Oil pricing reforms essential to stabilise economy

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Sushma Ramachandran | 15 Feb, 2010
Politics and economics rarely mix well. This has been highlighted in the case of energy pricing where good economics says fuel prices must be raised, but political will is clearly lacking.

The latest report of the Kirit S. Parikh committee on oil pricing -- one of the many on the subject -- has argued strongly in favour of market-driven prices of petrol and diesel, while cutting back on subsidies for kerosene and cooking gas. Prime Minister Manmohan Singh is reported to be in favour of implementing several of its recommendations, but the Congress party fears public outcry in case prices are raised in line with the committee's recommendations.

Based on the Parikh committee report, the petroleum ministry had prepared a set of proposals for raising the prices of all products. These were discussed threadbare with the Congress party and its United Progressive Alliance (UPA) partners, who are reported to have strongly opposed any price hike plans.

The proposals were then supposed to have been taken up by the federal cabinet, but it has not yet been put on the agenda, clearly indicating that oil pricing changes are going to take some time.

At the same time, there is no doubt that revision in oil prices cannot be avoided for all time to come. With world crude oil prices at around $72 per barrel, public sector oil companies are reeling from under-recoveries -- the oil industry jargon for selling fuels at below cost -- of around Rs.40,000 crore (Rs.400 billion/$8 billion) annually at current retail prices of oil products.

If the government takes no action at all, oil companies, which play a tremendous strategic role in the country, will gradually become bankrupt. As the Parikh committee report points out, ultimately the people will have to pay a price in some form or another. In case the government decides to issue bonds to cover the under-recoveries, taxes will go up and if the fiscal deficit continues to widen, prices will go up across the board for the common man.

It has thus argued in favour of more transparency and allowing prices to be market driven, at least in the case of petrol and diesel. As for cooking gas, it says an increase of Rs.100 per cylinder is not only required but can easily be borne by consumers based on comparisons with the past when this fuel comprised a much bigger share of the household budget. Similarly, it has pointed out that kerosene accounts for only two percent of the household budget in rural areas and an increase of Rs.6 per litre will only raise this to three percent.

Contrary to the general impression, the Parikh committee has not taken a cold and unfeeling attitude to the problems of the poor who use kerosene. It has in fact, reinforced the stance that kerosene must continue to be subsidised for those below the poverty line.

It has, however, pointed out -- like other previous oil pricing committees -- that the supply of kerosene through the public distribution system needs to be rationalised. The earlier C. Rangarajan committee had advocated the introduction of smart cards to identify people below the poverty line who consume kerosene.

The Parikh committee has suggested that till the smart card or a unique identification system is put in place, rationalisation would bring about a 20 percent reduction in kerosene consumption. It has also highlighted, again like past committees, the need to eliminate adulteration which is leading to a leakage of as much as 35 percent of kerosene supplies from the public distribution system.

Unfortunately, this glaring problem has till now not received the attention it has deserved, obscured largely by the need to ensure that kerosene prices are kept low to avoid any political fallout on the ruling party.

As for cooking gas, the committee has pointed out that the subsidy of Rs.268 per cylinder does not have to be wiped out at one stroke. But it has stressed that an increase of Rs.100 per cylinder can be borne by consumers and given comparisons with the past to buttress this argument.

The most interesting element of the report, however, is the fact that it has proposed a system by which the oil pricing formula can remain the same even if international prices climb up to $150 per barrel. In the case of petrol and diesel, it says prices should be market driven. In regard to kerosene and cooking gas, it has proposed that revenues from blocks given by nomination to the Oil and Natural Gas Corp (ONGC) and Oil India Ltd (OIL) can be used to provide a subsidy to these two products.

It is also in favour of oil marketing companies being given full compensation for their losses on kerosene and cooking gas sales. The committee maintains this would completely wipe out the current under-recoveries of the oil marketing companies.

The critical issue is whether the political establishment is prepared to accept the increase in the prices of kerosene and cooking gas. The fact is that unless reforms in the oil pricing system are carried out, the country is going to face one crisis after another. International prices are rising relentlessly and domestic oil production has stagnated for several years now.

The long-term solution to ensuring adequate energy supplies is for the ONGC to become pro-active in acquiring oil acreages abroad on the same lines as China has been doing for the last few years.

Simultaneously, the prospects of increasing natural gas supplies from neighbouring countries like Iran, Qatar and Myanmar need to be explored, though political considerations too have proved a road block. The Iran-Pakistan-India pipeline is currently in the nature of a pipedream and the Chinese have shown a greater initiative in Myanmar. Even Bangladesh has clamped down on the prospects of gas supply to India. Diplomatic initiatives are urgently needed to resolve these various impasses if India is to meet the energy needs of the future.

As for the immediate problem, there is a pressing need to implement the reforms outlined by the Parikh committee. Some amount of hardship may be felt by consumers for the time being. But this is far less than the disaster that could befall the country if the oil marketing companies collapse under the weight of under-recoveries.

Now is the time for the prime minister to convince the Congress party and its allies that oil pricing reforms are essential to stabilise the economy at a time when it is rebounding from the effects of the global recession.

* Sushma Ramachandran is an economic and corporate analyst. She can be reached at sushma.ramachandran@gmail.com
* The views expressed by the author in this feature are entirely his/her own and do not necessarily reflect the views of SME Times.