October 11, 2009

Oil Price Manoeuvres

C P Chandrasekhar

IN a show of bravado, the prime minister Manmohan Singh has declared that the free pricing scheme announced recently for petrol would be applied to diesel as well. This makes clear that the policy on pricing of petroleum products had been decided and what occurred a few days back was a well- planned manoeuvre. Not having got an adequate traction from the Rangarajan Committee report on the pricing and taxation of petroleum products and not wanting to lose the opportunity of pushing ahead with petroleum price decontrol under a government not dependent on Left support, UPA II set up an expert group chaired by former Planning Commission member Kirit Parikh. The committee’s clear mandate was to examine the pricing policy for four sensitive petroleum products (petrol, diesel, PDS kerosene and domestic LPG) and recommend a viable and sustainable pricing strategy for these products. The composition of the committee suggested that it was expected to recommend wholesale liberalisation of the pricing of petroleum products. The expert group did not disappoint, and delivered its recommendations in a period of five months. What is surprising is that the government has decided to accept most of the committee’s recommendations and hike the prices of petrol, diesel, kerosene and LPG, opt for price decontrol for petrol immediately and announce that a similar transition would follow for diesel in the not too distant future.

SURPRISING
MOVE
The move is especially surprising because persisting inflation is already a major cause for concern. The Wholesale Price Index (WPI) figures for May pointed to three worrying trends. First, for the fifth month running, the aggregate annual rate of inflation as reflected in the month-on-month increase in the WPI was near or well above double-digit levels. The figures for May put inflation at 10.2 per cent over the year. Second, the current inflation is particularly sharp in the case of some essential commodities, as a result of which the prices of food articles as a group have risen by 16.5 per cent and of food grain by close to 10 per cent. Finally, there are clear signs that what was largely inflation in food prices is now more generalised with fuel prices rising by 13 per cent and manufactured goods prices by 6-7 per cent.

The immediate and near-term impact of the oil price decisions would be an aggravation of these inflationary trends focused on essential commodities that currently burden the common man. Petroleum products are consumed in some measure by all. Given the fact that these products are universal intermediates, entering into the costs of production of a number of goods and services, the cascading effects of the price hike on the costs and prices of a range of commodities is likely to be significant. With prices of essentials already on the rise, the move threatens a return to the days when inflation was a major economic problem faced by the country. It follows, therefore, that this is the worst time for hikes in and the decontrol of the prices of petroleum products.

The government claims that this was unavoidable because of the “losses” being suffered by the oil marketing companies (OMCs). When the domestic prices of oil products are controlled but the price of imported oil is rising, oil marketing companies receive from the consumer less than what it costs them to acquire the products they distribute. This leads to what are termed “under-recoveries”, which would affect the accounts of the oil marketing companies (Indian Oil Corporation, Bharat Petroleum Corporation, Hindustan Petroleum Corporation and IBP) that obtain their supplies of petrol and diesel from the refineries at prices that equal their import price inclusive of customs duty. According to estimates, if retail prices had not been raised, under-recoveries by the oil marketing companies would have exceeded Rs 70,000 crore in the current fiscal year. Since this is unsustainable, it is argued, the hike in prices and a shift out of a controlled pricing regime is unavoidable.

The government’s argument is by no means water-tight. While under-recoveries are a reality, they do not turn oil refining and marketing firms into loss-making enterprises, because those firms deliver a range of products and services, the prices of all of which are not controlled. If, for example, even if we consider the profit after taxes of the most important oil companies over the last ten years, they have remained positive in all years and quite substantially so in some. Under-recoveries are notional losses that only lower book profits relative to some benchmark. Thus, there is little danger that the industry would be bankrupted even if prices were kept at their earlier levels.

There is, of course, the question of fairness. Since there are many players involved in the industry there is no reason why under-recoveries should affect only the books of the oil marketing companies. The returns on net worth earned by the oil marketing companies are far more volatile and vulnerable than that garnered by the upstream oil companies (ONGC, OIL and GAIL). The burden should be shared by the latter, which receive prices that more than compensate for costs; by the central government which garners revenues in the form of customs duties and excise duties (besides dividends from the oil majors); and by the state governments which benefit from sales taxes. This requires, for example, the oil refineries to offer discounts when selling products to the OMCs and for the government to reduce the taxes it levies on oil products in order to absorb part of the under-recovery.

The controversial question as to how the burden should be shared was analysed by a committee headed by C Rangarajan appointed to examine the issue. The committee spent much of its energies on the different stages through which imported and domestic crude is converted into petroleum products supplied to the consumer, and the cost escalation that arises as the raw material passes through these stages. Through that analysis, it found that the upstream oil companies (or oil companies other than the oil marketing companies, such as ONGC, OIL and GAIL) had recorded profits to the tune of Rs 15,600 core in 2004-05 and Rs 14,600 crore in the first nine months of 2005-06. That the oil industry’s contribution to the central exchequer in terms of duties, taxes, royalty, dividends etc. rose from Rs 64,595 crore in 2002-03 to 77,692 crore in 2004-05. That the petroleum sector alone contributed around two-fifths of the total net excise revenues of the centre. That taking Delhi as an example, central and state taxes amounted to 38 and 17 per cent respectively of the retail price of petrol and 23 and 11 per cent respectively of diesel. And that the incidence of taxes as a proportion of the retail price in India was, higher than in the US, Canada, Pakistan, Nepal, Bangladesh and Sri Lanka, though they were lower than in many countries in Europe known for their higher average level of prices. In sum, the numbers suggested that there was an adequate buffer to shield domestic consumers from the effects of increases in international prices, so long as segments that can afford to take a cut in petroleum-related revenues because they have alternative sources of resource mobilisation are willing to accept such a reduction.

MOVE FAVOURING
PRIVATE COMPANIES
Thus, if at all there is an argument for price deregulation, it can only be that it is for some wrong reason to expect the oil companies and the government to bear the burden of the irrational fluctuations in the global prices of oil. That argument too is difficult to justify. When the industry was wholly in the public sector, the prices of oil products were treated as one set of instruments in the tax-cum-subsidy regime of the government. Any losses suffered by the industry or any shortfall in funds required for investment as a result of price regulation were to be met from resources mobilised through progressive taxes rather than from regressive price increases. The government should have adopted a similar approach in the current situation and focused on rules that can and have been devised.

It needs to be noted here that oil prices have not been held constant in recent history. Rather, the average annual increase in prices over the last two decades indicate that the increase (16.5 per cent) has been much higher in the case of retail prices of petrol, for example, than in the wholesale price index for all commodities (9.3 per cent). The common person has indeed borne some of the burden of volatile oil prices. What the government is arguing now is that the burden of irrational shifts in the international prices of oil should largely be borne by the consumer, even if the burden sharing involved is extremely regressive. In what seems an afterthought, the government has declared in its recent pricing policy announcement that it reserves the right to intervene in the market to protect consumers if prices rise to levels too high or price movements are excessively volatile. Nobody can or has taken that right from the government. It is the government that is giving it up, and exposing the common person to the volatility in international prices that has no rational basis.

The question remains as to why the government is choosing this policy direction. Ideological commitment may be playing a role. But, more importantly, the government’s move seems intended to favour the private companies that have been allowed to enter and expand in this sector. Private companies will treat any shortfall in profits as a “loss” and demand price adjustments. The government seems inclined to oblige.

People's Democracy