Saturday, March 13, 2010

Oil Price Deregulation – What is it for India?

Petroleum, in one form or another, has been used since ancient times, and is now important across society, including in economy, politics and technology. Most governments across the globe consider oil price as one of the important economic indicators. Any rise or fall of oil price is felt by all, which includes business houses, stock markets and policy makers. India has for long controlled retail prices all petroleum related products (and still continues…). While one hand this subsidy is good for retail consumers, it puts a huge burden on state run oil companies. The recent expert panel, led by planning commission member Kirit Parikh has suggested oil ministry of India to look at deregulating oil prices in India. It is yet to be seen if the cabinet accepts the recommendations provided by the panel as any price hike in petrol and diesel would have repercussions not only at the political level, but will also impact various other related industries.
Let’s take a closer look at what deregulation means and how does it impact the government, Oil PSU’s and common man.
What is deregulation?
Deregulation generally means the lifting of government control and letting market forces work in the business.
For the local oil downstream industry, the concept of deregulation covers:
1. Price decontrol and
2. Removal of restrictions on the establishment and operation of facilities as well as the importation and exportation of crude oil and petroleum products.
So why have Indian government regulated oil prices??
More than any economic reason I feel that oil and petroleum related prices have been regulated by government more because of socialist or populist reasons. Even, the current price hike is not being politically favored by most UPA allies. Why? It’s not rocket science to understand that any rise in oil prices would cause social unrest and would eventually lead to vote bank issues. So, even though state run oil companies are selling petrol, diesel, kerosene and LPG below the market price, government policy makers are happy to provide subsidy on all petroleum related products. Also, our government feels that by deregulating oil prices it would stoke inflation, which might lead to prices getting increased in all other commodity items. Which might be true….but beneficial to our economy when looked from a long term perspective.
Currently, according to oil minister Mr. Murli Deora the new report has been submitted to the PMO and cabinet for approval. While on one hand ONGC, BPCL, Indian Oil and other state oil PSU’s see it as a game-changer and big sentiment booster, it remains to be seen to what extent the government policy makers agree to deregulate oil prices in India.
Will this benefit India??
Coming to the crux of the issue, will our government deregulate oil prices? If so, what would be the immediate impact on our economy? How will it impact in the longer run?
Let’s look at a transparent picture of the situation.
Global oil rates have touched an all-time record high of $135, and currently at $74 a barrel which roughly translates into a loss of Rs. 1,00,000 crore on the sale of petrol, LPG gas, diesel and so on because the Government is selling all of the above at subsidized rates. If they sell at the real rates (Rs. 15 app. more), then inflation will rise, income levels with proportionately drop, and there will be abject poverty. This being the election year, UPA (Congress) Government has been caught in a Catch-22 situation where it has 2 alternatives –
• Let the price of petrol stay as it is. Due to little or no hedged positions in oil, Government and state-run oil firms are likely to get a beating, as mentioned before, to the tune of Rs. 1,00,000 crore.
• Increase prices of petrol to avoid losses. This transfers all the heavy cost onto the consumers. Being the election year, these voters are going to vent their frustration by voting against congress led UPA Government.

A full deregulation might prove to be detrimental, so government should look at a staggered increase in price and eventually deregulate oil and other petroleum related price over a period of time. If prices are decontrolled, petrol and diesel would be dearer by Rs 4.72 and Rs 2.33 a litre, respectively. But on the brighter side it would lead to a more competitive market, encourage investments and also remove any cross product subsidies (like implicitly regulation favors diesel product over petrol). The main problem with the government has been the system of subsidization by giving oil bonds to make up for a part of the revenue lost on selling fuel below cost. The social and fiscal costs arising out of the current method of subsidization, and taxation are very severe forming a big part of the deficit our country faces at the moment. The new system would help in freeing up all the subsidy money and cut down our deficit thus reducing government borrowing which in turn would check inflation. The money can be better utilized in infrastructure and social and education sectors.
In the short term increasing fuel prices can cause inflation due to an increase in transport costs of the commodities, however sustained study of prices in the US, Europe and Japan where fuel prices are not regulated do not show much effect of fuel prices on the prices of commodity. Even the Indian economy during the OPEC embargo years of the 1980’s did not inflate much on the sudden increase in prices.
In the longer run India’s demand for primary energy by 2030 is projected to be four times what we are consuming today (423 million tonnes of oil equivalent). Hence, it’s imperative that we need to move towards an open and fair market priced petroleum products.

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