Is import parity pricing for oil justified?

While there is a case for international-parity pricing, this is unjustifiable in a situation where oil firms fix prices together and pass on all costs to consumers.

T N R Rao
Former secretary, Petroleum,
Government of India

A debate on increasing the prices of petroleum products gets periodically revived whenever oil companies start screaming and kicking about them.

The public is treated to an incomplete set of numbers of how the companies' bottomlines are getting "hit", to goad a very reluctant government, passionately committed to the common man's welfare, to increase the prices to protect the welfare of the oil companies.

The remedy suggested is extraordinarily simple. As we are supposed to have a regime of "market" determined prices, both the input as well as output prices should be so, and as crude oil is bought at international prices, the product prices should also be benchmarked internationally.

That our "market" has no competition, has high tariff and entry barriers and the prices are cartelised without any regulatory regime are all beside the point.

Even conceding that we are at a transitional stage and so may not be able to have a completely open market right away, it would be reasonable to ask what other international benchmarks with regard to value-addition, distribution and marketing costs are being complied with before we conclude that products are to be priced on parity with international prices.

Similarly, the public should be treated to the numbers relating to the adventitious gains in refinery margins that the sheltered oil companies are reaping along with the windfall tax revenues that the government is garnering owing to the runaway global prices of crude oil.

It would only then be possible to put the putative losses in a correct perspective to have a meaningful debate.

It would be foolish to consider mechanical price increases without addressing the basic issues ailing our energy pricing.

The current pricing structure is encouraging price arbitrage and adulteration, misdirecting subsidies, fouling up proper inter-fuel substitution, distorting true social costs of using energy and discouraging energy users and suppliers from making better choices relating to energy efficiency, adoption of environmentally safe technologies and development of alternative energy sources.

Ill-considered increases just to arrest oil company cash flows would further aggravate the above anomalies and render a sensible energy pricing later well nigh impossible.

It should not be forgotten that with our long history of retention prices in the oil sector, considerable amounts of hidden costs of a cost-plus regime are still being passed on to the consumer.

Under the administered pricing regime, cost-plus returns were given within norms fixed for each item of expenditure. Though it did not fully encourage efficiency and productivity, the costs were controllable within these norms.

Those who performed better, retained the gains and those that did not, lost out. In a market-based regime, this gets achieved by forces of competition.

But in our situation where the market is closed and the operations are monopolistic, there is not even a nominal oversight of the costs of the oil companies.

The old baggage of retention pricing (over-staffing, poor and wasteful procurement procedures, avoidable transaction costs) are carried forward to this day and have become pass-through expenses so far as the consumer is concerned, without any chance of the efficiency gains accruing to him.

An analysis of the build-up of costs of one single product, LPG, is enough to expose the enormous amount of flab being carried in its pricing.

LPG was opened up for private players in the early 1990s and thousands of crores of private infrastructure came up. But with the subsidy being limited to public sector companies only and unchecked diversion to non-domestic uses, these investments have become non-performing assets.

Today, public sector oil companies pay 60 to 100 per cent more than a private player for the same quality and size of the cylinder.

In road transport, they pay exorbitantly high rates in collusive bidding over the ruling market prices. Add to this the criss-cross and uneconomic movement of the product, from and to gold-plated and overstaffed bottling plants.

All these easily contribute Rs 100 per cylinder, a figure equal to almost the current level of subsidy. In the absence of any competition or enforcement of cost norms, this will increase further.

Therefore, the priority should be to eliminate such wasteful and avoidable expenses on all products that are inflating costs and subsidies.

Any price increase should be resorted to only after all such inefficient costs are eliminated. Being in full control of prices, the government should be equally obliged to take steps to pare this flab in the first instance.

P Sugavanam
Director (Finance),
Indian Oil Corporation Limited

Since India is dependent on import of crude to the extent of about 70 per cent of its requirements, refineries have to be compensated for buying crude at international prices as well as for their processing costs.

This is done by pricing finished products based on import parity, including the element of customs duty on the finished products.

Such compensation is essential for refineries to get a reasonable return on the capital employed as well as the investment on environmental and quality up-gradation projects.

Refineries also have to be compensated on account of central sales tax on inter-state sales of products and cost of various irrecoverable taxes levied on them such as entry tax, octroi on the crude input and so on.

For oil marketing companies (OMCs), the pricing includes essential elements of marketing costs and marketing margins, which are frozen based on the international price levels that prevailed in March 2002.

Import parity pricing (IPP) is further justified because it equates the cost of product placement from various sources (say, a refiner or an importer), thereby providing a level playing field for all players.

Such a practice will encourage more players to enter the market and the competition will ultimately benefit to the consumer.

The IPP principle has also attracted private sector investment in both upstream and downstream sectors, equipping the country to meet the projected demand for petroleum products.

The refining sector would also be able to generate funds to meet the investment required in projects to upgrade the quality of fuels and to deal with environmental concerns.

The IPP principle would enable OMCs to keep pace with future investment requirements, particularly in development of retail outlets and their modernisation to match international standards, thereby making retail purchasing a customer's delight.

Although initially petrol and diesel were being priced on the IPP principle, the implementation suffered a setback when crude prices started increasing and product prices also followed suit.

While the retail selling prices of these products were revised 14 times during 2002-03, that is the first year of de-regulation, during 2003-04 prices were revised only eight times.

Since January 2004, there have been only six revisions till now, mainly due to very high prices in the international market.

A price band mechanism was developed to give freedom to oil companies to fix the retail selling prices within the band; price increase or reduction beyond the band would only require changes in the duty structure.

However, the implementation of the above mechanism could not be followed beyond August 2004, in the backdrop of sustained increases in international prices of crude and finished products.

Since the compensation to domestic refineries are being revised fortnightly based on the international prices during the previous fortnight, OMCs have accumulated significantly under-realisation during 2004-05.

Although the duty changes were revenue neutral, OMCs had to absorb the additional burden due to enhancement of excise duty in Union Budget, 2005.

The benefits for reduced customs duty went to the refiners who are not marketers. Besides, as per government directive, the quality of petrol and diesel has been upgraded to Euro III standards in 11 major cities, and to Bharat Stage II standards in rest of India, except in a few states.

This activity has resulted in further under-realisation due to non-revision of retail selling prices (RSPs) on this account, since quality upgradation projects necessitated huge investments as well as additional operating and processing costs for domestic refineries as well as additional distribution costs.

OMCs had also to resort to import of these products at an additional cost since January 2005 to meet the transitionary requirements, while the domestic refineries were stabilising.

The under-realisation of petrol and diesel are, in addition to exorbitant under-realisation on kerosene, for public distribution and LPG for domestic consumption.

We apprehend that unless the RSPs of these products are immediately revised, the oil industry would not be in a position to undertake investments in the developmental projects for future as well as continue its position as profitable public sector enterprises, making the single-largest sustained contribution to the exchequer.