RAISING PRICE OF OIL

Deepak Basu 

DURING the past few years, international prices of crude petroleum have increased very sharply, with the price rising from 11 dollars per barrel in February 1999 to 35 dollars per barrel in September 2000 and to 52 dollars per barrel in October 2004. In India, petrol and diesel prices may go up in response. Domestic petrol prices are short by Rs 1.88 a litre of the international prices and diesel by Rs 3.30 per litre.

THE OIL POOL ACCOUNT

However, the oil companies are not allowed to raise prices by that level, because of the existence of the price control system that exists as part of the Indian planning. Besides petrol and diesel, the nationalised oil companies are losing heavily on LPG and kerosene, with losses being put at Rs 13,250 crore for 2004-05 fiscal. LPG is being priced Rs 158 per cylinder below the import price and kerosene by Rs 11 a litre, sources said.

The loss is compensated by the Oil Pool Account, which keeps the price within India the same irrespective of vicissitudes of the international price. As a result, when international prices are very low, as they were from the early 1980s until the first Gulf War in 1990-91 and again from 1992 until the second Gulf War in 2002-03, the Oil Pool account would have massive surplus funds. If the government would not divert that money, in theory, it would be sufficient to cover the deficits when the international price would go up, as it is now.

Unfortunately, in India, the government has in the past took away massive amounts of money from the Oil Pool Account and took away the surplus to fill up the increasing revenue gap of the government. India government, due to its irrational, inequitable and corrupt tax system and banking laws, has been unable to collect enough revenues and has to divert money from the Oil Pool Account. The Oil Pool Account like any other stabilisation fund was designed to stablise the domestic prices of the most important industrial raw material viz. petroleum so that both the ordinary public and industries would be protected from the storms in the international petroleum market. If the domestic price of refined petroleum products are allowed to go up and down, most industries and particularly the transport sector will be unable to cope with the uncertainties. Both farmers and ordinary Indians will also suffer.

Although India’s petroleum sector was deregulated in the last April and state-run oil companies were allowed to adjust domestic oil prices in line with global levels every two weeks, the government has been intervening to keep prices down in the face of record high crude prices. Indian basket of crude oil, which had averaged 27.98 dollars per barrel in 2003-04, increased to 34.17 dollars a barrel in April-June and 38.66 dollars a barrel in July-September in 2004.

According to Reserve Bank of India estimates, for every 1 dollars increase in international oil prices, India’s oil import bill swells around 600 million dollars. Oil imports cost India 15 billion US dollars last year about 3 per cent of Gross Domestic Products (GDP). Analysts say that every 5 dollars rise in international oil prices, shaves of 0.5 per cent of India’s GDP. Inflation, which was just 4.32 per cent in April, jumped by more than a quarter of a percentage point to hit 7.38 per cent in the week ending October 23.

The government currently levies a 10 per cent customs duty on petrol and diesel and a 5 per cent Tax on crude imports. India imports about 75 per cent of the 2.2 million barrels of crude oil it uses every day. In the last quarter of 2003, the country imported crude worth 6.6 billion dollars, about a third of the total value of its imports. On the average, India paid 26.70 dollars a barrel for oil in 2003. we should expect India’s crude imports to be almost 2 mm bpd in 2004 compared with 1.8 mm bpd in 2003.

CRUDE OIL AND NATURAL GAS POSITION

India’s crude oil and natural gas production has been stagnating in recent years. Demand, however, has been growing by more than 6 per cent annually, resulting in rapid growth in oil imports. Oil imports presently account for 60 per cent of total oil consumption and are expected to increase to 70 per cent within five years, if current demand and production trends continue. The Indian crude oil import is now around 1.98 million barrels per day, according to the Petroleum Intelligence Weekly. This would translate to around 98 MMTPA (Million tons per year).

Oil dependency increased steadily since 1984, from almost 30 per cent in 1984 to 62 per cent in 1997. It is expected to rise to 77 per cent by 2010 and reach almost 90 per cent in 2020. Currently India’s government does not have plans for strategic reserves. The interest for it is growing, especially from the refining private sector.

India’s yawning energy needs and the looming import gap have led to a reassessment of its energy strategy in recent years. Policies in the energy sector are now aimed at exploiting domestic oil and gas resources more efficiently, attracting foreign investment to finance the required infrastructure, and shifting from imported oil toward the more competitive natural gas.

THE ENERGY SITUATION    

India’s total energy consumption, driven by the demand in electricity generation, industry, and transportation, is expected to more than double by 2020. Assuming a GDP growth rate of 5.5 per cent per annum, average energy consumption in India is expected in grow annually by 3.8 per cent between now and 2020; similar estimates are one per cent for the United States and Western Europe, and 4.1 per cent for China. Average annual growth between now and 2020 in net electricity consumption is projected at 4.9 per cent, in India second only to the corresponding growth rate in China (5.7 per cent).

Currently, coal is India’s most abundant fuel, accounting for nearly 60 per cent of primary energy consumption, followed by oil (30 per cent) and natural gas (8 per cent). By 2010 the share of natural gas in primary energy consumption is expected to rise to 12 per cent, of coal to diminish to 50 per cent and of oil to remain at 30 per cent.

Table 1

Source: UN International Energy Agency, Annual Energy Outlook.

India’s domestic oil and natural gas production has been stagnating, with declining oil reserves. Since 1993, private investors have been allowed to import and market liquefied petroleum gas (LPG) and kerosene freely; private investment is also allowed in lubricants, which are not subject to price controls. Prices for naphtha and some other fuels have been liberalised. In 1997, the government introduced the New Exploration Licensing Policy (NELP) in an effort to promote investment in the exploration and production of domestic oil and gas. In addition, the refining sector has been opened to private and foreign investors in order to reduce imports of refined products, and investment in downstream pipelines is being encouraged. Attractive terms are being offered to investors for the construction of liquefied natural gas (LNG) import terminals. 

Prices of petroleum products have seen their subsidies decrease in the past two years, following the implementation of the second phase of reform. The government is committed to its 2002 target, whereby subsidies to the prices of LPG and kerosene, the remaining subsidised petroleum products, should be reduced to 15 per cent and 33.33 per cent of import parities. The government increased the price of kerosene in 1999. The hike in international crude oil prices towards the second part of the year renewed the need for a major increase in the price of kerosene. However, the decision was delayed due to its political sensitivity.

ACCOUNTS & THE PETROLEUM SUBSIDY

The reformers have pointed out the cost of the Oil Pool account, the stabilisation fund for the crude oil in India. The OPA (Oil Pool Account) is maintained to provide uniform and stable prices by balancing high and low input costs. The private sector and foreign investors are entitled to the global price of crude oil. The two national oil companies, the ONGC (Oil and Natural Gas Corporation) and the OIL (Oil India Limited) are entitled to 77.5 per cent of the FOB (free-on-board) price prevailing in the world market. Petroleum refineries, however, pay the landed cost of crude with duties added on. The oil pool account gets 22.5 per cent of the landed cost of crude oil.

The oil pool account is meant to be self-financing over a period, unless the government takes away the surplus. The APM (Administered price mechanism) is based on the retention concept under which refineries, marketing companies and pipelines are compensated for the operating costs and are allowed a return of 12 per cent post-tax net worth. The efficiency of the APM depends entirely on the ability of the system to keep the OPA in balance. Until the late eighties, the account was in surplus and it became an extra source of income of the government. However, the nineties saw a growing deficit, and by 1997, the Oil Pool Account recorded a deficit of 5 billion dollars, thereby leaving no other option for the government of India but to issue oil pool bonds. However, with international crude prices falling as low as 11 dollars per barrel in early 1999, the OPA showed a surplus and this resulted in the pool bonds being redeemed. With the increasing price of crude oil the Oil Pool Account once again began showing a deficit.

The ceiling of Rs 5570 per tonne (17.67 dollars per barrel) will ensure that the difference between the administered price and global price (close to 28 dollars a barrel free on board) flows steadily into the oil pool account. The ceiling ensures an inflow of close to Rs 40 billion from the price petroleum refineries pay for crude oil and keeps the Rs 60 billion deficit in the kitty from getting bigger. The concern over the growing oil pool deficit and despair over the government’s efforts to roll back subsidies suggest that the cap on the domestic price of crude, is likely to stay. The ceiling price, notwithstanding, the sales margins of the ONGC and the OIL should get considerably plumper since the middle of last year, when they were paid a floor price. Partial parity with international crude rates followed until crude prices touched 25 dollars a barrel in November 2003. The November 2003 rate determined the price ONGC and OIL got in January. The petroleum ministry has now decided to keep the November 2003 price (17.67 dollars a barrel at 77.5 per cent of the world price) as a ceiling.         

EFFECTS ON INDUSTRIES

The reformers have pointed out the inefficiency of the subsidy system in India by looking at the Table 2, prepared by the international Energy Agency about the effects of the removal of subsidies on the prices of various types of refined petroleum products in India. As we can see, the effects are mainly on those products, which are very important industrial raw materials for steel, cement, and chemical industries, the backbone of any modern economy.

Table 2

Notes: Calculations are based on 1998 prices and quantities.

Sources: International Energy Agency (IEA) World Energy Outlook.

Transport is the obvious sector, which bears the main burden of any price rise of refined petroleum. Through the transport sector, the effects would be felt on the entire economy. Inflation, without the Oil Pool Account subsidies can very well reach 25 per cent as it was during 1974-75, when the international price of crude oil rose by 400 per cent. However, during the 1970s Indian economy was protected from the imports from the other developed countries and China, who very wisely maintain massive subsidies on all types of products and adjust their exchange rates to promote exports. In India, since 1991, the government has removed protections for the Indian industries. The Reserve Bank of India quite foolishly thinks that the strength of the Rupee is the strength of Indian economy. It is not taking into account of the ill effects of the huge amounts of temporary foreign deposits in India that has increased India’s foreign exchange reserve to a very high level, thereby disabling rupee to go down as required when the country is receiving foreign investments.

If we add the recent decisions by the reformers to reduce import taxes on products already produced in India, the total effect of the combined attacks of high price of petroleum products, lower import taxes and strong rupee will devastate Indian industries. India’s Rs 1,30,000 crore chemical industry --- the backbone of the basic industry – is undergoing a silent transition. However, the ongoing wild fluctuations in the crude oil prices, reflected in the current flare-up of the domestic chemicals and petroleum prices, are matters of great concern for the domestic chemical industry as a whole. Even, raw materials price rise is faster than industry players can raise the prices and hence, in turn, this situation could put the chemical and petrochemical pricing under severe pressure.

The overall impact would be far more serious, with the sharp drop in import tariffs, which has posed significant challenges for the local chemical industry players. The problems have aggravated since the last decade, with the gradual lowering of the import tariffs. The argument that lower import tariffs would encourage more foreign investments is unfounded. Even when the entry barriers have been pulled down, there has been no significant improvement in the foreign direct investments (FDI) in this sector. 

THE ROLE OF CHINA

Energy demands are rising in China constantly to keep up with economic growth. The country is already expected to pay an extra 8.8 billion US dollars to import the 880 million barrels of oil it needs this year. Government price adjustments have protected Chinese consumers from the jump in international energy prices.

Although China’s domestic oil prices are linked to the three global trading hubs Rotterdam, Singapore and New York—the government has maintained a cap on domestic levels since May 2004. The Chinese government ordered an average 6 per cent increase to retail petrol and diesel prices in August 2004. Domestic prices of petroleum products are still far below international prices.

The Chinese government, worried that excess growth could set the economy up for a painful downturn, has curbed credit, tightened lending to some industries, such as cement and steel, and made it tougher to gain approval for industrial projects. Chinese demand grew at a much slower rate in July 2004, at just 778,000 bpd as compared with a year ago, and also in comparison with the preceding three months, which booked annual growth of 1.1 and 1.45 million bpd respectively.

There is debate over whether China’s massive crude imports for this year – up about 40 per cent from 2003 – represent real demand. Some analysts reckon the Chinese government has ordered state oil companies to hold inventory. China may have stocked as much as 285 million barrels of oil since early last year. Chinese officials have said work is going on to build the initial phase of a strategic oil stockpile, which could be filled within the next year. It seems that China’s decision to create the strategic stockpile of petroleum is due to its fear of an international embargo, if and when, China reclaims Taiwan.

THE ROLE OF THE USA

 However, China is not a major factor in the recent rise of oil prices, but USA is. Dependency on imported oil for the US is growing. Even before the 9/11 attack USA was trying to expand its Strategic Petroleum Reserve (SPR). This had a dual purpose: to maintain the domestic price of oil at a desired level by releasing petroleum from time to time to the domestic market and to maintain a massive reserve in case of any major political changes either in the Middle – East or in Venezuela. Since 1974, oil prices within the domestic economy are controlled by the government by using both taxes and subsidies. Indian reformers should take the clue from the US that even the champion of the free market system uses subsidies whenever it is required for the economy. Increasing demand for crude oil in the international market is mainly due to the increasing demand of the USA to increase the stockpile in the SPR.

There is another factor, which is equally important, if not more so. Given the need for the US war efforts, its budget deficits are increasing, as it was the case during the Vietnam War. As a  result, the value of dollars in the international market is falling, as it is becoming less and less attractive compared to euro. However, dollars has a major instrument to prop up its value. The international trade in crude petroleum is conducted only through dollars. If any oil producer will try to change the system by accepting euro, it cannot survive. Iraq was invaded, as Saddam Hussein had tried to change its foreign exchange reserve from dollars to euro and was ready to accept euro rather than dollars for its export of oil. OPEC (the Organisation of Petroleum Exporting Countries) was also considering the change from dollars to euro in early 2001. The US invasion of Iraq has stopped that effort.

Given dollars is the only means of exchange in the international petroleum market, increased price of oil means more demands for dollars. That would automatically increase the value of dollars. Increased price of oil does not affect the US government, as it can print dollars at will and buy whatever it needs from other countries. There is no need for the US to earn foreign currencies in order to import, it can pay by its own currency i.e. dollars. If USA has balance of payments deficits, the IMF will not force it to devalue dollars. Instead, USA will ask other countries to buy US government bonds. Because of this unique position of dollars, by which USA can buy anything from other countries practically free of charge and force others to lend money to it. In this scenario, increased price of oil means increasing deposits in the US banks, increased sales of US government bonds, increased profits of the Western oil companies and as a result increased tax revenues of the US government. Thus, the war in Iraq can be financed by itself.

How long this process will continue will depend on the willingness of the US allies in Europe and Japan to tolerate the increased price of oil, which hurts their economies as well. When the pressure from the allies would be strong, the price of crude oil will come down, as it is not a result of normal supply deficiency, but it is manufactured artificially to serve the imperial ambition of the US to dominate the world.

WHAT SHOULD INDIA DO?

It is unfortunate that rather than having a comprehensive energy planning, India since 1991, has abandoned planning altogether, and has decided to go along with the tide of the ‘Economic Reform’ policy. The result is the present crisis. The solution for India is to go back to the comprehensive planning of the energy sector as well as the economy, as one cannot happen without the other.

The transport policy, based on road system and private transport, is infeasible for India given very limited petroleum reserves. India should develop public transport system based on electricity and develop more and more railway transport instead of road transport. Given the massive coal reserve for thermal power plants and India’s expertise with the nuclear power plants, it is the best option. There should be subsidies for solar energy, which can meet the demands from the residential sector in a big way. Private ownership of car should be discouraged by tax increases on car ownership. In public transports, electricity instead of petroleum can be used in a big way by converting the normal bus into trolley bus, which can run on electricity with the same speed. Trams, restricted only to Calcutta, should be introduced in every city and in the link road between the cities and nearby towns. More railway lines should be there between the major cities. In these ways, the demand for oil from the transport and the household sector can be controlled. However, industrial demands for petroleum cannot be reduced without major changes in technology. For that case, import controls and increased tariffs on imports, to protect Indian domestic industries and to reduce India’s total import cost, are the answer.

The recent energy crisis is the result of the false doctrine of “Economic Reforms’ and the unwise decision of the ministry of finance to withdraw money from the Oil Pool Account without compensating it when needed. Without subsidies, the costs will escalate throughout the economy and in near future the government will be forced, to give either, direct subsidies to the industries and farmers or to provide special loans and tax-breaks to help them to recover. The eventual cost will be much more than the subsidies for the Oil Pool Account.

Another fear is the growing inflation due to the rise in domestic prices of oil products, which would affect the poor much more than the industrialists or rich farmers. If the government wants to reduced inflation by increasing the interest rate, the cost of borrowing will go up, there will be more industrial failures and unemployment. These are the perils of a privatised economy, which a planned economy can avoid easily through cross subsidies and direct infusions of investments.

The costs of subsidies to the oil Pool Account are very insignificant compared to the uncollected tax revenue (about Rs 95,000 crore) or the unpaid loans (about Rs 150,000 crore) from the nationalised banks. If the Indian government, just like the government in any of the developed countries, makes tax avoidance a criminal offence and uses bankruptcy procedures as the mandatory instrument to collect both unpaid loans and taxes, the revenue situation of the government will improve significantly. As a result, the country can tide over this crisis of the oil price-rise easily without putting the burden on the poor Indians.

(Dr Deepak Basu is presently Professor in International Economics in Nagasaki University, Japan)