Should fuel prices in India be freed permanently?

Bibek Debroy, May 8, 2011, 06.17am IST

Tags:
 Rangarajan committee|
 India
Let's note that had all official promises been kept, fuel pricing would have been market determined by
now, and kerosene and LPG subsidies would have been zero. Now, let's look at the cost of the current
system of pricing. Since 2004, we have had a band (+/-10%) around a rolling average of import prices. 

But this was honoured in the breach rather than in the observance. If there is an agreed and transparent
band, as an oil marketing company (OMC), why do I have ask the government for permission before
implementing an increase? But OMCs do have to ask for permission and permissions have become rarer
and rarer. 

For LPG and kerosene, it is worse. Kerosene is a so-called poor man's consumption item, despite it being
used to adulterate diesel and despite it leaking to neighbouring countries. NSS data show the poor are
switching from firewood to LPG. 

In any event, vocal non-poor (urban middle class), as opposed to genuine poor, will resent increases in
LPG prices, notwithstanding LPG (instead of CNG) being used for vehicles. Thus, the price of not one
petroleum product is what it should be. Had retail price increases been continuous and incremental, they
would have had small cost-push shocks. However, if backlog of repressed price increase accumulates, any
price increase is difficult to contemplate. 

The second distortion comes from losses suffered by OMCs. To counter this, the government ordered
adjustment of refining margins and got upstream oil companies to cross-subsidise downstream OMCs.
Computations of "refining margin" and "import parity price" are both non-transparent. Every indirect tax
reform committee has decided to leave petroleum products (and liquor and tobacco) outside the reform
mandate. Those high taxes are the primary reason why retail prices of petroleum products are so high. 

But upstream companies also complain about losses. So we conjure up another "brilliant" idea of selling
government bonds to OMCs, effectively postponing the problem. After all, government bonds are not
open-ended, they will mature. However, the golden rule of policy-formulation is always to be myopic and
focus on short-term. Didn't Keynes say we are dead in the long run? Who cares if future investments in
petroleum sector are also dead in the long run? 
There was also another non-brilliant idea, in the sense that it wasn't a new one. Whenever in doubt, and
whenever there is discomfort with implementing change, set up a committee. If there is one sector studied
ad nauseam by committees, that's the petroleum sector. Thus, we set up the Rangarajan Committee in
2006. There are, of course, also groups of ministers on petroleum. And a GoM meet is scheduled next
week. 

All this is, obviously, tinkering. We have to remember that there is no reason why crude oil prices should
cool. This has implications for growth. Every $10 increase shaves off around 0.35% from GDP growth.
This has implications for managing balance of payments. 

It also has implications for inflation; the underlying reasons for food price inflation aren't going to
disappear. But most importantly, it has implications for reforming the petroleum sector. Should retail
prices of petroleum products be increased? Stated thus, the answer is that they should. 

But the real answer is a little bit more complicated. If there is one sector that demonstrates dangers of
half-hearted and half-baked reform, that's petroleum. This isn't about consumption subsidies and retail
prices alone. The entire system (refining margins, taxes, price determination) is messed up through
government intervention. Reforms aren't about tinkering with one small piece in the jigsaw. We need a
thorough overhaul. 

If the cost price of petrol per litre is Rs 58.90, following is the break up of cost calculated by
the government.
 Basic Price: Rs 28.93
 Excise duty: Rs 14.35
 Education Tax: Rs 0.43
 Dealer commission: Rs 1.05
 VAT: Rs 5.5
 Crude Oil Custom duty: Rs 1.1
 Petrol Custom: Rs 1.54
 Transportation Charge: Rs 6.00
 Total price: Rs 58.90
Company Basic Price calculation – Considering that the current price of crude oil is $107
(on 22 September 2008) per barell, cost of per barrel in RS will be 107*45.40 ($1 =
Rs45.40 as on 22 September 2008) = 4858.
One barell consists of approximately 160 litres. So Price of crude oil per litre will be
4858/160 = Rs.30.36.
Now Indian Oil Company loses 1.43 Rs per litre + cost of transportation of crude oil and
refining the price.

1) Will lead to rise in inflation sharply which is around 10.16 % already in double digit.
2) Will Lead to rise in prices in almost all sectors major sectors affected will be Transport, Auto, FMCG, Textiles.
3) The rise in LPG gas will cut the common man’s pocket deeply.
4) It will also have an impact on banking sectors as the hike may lead to rise in inflation which will urge RBI to rise
interest rates thus affecting banks due to tightening of CRR.
5) The decision will help to rein in the fiscal deficit, which is projected at 5.5 percent of the gross domestic product
in 2010/11 and free up revenues for other progammes.
6) State oil firms currently lose about Rs 215 crores per day on selling fuel below the imported cost. Thus it will help
these companies to make profits. 

The Government subsidy on the prices of fuel has kept the prices low. But this subsidy has led to defects in
government budget. This in turn effects plan out lay for other projects. It lhas come to a stage that the
governmnet is no longer in a position to provide this subsidy.So the government is deregulating the prices of
fuel.Now the prices will be according to the international market conditions.Once the government remove this
subsidy it will have money to spend for other economic growth this will in turn will bring down the negative inpact
of fuel price rise. But till such time the price rise will add to inflation. and prices of other commodities will go up.
By deregulating the market the governemnt is looking for long term growth.

Petrol price deregulation

The Indian government has said that gasoline and diesel prices will now be market-
determined as the federal government seeks to shrink its budget deficit and help state-run
marketing companies cut losses on selling fuel products at state-set prices. The
deregulation will lead to a INR3.5 per liter increase in the price of gasoline, while the price
of diesel will go up by INR2 per liter as of now.
 
India's reform of fuel pricing is likely to have significant effect on the regional oil products
market. It's a game changer for Indian companies. Refiners Reliance Industries and Essar
are to compete with state-run firms for retail market share; private Indian refiners typically
see better refining margins. Private companies will now compete with state run companies
to sell their products.
 
The Big Rider
But the ministry secretary hints a possible comeback of government controls if and when
crude prices surge; the move resembles similar strategy in 2002 when India freed price
controls but brought them back once rising crude was affecting the local inflation rate. The
secretary says government may intervene in fuel prices if crude prices surge.
 
EFFECTS
 
1)     Inflation will rise. There is no doubt over the same. In the short term and medium
term overall inflation will rise. But in the long term the higher base effect will negate
all the rise.
2)     Interest rates: Higher inflation will in higher the cost of borrowing. We expect RBI to
raise interest rates by seventy five basis points before the end of December.
3)     Private sector oil companies and oil marketing company’s margins will rise.
4)     Fiscal deficit will be contained but all depend on the monsoon which so far has had
unsatisfactory progress.
5)     Hedging: Now even a single petrol pump owner will resort to hedging of petrol. For
example a petrol pump owner has 10,000 litres of petrol in his stock today (25 th June
2010) and say on Monday 28th June petrol prices will be changed. The petrol pump
dealer (A) Will sell crude oil futures in MCX or any other commodity exchange if he
expects petrol prices to fall on Monday (28 th June). (B) If the petrol pump owner sees
a short term bottom being formed in petrol prices he will buy crude oil futures in
MCX or any other commodity exchange.
 
Will the common man benefit OR loose from the petrol price deregulation
 
Initially the common man will stand to loose as higher fuel prices destabilises this monthly
budget. A rise in fuel prices implies a rise in the cost of everything without any increase in
salaries or income. There will be a marginal fall in short term savings. In the long term
when crude oil prices stabilise or stay at low levels for a considerable period of time then
the common man will benefit.
 
Certain Things need more clarification
 
There is no information after how much time petrol prices will change say every week or a
fortnight etc. Unless there a clear view on the same it will be very difficult to give a precise
view of the effects. Further, will state run oil marketing companies be free to actually raise
prices OR they will be dictated by the whims and fancies of the ruling UPA coalition. I am
talking about independence of state run oil marketing companies. I also have my doubts
whether diesel will be decontrolled in the future if global crude oil prices break and float
over $100 before the close of the year and stay over $100 for a longer period of time.
The hike in petrol prices will fuel inflation further as commuting costs go up and add to the
crushing burden on household budgets already stretched with soaring prices of essential
foodstuffs.

The increase in the price of petrol comes into effect from the midnight of Saturday-Sunday.

Petrol at Indian Oil filling stations in Delhi will cost Rs 58.37 per litre up from Rs 55.87 a
litre till Saturday. The price at Hindustan Petroleum and Bharat Petroleum pumps has been
fixed at Rs 58.39 per litre.

This is the second hike in petrol prices in a month as crude oil prices have skyrocketed to $
92 a barrel in the international market.

The government has officially allowed the public sector oil companies to charge
marketdetermined prices since June 2010 but the oil companies still consult the petroleum
ministry headed by Murli Deora before announcing any increase in prices as inflation has
become a political hot potato.

"This government is indifferent to the continued agony of the common man," said Ravi
Shankar Prasad, chief spokesperson for the BJP. "For the last two years, prices have been
escalating without any check. And the government, instead of taking tangible steps to
control it, only seems to be making the situation worse. They do not seem to have any
direction, vision or commitment to manage price rise."

CPI MP Gurudas Dasgupta said, "It is a dangerous move. Prices have already become

uncontrollable and another hike in petrol prices will only spiral prices further. I do not
understand what they are trying to prove, it is almost as if there is no government in this
country."

It is not just petrol prices, the oil companies also want to raise the price of diesel as the
revenue loss on sales is currently at Rs 7 per litre, but the government has been over-
cautious on diesel as it is a politically sensitive commodity.

Not surprisingly, diesel prices have remained constant, while petrol prices have risen six
times since June last year.

Petrol hike fuels anger in capital

TNN, Jan 16, 2011, 12.18am IST

NEW DELHI: Petrol prices were hiked once again on Saturday evening, much to the dismay of Delhiites,
who had been put through a similar hike barely a month ago. With effect from Sunday, petrol will become
dearer by Rs 2.53 per litre.

"This is a shocking development. They just had a fuel price hike towards the end of last year. Why are we
being tortured by another one? Petrol will now be available for almost Rs 60 per litre. The last year has
been extremely difficult for everyone with prices of so many things rising. Onion price touched Rs 80 per
kg so even the poor man was affected. The government is heading for a huge crisis if this continues," said
Satish Chaturvedi, a businessman.

Alok Singh, a resident of Karol Bagh, said: "Public transport has become expensive in Delhi. Buses and
Metro are packed beyond capacity, so I would not like to use those. If I can't afford a petrol car, I will have
to switch over to diesel, as will several other people. The government should not complain about rising
pollution levels then."