Oil Price Deregulation

Inevitable or by choice? Despite the entire hullabaloo over inflation, petrol is set on fire yet again!!!

Recently, our nation facing one of the worst inflationary burdens got another big blow when the government announced hikes in oil and petroleum product prices. That this price hike is going to add to the inflationary woes is a foregone conclusion. Moreover, the recent rise in prices comes after a price hike announced in the budget in March, and thus acts as a double whammy.
There has been a lot of political hullabaloo about the whole issue that has generated immense political heat. But while politicians try to interpret the whole situation in their own paradigm, the government and subject matter ‘experts’ have been consistently saying that this was inevitable. Many have in fact congratulated the government for taking such a bold step given that it was inevitable. I personally feel that any step taken because it was ‘inevitable’ does not reflect one’s courage but rather one’s helplessness and desperation. It might show political courage in the face of rising inflation, but economically, this decision takes the inflationary situation from bad to worse, and there certainly cannot be anything laudable about that. Politics aside, what really is the economically compelling reason for this recent decision?

India as an economy is hugely dependant on importing oil and petroleum products. We do not have enough natural resources of the same, and given a growing economy and ever increasing population, our consumption levels are ever growing. We can have explorations and promises of discovering newer reserves within our geo-political domain; but for all practical purposes, ask any expert working on energy security and you will know that we are destined to remain as a net importer in any projection scenario. Thus, our current economy, and its future growth is heavily dependant on global petroleum
product prices.

Economical impact
However, given that petroleum products form such a crucial commodity for an economy, their pricing is naturally of utmost importance to the government. Till date, we had strictly regulated prices, with the government acting through PSUs controlling the entire procurement, refining and distribution of the products. Petroleum draws the highest amount of subsidies in this country, exceeding fertiliser or agricultural subsidies as the latter is quite sector specific while the former cuts across all sectors and strata of the economy and society. Bulk of this is used as a buffer between international prices (at which crude oil is bought by the country); and the final price at which it is sold to the consumer. In between there are intermediate processes like refining, distribution etc., which too have to be subsidised.

This high amount of subsidy has always created worries, but it was also accepted grudgingly that there was no other alternative. In that sense, subsidising the entire process till date was seen as ‘inevitable’.

Is it inevitable?
The diametric shift of ‘inevitability’ that has taken place today stems from unprecedented rise in oil prices over the last few years. Oil prices have been volatile ever since the US led coalition stepped into West Asia; they were rising during the speculative global boom and have spiraled post the recent financial crisis. Every economy as a result has been feeling the pinch. We too were no exception. The subsidy bill was reaching unprecedented level and it was realised by every expert that it was not possible to continue with it. Thus, the bold took a decision of deregulating oil prices, which means that instead of maintaining constant domestic prices and absorbing the price hike shocks through subsidies, retailers would be allowed to adjust domestic prices in lieu of global price changes. This recent hike is thus not just another hike, but an announcement that further hikes can and will take place anytime on its own. This is the crux of the explanation given by the ‘bold’ and their admirers to justify the recent policy decision.

However a lot remains unsaid. Oil prices and their rise in the global stage, the implications of the same for the domestic economy, the prospects of the PSUs and issues of subsidisation etc have always been an issue, and the proof for the same lies in the fact that the government over time had set up numerous committees to study the problem. The current decision is based on the proposals of the committee headed by Kirit Parekh, which was set up in August 2009. Before that, the same UPA government had setup a committee under Rangarajan in 2005 and another under B K Chaturvedi in 2008. Both the committees submitted their reports, which are also publicly available. But the government put both the committee reports in cold storage!

The previous committees too had accepted that price hike was inevitable. But there is a difference between price hike and deregulation of prices. When the international prices are high and the consumer is charged less, there is a loss known as ‘under recovery’. Such ‘under recovery’ is borne by oil marketing companies like Indian Oil Corporation, Bharat Petroleum or Hindustan Petroleum Corporation etc. It is a well accepted notion that the burden of such ‘under-recoveries’ must be shared by upstream oil companies like ONGC, OIC, GAIL, etc along with the central government that gets customs and excise duties and the state governments that benefit from sales taxes. The Rangarajan Committee explored these options and concluded that there is an adequate buffer to protect the domestic consumer from international oil price vagaries 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. However, the government chose to ignore these suggestions when the report was submitted.

'Forced' option
Instead, today it is pushing forth an option as ‘inevitable’ that is not only harsher on the consumers, but more importantly, an option that could have been well avoided. The logic for price deregulation thus cannot be justified by the current argument of ‘inevitability’ being offered by the experts.

The government has clearly chosen to deregulate prices. The reasons for the same are open to interpretation. One argument is that by choosing to ignore the Rangarajan Committee proposal, the government forced its hands, pushing matters to such extremes that a harsher option was posed as inevitable. This may stem from its reluctance to take upon the bold and complicated suggestions made by the Rangarajan Committee, which would entail revenue cuts for many of the upstream PSUs and its own coffers, along with the different state governments. Trying to derive a consensus of all the involved parties was a task too daunting for a coalition-based central government relying on allies support for its very existence. It was politically easier to push the burden on the final consumer.

The second argument is that this was done on behest of private companies into the oil retailing market, which also includes foreign giants like SHELL along with local biggies like Reliance. One way of dealing with the entire issue of ensuring supplies of oil and its price regulation is to outsource it to private operators and let market forces determine the prices. However, they would demand price fluctuations and have been strongly lobbying for the same. This decision then is another instance of the Government agreeing to their demands.

However, what is very clear is that the decision made by the government on which committee’s proposals to implement reflects a ‘choice’ made by it, which clearly defies the whole argument of ‘inevitability’ it is hard-selling to explain the current price deregulation.