve not merely putting the "Gurkhas" on the oil field, but in essentially taking over the country. If even the sole remaining superpower is incapable of doing this, it is absurd to believe that the aspiring superpowers of India and China would be able to do so. In fact, acquiring these foreign oil fields with national public resources would be giving an immense hostage to fortune.

But, it may be argued, even given this uncertainty about property rights, would the acquisition of foreign oil reserves not enable the domestic price of oil to be stabilised, and be kept lower than the projected rising world price for oil?

This mistakes what is the true opportunity cost of oil used in the Indian economy. Even if one owns a foreign oil field, the opportunity cost of using its oil is still given by the world price. For, if not used domestically, the oil could be sold elsewhere for the world price.

Perhaps, there is another advantage in our state-owned oil companies owning foreign oil fields, through the implicit profit (given by the difference between the rising oil price and the costs of production) accruing to the Indian state company rather than a foreign company?

But this implies it is a commercial venture and not a strategic one, in which it may be worthwhile investing public funds if the foreign investment offers a higher rate of return than other alternatives.

If this investment decision was being made by a private company, one would have more confidence in its judgment than the proposed acquisition by a state company, for well- known reasons concerning incentives and soft budget constraints of public enterprises. If these foreign investments are to be made on a commercial basis by an Indian oil company, it would be best to privatise the state-owned companies and let them then decide whether such investments are in their commercial interest.

The same argument applies to the proposed pipelines from Iran and Myannmar. Public investment in these international infrastructure projects would be justified if they yielded a higher social rate of return than alternative uses of public funds, like investing in domestic infrastructure.

Given the well-known limitations of the latter, such foreign investment is also of dubious economic value. Of course, it may be a viable private investment project and the Indian government could justifiably use its diplomatic clout to help it fructify.

The final reason often given for this race to acquire foreign energy resources is to ensure security of supplies of a vital resource input. But this fails to recognise that since the second oil shock of the late 1970s, oil has become just another commodity, being traded on NYMEX just like gold or iron ore (see D Yergin, The Prize, for an excellent history of the oil industry).

Buying futures in this "deep" market will ensure security of supply. With the diversification of world sources of supply, most recently from the Caspian Sea, and prospectively from the Canadian oil shales, there is no longer the geographic concentration of future supplies in the Middle East, which gave strategic planners such headaches. This commodification of oil has also reduced the power of OPEC, and the likelihood of a future oil cartel holding consumers to ransom.

Nor does India have to worry about being alone in keeping the worldwide channels of transport for this vital resource open. For, its new "strategic partner"-- the US -- has an even greater interest, and above all the military means to ensure that these channels are not blocked for political reasons.

There is no economic or strategic reason, therefore, for India to be in this race to acquire foreign energy resources by using its foreign exchange reserves, representing its people's savings, merely to allow megalomaniac politicians and bureaucrats to imitate the Sheikhs of the Arab world.