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.