Decontrolling fuel prices will cut government deficit

They even took recourse to a country-wide bundh causing hardships to the very ‘aam admi’ they wanted to help. Was it influenced by the ‘opposition dharma’ to disagree with whatever the ruling party does? Or was it out of ignorance of the reality that there is no free lunch? Or was it out of sincere concern that the ‘aam admi’ will really be affected?

Though I agree with the new initiative, it is useful to start the discussion by pointing out the fallacy in the government’s argument. While the government claims that the oil companies will still lose money while selling diesel even after the revision, my calculation based on integrated refining and marketing profitability shows that it is not true. Based on prevailing relationships between the international product prices and crude oil, Indian refineries should generate a profit of about $1.9 per barrel at crude oil price of $75/b, while the margin on diesel for oil marketing companies is estimated to be about Rs 2 per litre.

Ironically, the partial liberalisation may fail to create a competitive market for petrol as intended. The public sector oil companies may end up creating a pricing umbrella for private oil companies. When the crude oil price increases in the future, the oil companies may increase petrol prices more than needed to reduce their losses from the government controlled diesel price.

During a short period between 2006 and 2009, three high level committees headed successively by Dr C Rangarajan, former advisor to the prime minister, B K Chaturvedi, former Planning Commission advisor and Dr Kirit Parikh, another ex-advisor at the Planning Commission, were formed to recommend petroleum pricing policy. Though the terms of reference of these three committees differed, the bottom line was the same: How should the government manage the petroleum product prices, meeting multiple criteria of keeping inflation low, assisting those below the poverty line, ensuring the viability of public sector oil companies, promoting energy security and finally establishing a competitive market?

The UPA government avoided implementation of the sensible recommendations made by all the three committees as long as it could. It missed the window of opportunity between December 2008 and April 2009 when oil prices were below $50/b.

Truth finally dawned on the government that the oil companies cannot remain viable with under-recoveries year after year. This forced the government to implement the recommendations of the petroleum pricing policy committees. It liberalised petrol prices first to be followed by diesel at a later date. As an initial step, the government has increased residential LPG rate by Rs 30 per cylinder and PDS kerosene by Rs 3 per litre.

Overestimation

Between 2003-04 and 2008-09, the under recoveries of  public sector oil marketing companies are estimated to be about Rs 2,99,000 crore. These are based on Parikh committee report. Since under recoveries do not account for refinery profitability, they may overstate the losses of the oil marketing companies. However, during these five years such an overestimation is not significant. These losses would have been even higher if the government had not reduced the tax burden by reducing excise taxes on petrol and diesel.

Decontrolling petro-product prices helps the economy by cutting government deficit and reducing inflation in the medium to long term. Government revenues will increase significantly when they need not pay for the losses of the oil companies. This in turn can help the government to fight poverty by spending more money on welfare measures like water, health, education, PDS, employment guarantee programme, etc.

Can we justify the government subsidising petrol used by cars and two-wheelers owners and residential LPG? Only in recent years have the poor in urban areas started to use LPG. It is true that diesel price increases can fuel inflation. But as the Parikh committee reported, it will not be significant. The inflation impact of deficit financing caused indirectly by under-recoveries is far more pernicious to the poor.

Subsidies on PDS kerosene and residential LPG give rise to the mother of all corruption affecting good governance and energy security. This is bad for the rich as well as the poor. Kerosene is blended into petrol and diesel. Residential LPG is diverted to commercial and automotive sectors. These illegal activities have resulted in black money generation of about Rs 2,15,000 crore during the last five years.

While all the three reports have discussed the extensive diversion of these products, none have attempted to quantify the impact. All are unanimous in eliminating these subsidies and have recommended the use of smart cards to help the poor.

But why do opposition parties oppose decontrol of petroleum products? Some of them may be influenced by ideology. A few others may not have the right information. But most are influenced by Adam Smith’s ‘invisible hand of self-interest.’ Decontrol and improved subsidy delivery system will reduce the opportunity to earn black money.

It is a well-known and established fact that most of the petroleum dealers are either political leaders or those close to them. This ‘lobby’ also has a strong reason to oppose the decontrol of prices.