The Financial Express, May 08, 2006

By Shrawan Nigam

Not a day passes when we do not hear India’s petroleum PSUs bemoaning the losses they incur by holding the price line for petrol, diesel, kerosene and LPG, in spite of rising international prices of crude oil. Yet in the same sector, Reliance Industries Ltd announced that the profit margin of the group had been lifted by an unprecedented increase in the refinery profit margin, of $10.3 a barrel, in 2005-06. Are the oil PSUs hemorrhaging or are they trying to pull wool over our eyes?

The Rangarajan committee report on pricing and taxation of petroleum products had estimated that petro products get a protection level of 40%. It recommended the customs duty on petroleum products be reduced. Yet, the Budget came and went with no reduction in customs duty on petrol and diesel, and the oil PSUs continue to be provided with 40% protection for their value addition. It is this loss of super-normal profits that the oil PSUs cry about, not real losses. As there is almost no import of diesel or petrol, government revenues would not be affected even if import duty on them were abolished.

The continuation of the high import duty on diesel and petrol is surprising, as for all other industrial products it was reduced to a maximum of 12.5%. The NCAER’s latest quarterly economic update, released in April 2006, has estimated GDP to grow at 7.7% in 2006-07, a drop from 8.1% in 2005-06. This factors in an increase of 8% in the price of domestic crude and recommends an early increase in the price of petro products. If GDP is likely to decline, should the government raise the prices of diesel and petrol, an action that could make GDP decline steeper? Are petrol and diesel under-priced? If it were so, could Reliance Industries have earned high profit margins from their refinery operations?

The problem is in the methodology adopted for fixing retail prices. Domestic prices are determined on import parity based pricing, in which the notional import duty, notional sea transport cost and notional port handling costs are added, though these are not incurred. The oil companies have become so used to these unearned profits that they do not want the pricing to be based on costs.

  • The method of fixing retail prices based on import parity is irrational
  • The lowering of customs duty to 5% should be done without more delay
  • Our economy pays a high penalty for not allowing market-based pricing

Energy is the driving force for economic growth. Public policy should ensure no scope for over-pricing energy products, as that retards growth. There is no reason why the customs duty rate on petroleum products cannot be reduced now. A lowering of the duty to 5%, the same as for crude, would also promote competition, as it would allow private marketers to recommence operations. The opening of the Indian economy in the 1990s was followed by policy announcements to allow freedom in marketing of petroleum products. Private sector marketing of LPG was initiated and, more recently, of petrol and diesel. Many private players entered, but due to the implicit subsidy, the prices prevailing ensured private marketers could not run profitable operations.

The skewed pricing of petro products not only affects tax revenues, but also leads to misallocation of resources through the economy. The additional investments that could have been made are lost, with the jobs this extra investment would have generated. The development of non-conventional energy sources is deferred because these are not commercially viable in the face of low-priced petroleum products. Moreover, the prices of petroleum products, by not reflecting their scarcity value, lead to wasteful use. The result is that energy efficiency in India is among the lowest in the world.

The government-dictated retail prices are adversely affecting private oil marketing companies. Reliance Industries has sought a level playing field with the PSEs by demanding that private sector marketers also be given a subsidy equal to what the PSEs implicitly get. An essential element of competition is the ability of companies to determine prices based on market conditions. For this to happen, the Administered Pricing Mechanism needs to be truly buried.

There is a silver lining: the Petroleum and Natural Gas Regulatory Board Bill, introduced in Parliament in December 2005, is expected to be passed soon. It is expected that as with other regulatory bodies, the principles of competition will be enforced by the Board.

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