Petrol freeing comes with volatility

Use of global benchmarks to charge for products at home raises the issue of whether there's a better way to do this

When oil companies increase the price of diesel by about 50 paise a litre in a few days, many would question a third increase in a row when the average benchmark Indian crude oil basket, at around $108 a barrel, is below last year's average of $112.

In fact, while the diesel price is showing an uptrend, petrol at Rs 68.34 a litre in this city is seven per cent lower than the May 2012 high of Rs 73.18. Even the cooking gas subsidy of Rs 439 is limited to only nine cylinders now, beyond which domestic consumers have to pay Rs 904 for every refill.

As the UPA government enters the fifth year of its second term this May, its biggest policy imprint can be seen in the petroleum sector, where there is market pricing for petrol, dual pricing in diesel and a cap on subsidised liquefied petroleum gas (LPG) cylinders. "These initiatives, if implemented fully, are envisaged to reduce the under-recovery of oil marketing companies (OMCs). Though the government compensates OMCs for diesel and domestic cooking fuel, the implementation will improve the liquidity of companies," said P K Goyal, director (finance), Indian Oil Corporation.

In June 2010, oil companies were allowed to revise the price of petrol in accordance with international prices and the exchange rate. Though there have been political hiccups, forcing oil companies to refrain from increases despite the pricing freedom, by-and-large petrol prices have been moving in line with international prices.

The price of bulk diesel was also deregulated from January 18 this year and in-principle approval given to allow OMCs to raise the price of diesel at retail outlets by 40-50 paise a litre every month till the under-recoveries were wiped out. In the case of LPG, while the subsidised price continues to be Rs 410.5, the non-subsidised cylinder is currently priced at Rs 904, after a Rs 37.50 cut on March 2.

Calculations
Benchmarks such as the Persian Gulf region price for diesel, kerosene and LPG, and the Singapore region price for petrol, are used by OMCs to calculate the desired price and the revenue loss they incur on selling below that price. Petroleum product trading in the Asian region mainly takes place in Singapore, the primary trading centre. Assessment of the price of petroleum products for the Gulf market is determined net of freight from Singapore.

 

Explaining the rationale, Goyal said crude oil and petroleum products are global commodities, the prices determined by supply and demand factors on a worldwide basis. "There is no link between the Indian crude oil basket and prices of petroleum products. Prices of petroleum products are dependent on the fundamentals of demand-supply of individual products and other factors in the international market impacting the fundamentals," he added.

Accordingly, since the costs of an Indian refining company were based on imports, with linkage to the crude oil price in the international oil market, the prices for finished products at the refinery gate were also required to be determined on the principles of import parity with linkage to the prices for the respective products. The petrol price, for instance, showed a spurt during the first quarter of the calendar. "They generally start levelling back during the second quarter. Keeping this trend in view, prices might move downward as and when international petrol prices soften," said a senior executive.

Under the present system of trade parity, companies calculate the retail price of petroleum products with 80 per cent weight for import price and 20 per cent for export. Import parity price for petrol and diesel comes with a tariff protection equivalent to 2.5 per cent customs duty on these products. Export parity price consists of the Gulf price without freight. "This is why oil companies still run in profits, despite the under-recovery costs," said a petroleum ministry official. Earlier, this protection was 10 per cent, then reduced to five per cent and later made 2.5 per cent. There is no protection in kerosene and LPG.

Issues
Since a little more than 90 per cent of the refining cost of oil companies is accounted for by crude oil, OMCs argue the trade pricing mechanism should continue. Critics question the logic of using international benchmarks. "Customers in India merit insulation from the volatilities of international prices. For it to be reality, reducing dependence on imported crude oil and encouraging competition in domestic retail market are the two direct approaches without the government having to bear the burden," said Deepak Mahurkar, leader - oil and gas, PricewaterhouseCoopers India.

Actual cost is generally calculated on Brent crude's daily price and delivery price at the refinery. "In a vast country like India, we have to calculate the transportation costs to the refineries, too, as these are not situated at coastal areas. For the last three years, the actual cost of petroleum products has risen," said the ministry official. Compared with neighbouring countries, the prices of our petroleum products are lower, he said. Even in China, the prices are higher. "Moreover, we are selling kerosene at a price lower than water. Even in the case of LPG, the revenue loss of about Rs 500 a cylinder means that even if we consider the actual cost of production, customers are still being subsidised," said the official.