Petro-product pricing: Need for a dynamic and transparent policy

Over a short period of seven years between 2005 and 2012, the public sector oil marketing companies have incurred a notional loss of mind boggling Rs 5.4 lakh crore and may lose as much as another Rs 1.5 lakh crore in the next 12 months while selling petrol, diesel, PDS kerosene and domestic LPG. Who are the real beneficiaries of this government largesse?

Definitely not those who are below the poverty line. But for Bharat bandhs, street protests and opposition to any price rise by all the political leaders, no one seems to be interested in finding a permanent solution to the critical issue of petro product pricing. This is a perfect example of the UPA government’s policy paralysis.

After a great deal of deliberations, Administrative Pricing Mechanism (APM) was dismantled in 2002. It ensured that oil companies earned an acceptable rate of return. After APM was dismantled, the oil companies were allowed to set prices based on market forces. While dismantling lasted just a year, APM had lasted for over 30 years. During the time of APM also oil prices had experienced volatility though not as much as in recent years. Unfortunately the politicians could not resist the temptation of controlling the prices for populist reasons.

The APM was not the ideal way to determine the prices since it did not force oil companies to improve their efficiency. They had the luxury of gold-plating their costs. But when we compare it with today’s totally ad hoc and politically driven system, one may wish that the APM was not dismantled. There is no transparency in the current system. The methodology of sharing the so called under recoveries of oil companies is completely arbitrary. Upstream companies pay for 30 to 40 per cent, and the government absorbs about 30 per cent and the remaining is borne by the oil marketing companies. No one knows the rationale behind such a flexible sharing formula.

It is a mystery to everyone that despite absorbing such a high percentage of under recoveries, how did the oil companies still show profits? It was a mystery even to former petroleum minister Mani Shankar Ayer.

Computation of under recoveries itself is arbitrary. Since India is exporting diesel, it is not correct to base product prices on import basis to compute under recoveries. For example computation of loss/gain on selling diesel is based on trade parity ( 80 per cent import parity and 20 per cent export parity) using Arab Gulf oil prices. Also under recoveries does not take into consideration the profit or loss made by the refineries. Thus the product cost to oil marketing companies was often overstated especially when refining was profitable. Since public sector oil companies were making adequate level of profits in refinery sector, not only they could absorb their share of the losses, but even show some profit.

Earning huge profits

This is not to argue as some people have done that oil companies are earning huge profits. In fact the combined profit earned by the three public sector oil companies is Rs 6117 crore which is a mere 0.7 per cent of their combined turnover. In the case of Indian Oil Corporation its rate of return is less than 10 per cent on its equity in the last fiscal year. This is not at all satisfactory. If the oil companies did not get the compensation from the government, all of them would have lost massive amount of money.

The current under recoveries, as calculated in the traditional way, in the case of diesel is Rs 13.64/litre, PDS kerosene Rs 31.48/litre and domestic LPG Rs 480/cylinder. Despite the expert advice to the UPA government, it will be a political suicide to increase the prices to reduce oil company losses in one or two steps. However, if they start increasing the diesel prices in small doses say Re 1 or Rs 2 per litre every 15 or 30 days, and hope that oil prices will come down, they may be able to manage the losses. The same policy of charging market prices for LPG to be sold to the rich and middle class may be adapted. Otherwise it will be another disaster year for the oil companies and for the government.

This level of massive oil company losses will not only have huge impact on fiscal deficit (since the government is forced to compensate to keep them viable) resulting in higher inflation, the government will also be deprived of funds to invest on welfare measures like schooling, health, infrastructure etc. It is unfortunate that we do not have tall political leaders who are capable of communicating the message that no nation can have a free lunch when 78 per cent of its petroleum needs are met through imports. While the state governments are ever ready to level criticism against the Centre for any increase in petro prices, few are prepared to reduce sales taxes which are under their control.

If the government wants to avoid the Tuglaq raj in petro pricing policy, at the first opportunity it should start liberalising pricing. It should allow the freedom to oil sector to set its prices in a transparent manner with the regulator ensuring competition. It lost an excellent opportunity in early 2009 when oil prices fell to a low level of $40 per barrel. If it does not want to liberalise, the government may be forced to go back to the old APM which is less of an evil compared to the current politically driven system. But  that is really bringing back the old control raj.

(The writer is an energy expert)