Fuel prices: time for a national debate

After Trump pulled the US out of the Iran nuclear agreement, oil price shot up above $80 per barrel, the highest since November 2014. Petrol and diesel prices, which were stagnant during Karnataka assembly election went up to reflect this increase and reached record highs.

The government has three alternatives to face the increasing opposition from the public when faced with the rise in international oil price. The first is to do nothing and allow oil companies to move with the international market. The second is to reduce excise duties and also ask states to reduce VAT. The third is to ask oil companies to reduce prices and absorb losses.

During the period of high oil prices starting from 2006, the UPA government adopted the third alternative. Not only did the irrational pricing policy result in under-recoveries as high as Rs 1.6 lakh crore in 2012-13, but it also forced private sector oil companies to shut down their service stations.

The UPA policy of keeping fuel prices below cost helped the middle class and rich consumers in the short term, but it killed what little competition there was. Also, higher inflation, caused by deficit financing, harmed everyone.

Before the Karnataka assembly election, oil companies used their pricing autonomy to change prices on a daily basis. However, between April 24 and May 14, during the election period, prices remained stagnant though international oil prices were rising. During the Gujarat election last year, too, PSU oil companies kept the prices stagnant without reflecting the market realities.

Oil companies stated that it was their decision not to change the price during the election to “avoid any pain” to the consumer and that there was no request/suggestion from the oil ministry. This is hard to believe. During both these elections, the losses incurred by PSU oil companies were not huge and might have been recovered later. However, the fundamental question is, should the ruling government use petrol and diesel prices to influence voters?

Just before the Gujarat election, the Modi government decided to reduce excise duty on petrol and diesel by Rs. 2 per litre, though crude oil prices were less than $60 per barrel. It is obvious that the reason for the government to reduce excise duty was to influence voters. Such a strategy was not adopted during the Karnataka election, although crude prices were at higher than $70 per barrel.

It is to the credit of the Modi government that it took full benefit of lower oil price by increasing excise duty on petrol and diesel and did not pass on all the benefits to consumers. Petrol duty was increased from Rs. 9.48 per litre to the current Rs. 19.48 and, in the case of diesel, it was increased from Rs. 3.56 per litre to Rs. 15.33 per litre. As a result, government revenues from petrol and diesel increased from Rs. 49,570 crore in 2013-14 to 2,22,410 crore in 2016-17 — an increase of 350%.

Expectedly, there was some criticism of the government’s policy of increasing petrol and diesel duties by the opposition. Surprisingly, it was very muted. All over the world, especially in developed countries and also in many developing countries, petrol and diesel are heavily taxed to raise government revenues.

In recent days, with petrol and diesel prices reaching record highs, the government has come under intense pressure to reduce duties, even from industry and trade bodies. No one likes to pay higher taxes if they can force the government to reduce them. It is in this background that there should be a debate to determine the optimum amount of central and state taxes on petrol and diesel.

With the recent oil price increase, oil pundits have already started to redo their predictions. We now hear of oil touching $100/barrel. While oil price increase of a few dollars per barrel has grabbed all the attention, no one is talking about why we have not seen prices skyrocketing though there are fears of oil disruptions. The potential reduction in Iranian oil production of as much as 1.5 million barrels per day (mmbd) is similar to the disruption caused by the Arab oil embargo during 1973, which resulted in a quadrupling of oil prices.

Shaping policy

There is a possibility of a perfect storm hitting the international oil market which can result in oil prices skyrocketing above $150/b. World oil demand is likely to remain robust. Excess oil inventory has more or less disappeared. OPEC’s surplus capacity is less than 2 mmbd — a tipping point for higher prices. Venezuela’s production is predicted to go down further as a result of the worsening political situation there after the recent election. In addition, should there be even a small geopolitical event in West Asia, it can have a devastating impact on the oil supply/demand balance.

If the above scenario were to take place and oil companies are allowed price autonomy, fuel prices will go up by at least Rs 30/litre above today’s price. If the government decides to reduce excise duty, say, by Rs 10/litre, revenue loss will be Rs 1.32 lakh crore a year. Such a massive revenue loss will result in cutting funds to many welfare projects, if the government wants to control fiscal deficit, or in higher inflation. While the former will affect the poor the most, the latter will affect the people above the poverty line as well as the poor. While adopting any new policy on fuel price, we should also take into consideration its impact on the development of renewable energy sources and adoption of energy-efficient technologies — the main contributors to reducing global warming.

In short, the decision to protect consumers from the oil price shock will be highly complex, especially when the country is getting ready for the general election in 2019. The question before the nation is, what should shape the policy on fuel prices: winning an election or developing the country?