Oil pricing – between devil and deep blue sea

By Sushma Ramachandran

Global crude oil prices are rising once again. And once again developing countries like India are going to be the worst hit. Consumers in this country may have to face hikes in the prices of petrol, diesel and cooking gas in the coming months if the situation does not ease soon in world markets. Indian public sector oil companies are already gearing up to make a case for a price hike to the government, which ultimately takes these decisions.

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The latest hardening of prices in world markets is linked to unstable conditions in Nigeria, as a result of which this major oil producer has had to cut back on output. This has been one of the few instances in the last year that non-availability of supplies has actually forced up prices. In fact, prices are usually being pushed up by factors that have little to do with supply and demand. Nervous oil markets have been reacting to political developments in West Asia or strife in Iraq. On the other hand, international crude oil inventories are still reported to be at comfortable levels, which is why the price rise often appears to be due to speculative activity. Indian government officials, including Finance Minister P. Chidambaram, have therefore been repeatedly stressing that world oil markets are volatile largely because of speculative activity and not due to any shortfall in supplies.

Unfortunately, whatever the reason may be for oil prices going up, the country ultimately has to pay the price to meet rising fuel demand. Total imports of crude oil and petroleum products in 2006-7 are pegged at nearly $57 billion, over $12 billion higher than the previous fiscal. The oil import bill will be even higher this year, given the fact that world prices are now in the region of $66 to $67 per barrel.

And the oil companies are once again making what are known as "under-recoveries". This really means the companies are making losses on sales of fuel, but the impact has not hit their bottomlines as yet. Thus Indian Oil Corporation may still be making overall profits but is incurring losses on the sale of some oil products. Currently this includes petrol, diesel, kerosene and LPG. In the case of kerosene and cooking gas, there is a clear government policy that retail prices will be kept at low, subsidized levels to meet the needs of poorer segments of society. As far as diesel and petrol are concerned, the official policy is completely confusing. Several years ago it was decided to link the prices of these products to international levels but since then there has been some backtracking. In fact the products are now being sold at prices below the production costs. The reasons for keeping prices down is partly because a steep hike could lead to inflationary pressures on the economy, and more importantly, because of the political price that any government would have to pay on this account.

Public sector oil companies therefore keep totting up their "under-recoveries" and presenting them to the government, hoping for some subsidy to keep them afloat. For the past few years, a formula has been evolved to spread this subsidy over the entire oil industry, including the production and exploration companies, which are still making huge profits. Another unique way to lessen the financial impact on the oil companies is to convert the debt partially into government bonds to be repaid at a later date.

Clearly, these measures can only be a stopgap solution to a long-term problem. Ultimately the oil companies need to become free to fix the prices of products at commercial rates. The only exception could be in the case of kerosene, though here too the subsidized rates have only fostered widespread adulteration. As for LPG, this is largely used in urban areas and the subsidy can easily be dispensed within gradually over a period of time. Even several official committees have recognised the need to free oil companies from the grip of governmental control.

At the same time, petroleum is not just an economic raw material but also a highly political commodity. A small rise in diesel prices, for instance, can spark off an inflationary spiral that could bring down governments. A hike in kerosene prices is an equally inflammatory matter, even though subsidised supplies through the public distribution system have virtually dried up owing to rampant adulteration. Raising LPG prices has also raised the ire of the Left parties, which maintain this is a poor man's cooking fuel. Whether it is a National Democratic Alliance (NDA) or a United Progressive Alliance (UPA) government, the issue of raising oil prices has always been a political hot potato.

This time around too, the government is going to find itself in the usual dilemma. Unless prices of oil products are raised, the oil companies may run into losses. On the other hand, hiking prices would be an unpopular move for the UPA. One can only hope the government takes a long-term view of oil pricing issues to keep this sector healthy, but it is more likely that the short term formula will be adopted yet again.

(Sushma Ramachandran is an economic and corporate analyst. She can be reached at [email protected])