The Hindu : Business : Price band for petrol and diesel: a halfway house

Online edition of India's National Newspaper
Monday, Aug 09, 2004

Business

Business

Price band for petrol and diesel: a halfway house

Ultimately, it is a question of who bears the burden (of the oil shock) and in what proportion it is distributed. The sharing has to be done by the Government, the oil companies and the consumers.

ON JULY 31, retail prices of petrol and diesel went up by Rs. 1.10-1.19 and Rs.1.48-1.58 per litre respectively in the four metros. This is the second time after the UPA Government took office that the two oil prices have been marked up. The previous hike was on June 15 when petrol prices moved up by Rs. 2 and diesel by Re.1 a litre.

What is significant about the latest (July 31) mark up, of course, is that it was effected under the new `price band' arrangement, which the Government had worked hard to evolve. Basically, public sector oil companies have been given some leeway in determining the oil prices once every fortnight. A complicated formula has been devised that takes into account the previous 12 month rolling averages as well as three month averages of landed costs of the two products. The average price so arrived at will be the benchmark: the companies can quote above or below it but only within a 10 per cent variation either side.

Complex arrangement

The complexity of the arrangement does not however detract from its merits. By reckoning with a 12 month rolling average the effect of sharp international price increases can be moderated. Secondly, the basis of calculation in the new formula has shifted to C&F costs (of petrol and diesel) from FOB price adopted in the earlier calculations of the oil companies. Landed costs (C&F but excluding insurance) are more realistic from the oil companies' point of view. Besides, there could be scope in effecting efficiencies in transportation that work out to the advantage of consumers. Thirdly, the Government has said that it will calibrate the indirect tax structure to provide a further cushion to consumers in case the band is breached. This possibility however will not be straightforward, given the opacity surrounding price fixation in the oil industry from the refining to the marketing stage.

Consider just a few points: LPG and kerosene prices continue to be subsidised by the oil companies and the Government. The oil companies in turn cross subsidise these products by overcharging petrol. The spiralling crude prices in the international market, by sharply increasing the burden on oil companies, evidently limit such cross-subsidisation. In other words, petrol and diesel prices cannot be viewed in isolation as long as the subsidy regime continues.

The public sector oil companies buy crude from ONGC at prices that are $3 less than international prices. It is not clear where, if at all, these savings appear in the overall pricing structure. Moreover, in times of high prices including those of petrol and diesel, the oil refiners' margins go up. Most of the existing public sector marketing companies have refining capabilities of their own. The only stand-alone marketer, IBP, is now under the fold of Indian Oil.

Windfall for Government

Indirect taxes on petroleum products are on an ad valorem basis. This means that as the price of petroleum rises so do the taxes. In any case taxing petroleum products means large accretions to the Centre and the States. If the ex-refinery price of petrol is Rs. 17 a litre, taxes add another Rs. 20 or so. And obviously the higher the international prices, the more the taxes. Every dollar mark up in global prices yields a bonanza to the Government by way of customs, excise, corporate taxes and now the education cess.

The price band has already been sorely tested with the recent in global prices. Some political parties have decided to launch an agitation. Their argument is that in the prevailing scenario characterised by persistently high oil prices, the Government will have to adjust the taxes and minimise the impact of the rising prices on consumers. On the international oil front, the outlook continues to be grim.

The militant attacks on petroleum installations in Saudi Arabia are designed to scare away the managers and investors in the world's biggest oil producing area. In Russia, the Government's move against Yukos, the giant oil company, has raised question marks over supplies from an important source.

Two other points are of relevance. A price band or any other price agreement will work efficaciously as long as all the public sector oil companies have a monopoly over the marketing of petroleum products. But products distribution has been thrown open to the private sector. Foreign direct investment up to 100 per cent is now allowed and the latest news is that Royal Dutch Shell will soon enter distribution in a big way having already met the Government's stringent entry-level criteria. Reliance, which set up the first refinery in the private sector, is expected to be a major player in the marketing of oil products too. The Essar group, whose oil refinery is coming up, will also enter the marketing field.

The advent of full blown competition in oil marketing will pose all round challenges. For the government owned companies it will be a test case of coping with global level competition while still retaining some or all the characteristics of the public sector. Legacy issues are bound to play a role but already in the run up to a competitive environment public sector oil companies have been consciously improving their efficiencies. For the consumers, the price band mechanism may minimise the oil shock but obviously any relief will be temporary unless international oil prices soften.

C. R. L. Narasimhan

Printer friendly page
Send this article to Friends by E-Mail

Business

News Update

Stories in this Section

Is there still room for softer interest rates?

The big, noisy and underpowered

Salem Steel at a crossroads

Price band for petrol and diesel: a halfway house

Secure P2P file sharing tool

Not many changes in corporate taxation

Inflation, oil news upset sentiment