Tricky choice on oil prices

Reform plan: Our oil PSUs will gain if allowed to charge market price

As an emboldened Congress-led UPA government backed by clear mandate for governance gears up for pushing forward reforms in wide spectrum of the economy, the Petroleum Ministry is contemplating to implement the much-needed market-oriented liberalisation measures in the crucial oil and gas sector.

It is now considering to go ahead with a politically tough decision of free-market pricing of fuels, mainly petrol and diesel. This reform measure has been pending for a long time. If the deregulation happens, the price of petrol and diesel will change frequently in line with the international price of crude oil.

The Petroleum Minister Murli Deora while assuming charges of the Petroleum Minister for the second consecutive term has indicated that the Petroleum Ministry is contemplating to deregulate petrol and diesel prices by allowing market forces to determine the prices of auto fuels. It is learnt that the new government is also contemplating to remove subsidies on kerosene —considered to be the fuel of the poor — and cooking gas and devise a system to supply subsidised fuel directly to poor beneficiaries through smart cards or coupons.

Old plan

It is not that the government for the first time is contemplating to deregulate fuel pricing. In fact in 2002 the then National Democratic Alliance (NDA) government removed the Administrative Pricing Mechanism (APM), which was used to determine the prices of petroleum products through a complex price fixation procedure. Under the APM pricing of petroleum products at the retail level were fixed on a complicated combination of heavy subsidisation of petroleum products and cross subsidisation of auto fuels like petrol and diesel.

The government had resorted to APM for fixing retail prices of petroleum products in view of political sensitivity of oil pricing. As the country meets nearly 70 per cent of its total oil requirements through import, movement of global crude oil prices has a direct bearing on domestic oil prices.  For any government raising prices of four mass consumed petroleum products—petrol, diesel, LPG and kerosene—is used to be an unpleasant task as such measures are widely perceived as unpopular steps. Besides, any hike in prices of two auto fuels—petrol and diesel— generally triggers cascading effect on the economy leading to rise in inflation, which in turn leads to some disturbances on the overall fiscal fabric of the economy. Therefore, under the APM the government used to handle the sensitive issue of oil pricing purely on an ad-hoc basis.

But in the process the government used to tolerate multi-pronged damages to the economy. First: massive spending on oil subsidy enhances non-plan expenditure, which in turn pushes up fiscal deficit —the net difference between government expenditure and income. A high level of fiscal deficit negates the very process of fiscal consolidation, which in turn used to give rise to vicious cycle of upheavals in the economy disturbing the very fiscal equilibrium.

Second: by not allowing state-owned oil companies to determine the pricing of petroleum products as per the market condition, the government virtually undermined their financial viability. As a result the state-owned oil giants like Oil India, ONGC, Bharat Petroleum, Hindustan Petroleum, etc were very much restrained to charge remunarative prices for oil products.  Thirdly: the very denial of market forces to determine oil prices discouraged private sector as well as global players to enter into the country’s petroleum sector. Worst, the PSU oil companies were forced to significantly reduce their capital expenditure on modernisation and expansion. So when the then NDA government finally dismantled APM with effect from April One 2002, it no doubt, heralded the introduction of first phase of reforms in the petroleum sector. While taking out petrol and diesel from the ambit of APM the government allowed continuation of subsidy on kerosene and cooking gas for some more years. While dismantling APM it also allowed private firms including global oil giants to set-up their own petrol stations.

Market-determined pricing

After dismantling of the APM the state-owned oil marketing firms like Indian Oil Corporation (IOC), Bharat Petroleum and Hindustan Petroleum were allowed to determine the retail prices of petrol and diesel on the basis of average of import parity prices on fortnightly basis. That worked for some time. But in the wake of spiraling rise in global crude oil prices the government reverted back to the system of determining the retail prices of petrol and diesel.

The idea of allowing the state-owned oil firms to determine prices of petrol and diesel on the basis of international prices was floated from time to time even during the tenure of the previous Congress-led UPA government.

The argument was market-determined pricing system would help the state-owned oil firms to minimise their losses. For instance, due to unprecedented volatility in global crude oil prices — which peaked at 147 dollars a barrel in July 2008 and plunged to 40 dollars a barrel in December — state-owned oil  firms suffered revenue losses of over Rs 1,03,000 crore.

Then, the first UPA government evolved a three-pronged mechanism to  compensate state-owned oil firms, who were forced to sell petroleum products below cost prices. Under the compensation mechanism the government meets nearly 57 per cent of the total under-recoveries through oil bonds, another 33 per cent is met by the upstream state-owned companies like the ONGC, GAIL and OIL by selling crude at a discount to pubic sector oil marketing firms. Some portion of the uncovered under-recoveries are borne by the oil marketing firms themselves, while the rest are met by direct oil subsidies provided through Union Budget and periodic hike in retail prices as permitted by the government.  But as this type of compensatory mechanism has not been extended to private firms, they were finding it difficult to operate because they neither get government subsidy nor can they charge prices higher than the PSU peers. Unable to compete, Reliance Petroleum has shut down all 1,400 of its new gas stations, while Essar Oil has closed half its 1,250 pumps. Multinational Royal Dutch Shell (RDSA) has closed 40 out of 50 stations. But both public and private sector players are of the view that decontrol of fuel prices will be beneficial for the economy in the long run.

As a high ranking official of the IOC says “every body in the industry is for decontrol of pricing. The government also understands this. But considering the sensitivity of the issue, the government will have to take a final call taking all factors into consideration.” It is learnt that the Petroleum Ministry is working to adopt a middle path keeping the political sensitivity over the issue in mind. “We are working on an alternative mechanism to provide cheap kerosene and cooking gas to the poor and subsidised diesel to the agricultural sector,” sources in the Petroleum Ministry told Deccan Herald.  In fact, the process for initiating deregulation of auto fuel pricing mechanism was kicked off at a meeting of energy-related committee chaired by Prime Minister Manmohan Singh nearly six months ago. Now that the crude oil price in the global market is rising again, it has touched $65 a barrel for Indian basket of crude, the need for deregulation is emphasised again.

Revised draft

The meeting was convened to review the proposed Integrated Energy Policy (IEP) drafted by an expert panel chaired by Planning Commission member Kirit Parikh. In that meeting the Prime Minister had directed officials to submit a revised draft of the IEP to the Cabinet for approval. The IEP, which criticised the government for regulating retail prices of petrol, diesel, kerosene and cooking gas, recommended in its report that “the ultimate objective should be to remove government intervention in pricing of all petroleum products and provide targeted subsidies directly to the beneficiaries.”  
“It is unfair to force public sector oil marketing companies to sell fuel at government-determined prices and compensate them partially through discounts on crude oil purchase. If compensation is given to public sector oil refineries, the benefit should also be extended to private companies,” the document said.  But each time this suggestion of deregulation was floated by the oil PSUs the government could not muster political courage to implement this as such a move would have dented the “Aam Admi” plank of the government. The big question is: Will the government show political courage to go ahead with deregulation of oil pricing?

DH News Service

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