The price of oil hit a record high of $ 76/barrel last week. The energy crunch looks like going from bad to worse in coming decades. The BRIC report of Goldman Sachs predicts that between 2000 and 2050, India\’s GDP will rise almost 60 times and China\’s 40 times. That sounds great, but if oil consumption in these countries rises at just half their GDP growth rate, China will need 160 m. barrels/day and India 60 m. barrels/day by 2050. That\’s impossible: world production today is just 85 m. barrels/day, and does not seem likely to rise much higher. What\’s the way out? Maximising the use of coal is one obvious possibility. India has over 200 billion tones of coal reserves, the fourth largest in the world. Not all of this is extractable, but it still constitutes a large energy reservoir. The main use of such coal will be to generate electricity. But a new prospect is now on the horizon: the conversion of coal to oil. Last week, Finance Minister Chidambaram disclosed that South African company Sasol is considering investing $ 1 billion, rising ultimately to $ 6 billion, for a project to convert Indian coal into petroleum products. Sasol is a pioneer in CTL (coal-to-liquids) technology. It developed this technology in apartheid days to provide energy security to South Africa, which was then facing oil sanctions. Oil produced by this process was costly and uneconomic at the time. But with the sharp rise in oil prices in the last two years, coal-to-liquids suddenly looks a bargain technology. Sasol says discussions on the Indian project are at a preliminary stage. Among other things, it is worried that the price of oil might suddenly fall in the future for unanticipated reasons (like new technology). So, it has reportedly asked the government guarantee to buy its output at $ 45/barrel if the world price falls below that level. Should India give such guarantee to get this new technology and investment? My answer would be yes, subject to several conditions. Indian coal is very similar to South African coal, so Sasol\’s technology should work well in India. The cost of converting Indian coal into oil should be around $ 40/barrel. Note, however, that the output of a CTL plant is not crude oil but refined products, which carry a higher price. The sulphur content of diesel from such plants will be exceptionally low, justifying a price premium. The chemical cracking involved in CTL will yield high-value chemicals (toluene, xylenes) over and above refined products. And the CTL process can also produce surplus electricity through cogeneration. So, if the government agrees to guarantee a floor price, this should be fixed after taking into account all the potential profit streams, not just oil. If Sasol is to be given a guaranteed floor price, it should also be subject to a ceiling price. If the floor price guarantees profitability at $ 45/barrel, the ceiling should not be very much higher. It may be reasonable to fix this at $ 60/ barrel. This is well below the current world price. So, if oil prices remain high, the government will reap a huge windfall gain by getting oil from Sasol at just $ 60/barrel. Sasol cannot complain about such an arrangement. It cannot ask for a floor without also agreeing to a ceiling. If it wants the government to take the downside risk, it must also give the government the chance to gain an upside bonanza. There is some talk of negotiating a fixed conversion margin. This could be dangerous, as the case of Enron has already shown. There are dangers in all negotiated margins and guarantees. Ideally, Sasol should build a plant on ordinary commercial principles, with no guarantees, no floor and no ceiling price. Assuming this issue can be resolved, to what extent can oil from coal replace oil imports to meet India\’s future needs? The sobering answer is: not much. The proposed Sasol investment of $ 5.8 billion will be the biggest single foreign investment by far in India. Yet such a plant will take five years to build, and will produce no more than 4 million tonnes of oil per year. This will be less than one year\’s increase in consumption. More plants could be built, but scaling up will not be simple. Apart from the high cost and time involved, Sasol has found that the yield of oil in the CTL process is highly sensitive to the quality of coal. This means that only a small fraction of Indian\’s large coal reserves may be suitable for conversion. So, while converting coal to oil looks an important and worthwhile prospect, it can play only a limited role in meeting India\’s future energy needs. Technology has yet to meet the challenge of providing alternatives to scarce oil.