Oil pricing: a tale of missed opportunity financial scene
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The recent spurt in petroleum prices has put paid to all hopes of decontrol
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— FILE PHOTO
NEED FOR ROAD MAP: A ‘One Stop Truckers Shop’ on the Chennai-Kolkata Highway in Visakhapatnam.
The new UPA government has had to face the challenge of petroleum prices almost immediately after taking office. The task that had eluded all previous governments is to establish a mechanism to determine the retail prices of transportation and cooking fuels.
Nearly four weeks after announcing the government’s resolve to come to grips with the vexatious issue, Petroleum Minister Murli Deora has not followed up with any concrete plan of action.
Complex issue
In many ways the government’s inaction is understandable. ‘Rationalising’ oil prices, for which the government was preparing a plan of action, is a highly complex affair. Besides, if, as widely assumed, a rational pricing policy involves decontrolling some product prices, surely the spectre of rising petroleum prices cannot be ignored.
Unfortunately for the government, the recent spurt in petroleum prices has put paid to all hopes of decontrol even as a long-term solution. This is because any relaxation will cause domestic fuel prices to rise reflecting the hardening global prices. That will be politically unacceptable and may also have deleterious economic consequences. For instance, it can push up inflation.
The government probably missed the bus early this year when oil prices had plunged to below $40 a barrel. It would have been far easier to condition consumers’ expectations and shift to a market-oriented pricing formula when crude prices were low.
Currently global oil is ruling above $70 a barrel. When the UPA returned to power last month it was $10 lower. In any case, total decontrol is simply out of the question. The government will have to exercise a degree of control though what form that will take remains to be seen.
In August last year, the B. K. Chaturvedi committee had suggested a road map for switching over to a more permanent and transparent method of pricing petroleum products than the ones followed by successive governments.
Oil prices were then reigning high and the report could not be considered. But even when oil prices dipped unexpectedly in subsequent months the government of the day could not muster the necessary political will. Then came the elections. Major policy announcements were not possible although the government did bring about a reduction in the prices of diesel and petrol in late January. According to reports, the government is working on a modified version of the committee’s report.
Ad hoc policies
A shift to free market pricing is also not immediately possible given the legacy issues. After the Administered Price Mechanism was dismantled in April 2002, the government policy has been ad hoc and has lurched from one form of control to another.
There has been a high degree of cross-subsidisation among products as well as government subsidies. Oil marketing companies in the public sector do not have the freedom to fix retail prices and have complained of ‘under recoveries’, loosely interpreted as selling below cost. According to reports, IOC incurred a net loss of Rs. 3,673 crore in the nine months ended December31, 2008, HPCL Rs. 4,529 crore and BPCL Rs. 2,892 crore.
Finally, it would be surprising if the government can arrive at a solution that satisfies nearly all. Here, the basics of petroleum pricing need to be stressed.
(1) The petroleum sector is one of the largest contributors tothe Central Exchequer by way of taxes both at the Centre and in the States.
(2) India imports almost three fourths of its petroleum requirements. The oil import bill forms a significant part of the total import bill.
(3) There are four parties, whose interests have to be borne in mind while arriving at an equitable pricing formula for petroleum products: (a) the government (b) consumers (c) public sector oil marketing companies and (d) upstream companies (crude producers).
The global scenario
The recent rise in petroleum prices has defied logic. From its peak of $147a barrel last July oil came down by $115 in December, one of the most precipitous falls ever for any commodity.
A sharp contraction in global demand is said to be the principal cause. Illogical as it may seem in the context of the subsequent recovery in oil prices — they have roughly doubled over the past six months — demand for oil is nowhere near what it was last year around this time. Yet, there are signs that along with the early signs of a global economic recovery demand for energy is beginning to grow.
China and India, among the few countries poised to post positive GDP growth rates, continue be major importers of petroleum.
The reasons why oil prices should start climbing up even amidst recession are to be found in circumstances peculiar to the petroleum industry. There have been reports of under investment in crude production. In a rapidly falling market as existed during the later part of 2008 there was no incentive to invest. New investments take a long time to yield results.
Also, geo-political problems afflict some major oil producing regions of the world. In short, many of the factors that had caused oil price to go up to its peak earlier remain.
C. R. L. NARASIMHAN
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