The Hindu : Business : The burden is on economy

Online edition of India's National Newspaper
Monday, Oct 11, 2004

Business

Business

The burden is on economy

PETROLEUM PRICES are again on the boil. After crossing $50 a barrel on September 29 it softened a bit, only to spurt again last week. The outlook for an oil importing country like India is grim. Almost 70 per cent of the country's requirements of oil is sourced from outside. Oil purchases have driven up the import bill. The latest balance of payments statistics released by the Reserve Bank of India for the first quarter of this year indicate the highest merchandise trade deficit ever for any quarter at $6.1 billion. Oil imports account for a substantial portion but (in what is seen as a positive factor for the economy) non-oil imports have also been brisk.

There is no indication that the global demand for oil will ease in the near future. Meantime, the fortnightly review of retail prices of petroleum products took place on September 30 with the Government deciding that the public sector oil companies will bear the brunt of the high global oil prices. The state owned oil companies have no alternative but to comply. The oil shock is particularly onerous for them as it comes on top of a huge subsidy burden they bear in selling LPG and kerosene. Only recently, the top managements of these companies were airing their views on the sheer unsustainability of having to meet the cost of subsidies and `under recoveries' in the sales of petrol and diesel even when global oil prices zoom to $53.

Opaque pricing

Yet it is a measure of the opaqueness that characterises the petroleum industry's pricing in India that even a hugely negative development such as persistently high global prices result in fortuitous gains to refiners while inflicting losses on the marketing companies. That is one reason why ONGC's shares have been on the rise. The industry as a whole is hit by the oil shock. Recently ONGC's Chairman, Subir Raha, articulated the concerns of all petroleum companies over their strained finances.

The Government, the third stakeholder — domestic consumers and the petroleum companies are the other two — says that it is reviewing the indirect tax structure. It points out that it had forsaken Rs. 2,400 crores when it cut indirect taxes in August. Further duty cuts to moderate petroleum price increases will depend upon the willingness to forego large revenues. The saving grace is that the Centre will essentially be giving up windfall gains. When the budget was framed in July nobody would have visualised petroleum prices to go above the $50 mark. As the indirect taxes are being levied on an ad valorem basis, there is a cascading effect every time global oil prices move up.

For the record, the Government claims that its petroleum `basket' currently costs $40 a barrel but if international prices continue to stay at current levels, the figure will have to be revised upwards. The message is clear. In the end the entire economy bears the costs of the oil crisis. The Government may try and artificially distribute the burden among the various stakeholders. Those are, at best, interim solutions.

A snapshot of the global oil situation reinforces the growing pessimism over oil supplies. Within OPEC only Saudi Arabia, Venezuela and Iraq have excess production capacity but all three have varying constraints. All of them need to invest substantial sums. The geo-political situation in West Asia is unlikely to improve dramatically in the short run. Analysts say that the huge Caspian oil reserves cannot be exploited so easily because of the attendant political risks. Unstable conditions in the Niger delta in West Africa also inhibit oil supplies. On the other side, major existing production zones in the West such as the North Sea and Alaska are in a state of decline. The International Energy Agency has underestimated global oil demand in the past .It now estimates a shortfall of more than a million barrels a day in the last quarter (October-December 2004).

Interestingly it lists, for the first time, India and China as major consumers. The global oil market has attracted speculators, although no one can be sure whether they alone have contributed to the high prices. It is more likely that speculators have followed investors.

That is perhaps inevitable given that oil has been one asset where investors could never have gone wrong over the past one year. There is unanimity among experts that the current oil scenario is unique in one respect: for the first time global oil price is determined by demand and supply unhindered by the actions of a cartel.

Under those circumstances there is precious little that a country like India can do to lower its import bill.

C. R. L. Narasimhan

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