Petroleum Pricing Policy in India: Need for Change

India is one of the fastest growing economies of the world. At the same time, the country is also home to almost one fifth of the total world population. With such a huge chunk of the world population and growth rate of the economy hovering around 8 to 9 per cent per annum for last five years, the demand for the petroleum products is expectedly high. Keeping the social and economic
ramifications in mind the government has always remained involved with the pricing and supply of these products.

The reasons for the direct involvement of the government are not difficult to seek. While the demand for the petroleum products is rising by almost 15 per cent per annum, the domestic production of the crude oil has virtually remained stagnant over the last two decades, making the country heavily dependent on the import of crude.

Further, the rapidly developing economy requires petroleum products like diesel and petrol in huge quantities for carrying goods across this vast country. Diesel is also used by many industries as a critical input for production. The booming automobile sector of the country also needs a lot of petrol and diesel at reasonable prices. Thus, any steep increase in the prices of oil adversely affects the Indian economy.

More than 250 million people in the country live below poverty line and there is a vast majority of population classified as the middle class. It is the responsibility of the government to provide the cooking fuel to the poorer sections at affordable rate and the government has been continuing with its policy of subsidising kerosene heavily. At the same time, the middle class, constituting majority of the population of the country, cannot afford the LPG at the market rate and hence the government has to subsidise the LPG as well.

Immediately after independence the cost realization to the oil companies in the country was linked to the ‘import parity’ type of pricing, known as the ‘Value Stock Pricing’ (VSA). This mechanism was basically a cost-plus formula to the import price, which included added elements of all the costs such as shipping charges upto the Indian ports, insurance, transit losses, import duties and other levies and charges.

The VSA was followed by the Administered Price Mechanism (APM) which actually involved artificial price fixing by the government from time to time and hike or reduction in the prices become a political decision, rather than being a rational economic decision. The decision to dismantle the APM was aimed at gradually shifting from artificial pricing of petroleum products towards a situation where the price is determined by the market forces of demand and supply. Hence, as a conscious policy decision, the government brought into the force a new pricing mechanism with effect from April 1, 2002.

The new mechanism was designed to partially insulate the prices of petroleum products in the country from volatile international crude oil prices. At the same time it was to ensure that the prices of certain products like kerosene and LPG remained subsidised as per the government policy.

It was expected that the new pricing mechanism would be the first step to move forward towards a pricing mechanism based on the interaction of the market forces.

While the weaknesses of the new system had come to the fore during the past six years of its enforcement, the recent spurt in the global crude prices has completely exposed the flip side of it. While devising the new mechanism six years ago, no one had thought that the global crude prices would be close to $150 per barrel.

One of the most prominent arguments advanced by the Central government in favour of the recent steep hike in the prices of the petroleum products was that the oil companies were suffering heavy losses and had to be bailed out. This logic, however, exposes the illogic of system of pricing these products. If the aim was to effect the import price recovery, the same badly lost focus in the previous years and the price determination for this sector has again turned out to be a purely political decision.

While the country is undoubtedly dependent heavily on imports, almost one fourth of the total crude requirement is met by domestic production. When price per barrel of crude oil is discussed, the fact that one fourth of the total supply of the crude is met domestically is over-looked. Domestically produced crude oil costs the nation something around $55 per barrel and if the global price is taken to be around $150 per barrel, the average weighted domestic price comes to be around
$122 per barrel. When converted to per litre, it costs the country about Rs 31 per litre. The refining and distribution costs included, the average cost of petroleum products like diesel and petrol should not be more than Rs 35 per litre, while the average rate of these commodities has been fixed higher.

At the same time it should not be forgotten that the petroleum products are the most taxed commodities in the country. If the government is so much concerned about the prices of the petroleum products, it must reduce the excise duty and the VAT rates across the country. But such a decision would result in loss of revenue. It looks like the loss to the oil companies is a myth created by the government to protect its own revenues.

The performance of the public sector oil companies does not suggest that these companies are under any threat of loosing out their profits after the global crude price increase. Their profits have actually increased.

The Alternative
The logic behind the extent of increase in prices is neither understood by the general public and nor is transparent. Under the current scenario, where the crude oil prices are fluctuating with upward trend, the pricing mechanism has become even more suspect.

But the government does not have many options. One option is to go back to the previous APM regime, having zero transparency. But such a step would be retrograde in nature. Even if re-introduced with certain modifications, the APM may fail to come up to the expectations of the consumers.

Second option is to switch over the market driven system under which the government would have little role in determination of petroleum prices. Should the government decide to go in for this regime, several prior actions are required to be taken. The government shall have to dismantle the regime of subsidies in respect of diesel, LPG and kerosene altogether. If the subsidies are not to be scrapped altogether and are to be provided to the targeted group of people (viz. those living below poverty line), then a separate distribution network needs to be identified to cater to their needs.

Such a system, however, may be politically unacceptable to most of the political parties. More particularly in the present day scenario, when the inflationary pressures are at their peak.

The solution lies in suitably modifying the existing system to a large extent. The changes must aim at reducing the discretion in the process of determining the prices of the petroleum products. Deter-mination of prices should be more transparent, with sufficient and well defined role of the market forces. Subsidisation of the products like kerosene and LPG should only be targeted to the people living below the poverty line by devising a suitable mechanism. Remaining subsidies must be withdrawn by adhering to a prescribed timeline.

A suggestion has been made that different types of diesels should be used for trucks and luxury cars. It makes no sense to supply diesel at subsidised rate for the owner of a luxury diesel car. It is high time that the railways also switched over to the use of 100% electricity for running the trains. For transport vehicles CNG should be used, which is less polluting, on the one hand, and would result in liberating the goods transport sector from the use of diesel, on the other.