Towards Market-Determined Oil Pricing

In this din, the main issue has been lost. While the ways to pare the oil pool deficit are being discussed, there is no meaningful debate on the root of the problem -- the administered price mechanism (APM). In fact, the oil pool deficit is just one of the manifestations of the APM.

Although much has been written about the APM in recent months, an outline of its main features, at the risk of repetition, would be appropriate.

* Prices of petroleum products are controlled by the government. Products presumably consumed by the poor are subsidised by charging higher prices for products consumed by the affluent.

 

* All the companies in the petroleum sector are assured a fixed return on the capital employed.

* Accounts of the sector are managed by the Oil Coordinating Committee (OCC) through the oil pool account.

* Investment decisions are taken by the government.

* Since the oil pool is expected to be self balancing, no budgetary support is provided by the government.

The price mismatch

The APM can work if higher prices on some products match the subsidy outgo on other products. However, over the last few years, due to political compulsions, the government has not raised the prices of petroleum products sufficiently to neutralise the increased cost of production and imports. This mismatch between the cost and price of various petroleum products was more pronounced last year for a number of reasons and the oil pool deficit touched an astronomical Rs 15,500 crore. Thus, a politically motivated response to a commercial problem has caused this mess.

It needs to be understood that as long as the Oil Pool Account (OPA) remains in deficit, the oil sector companies make notional rather than real profits. Since this deficit is not underwritten by the government, revenues booked would remain as receivables until prices are adjusted and the deficit is wiped out.

Meanwhile, the deficit is funded by the banking system against the receivables of the oil companies. These borrowings are indirectly government borrowings at commercial rates of interest, applicable to corporations. Bharat Petroleum's just released annual results show a 108 per cent increase in interest costs.

If oil companies are earning only notional profits, it is difficult for them to mobilise funds for their expansion and modernisation plans. In fact, oil companies are tapping the debt market for meeting even their working capital requirements which reduces the lendable funds for other sectors of the economy. Banks have decided to limit their exposure to oil companies, given the magnitude of the deficit.

Even if OPA can be kept in surplus, there are other costs to the economy that warrant dismantling the APM. Some of these are discussed here.

Since APM guarantees fixed returns to refineries, there is no competitive pressure on them to improve their efficiency. Indian refineries report fuel and loss (f&l) -- the amount of crude needed to run the refinery -- at seven per cent, while the international norm is three to four per cent. A three per cent drop in f&l would result in a saving of Rs 1,100 crore in foreign exchange at today's production levels.

Artificial pricing of petroleum products leads to their usage in applications for which they are not suited. For instance, although diesel is highly polluting, some 1.8 million tonnes of it was consumed in 1995-96 for captive generation of power by the industry and the household sector, solely because it is subsidised. Thus, nearly Rs 400 crore of subsidy is provided to turn people into independent power producers (IPPs). Similarly, kerosene, which has properties similar to aviation turbine fuel, is used in India for cooking food.

The mismatch between the price and the economic worth of petroleum products causes large-scale pilferage and adulteration which makes the subsidy meaningless. That LPG meant for households finds its way into commercial and industrial sectors and that kerosene is freely mixed with diesel by unscrupulous petrol pump owners is only too well known.

Time is running out

India has strategically decided to create large refining capacity to meet the growing demand for petroleum products. Currently, at least two private and many joint sector grassroots projects are in the pipeline. At a conservative estimate, the refining capacity would increase from 60 million metric tonnes per annum (MMTPA) now to 100 MMTPA by the end of the ninth plan. If at that time, the petroleum sector is still under APM, all these new refineries would need to be paid assured returns. The amount of oil pool deficit is unimaginable. Thus, it is imperative to dismantle APM before fresh capacity is created.

The Sundarrajan Committee and the