The Hindu Business Line : The oil xenophobia

WITH global oil prices shooting up, there is all-round fear that petrol and diesel prices will go up and the subsidy burden for kerosene and LPG will swell. With crude touching an all-time high $41 a barrel, fears are mounting over inflation and balance of payment.

Reasons: 70 per cent of India's oil requirement is met by imports; the oil bill constitutes more than one fourth of total country's import; oil is the second biggest conventional energy and world prices are unlikely to drop significantly; and the country's production of crude has remained stagnant at 32-33 million tonnes. With the spurt in global oil prices, speculation is rife that petrol prices will go up by Rs 5 a litre and diesel by Rs 3.

The new government is reluctant to raise prices, as some of the alliance partners will not be favourably disposed to such a move. The previous NDA government had avoided raising the prices of petrol and diesel since January in the run-up to the general elections and that of kerosene and LPG for over two years with an eye on the Assembly elections. But, then, oil product prices have always been sensitive for any ruling government considering its political significance.

Thus, ironically, even after the dismantling of APM (Administrative Price Mechanism) in April 2002 that theoretically empowers oil companies to determine product prices at market driven rates, the government continues to exercise control over the prices. Are petrol, diesel and even LPG really so politically sensitive that the government wants to exercise its control through the back (after all, oil marketing companies are owned by government)?

In fact, the fear of oil price hike and its impact on the people are more psychological. Oil is not a poor-man's energy source. Except kerosene, oil products are not the energy source for the poor or farmers. Petrol is rich-man's energy source and constitutes only 8 per cent of total product consumption. Diesel, which constitutes the biggest chunk of all oil product consumption at about 41 per cent, is largely the transport fuel; this sector consumes about 60 per cent of high speed diesel. Agriculture consumes about 20 per cent of diesel for running agricultural pumps, when electricity is not available. LPG, which constitutes about 9 per cent of all oil product consumption, is entirely consumed by the urban people.

Kerosene is the only oil product which is largely consumed by farmers and the poor people for lighting and cooking. Assuming all the kerosene and one-fifth of diesel are consumed by poor people and farmers, the ratio of oil energy consumption by these sections is merely 20 per cent of the total oil product used in the country.

In this situation, how will the hike in petrol, diesel and LPG prices affect the poor people and farmers?

Fear surges as and when diesel prices are raised, as it pushes up the inflation expectation. This is because a large chunk of essential goods are transported by trucks. Besides, traders fuel inflation by hoarding goods.

Thus, during the two oil shocks in the 1970s, inflation skyrocketed by 17-18 per cent a year. But the situation has changed in the new millennium, when oil price hikes have had no major impact on inflation. In fact, there has been an inverse relation between the diesel prices and the overall inflation rate in the last four years. Diesel prices spurted by over 40 per cent since April 2000, but the general inflation rate slipped from 7 per cent in 2000-01 to 5 per cent in 2003-04.

Another significant change in the impact of global oil price hike on inflation is its duration. The duration of peak inflation was longer during the 1970s than post-2000. While the peak inflation of 17 per cent during second oil shock in 1979 continued for over two years till 1980-81, the 7 per cent inflation in 2000-01(compared to 3.3 per cent the previous year) due to crude price hike by 59 per cent lasted one year though the high global oil prices persisted. This was because of the government's steps to promote oil saving and conservation measures. Unlike other countries, in India oil price/supply volatility has less impact on the major sectors. Oil is not the major source of energy for agriculture and industry, which contribute over half the GDP.

Oil dependence of agriculture is a mere 10 per cent. Electricity is the main source of energy for agriculture. About 90 per cent of energy requirement for agriculture is met by electricity. Hence, any oil price hike or supply constraint are unlikely to affect agricultural growth.

Similarly, the oil dependence of industry is only 15 per cent. About 75 per cent of energy requirement of industry is met by coal. Coal is also the major input for power generation; oil contributing only 3 per cent of the electricity generation. Therefore, either for agriculture or for industry oil makes little contribution to their growth. The significance of oil in terms of direct contribution to the growth of GDP, which is now at 6-7 per cent, is outpaced by abundant availability of non-oil energy resources. Coal is the major source of energy. Over 52 per cent of the total commercial energy is from coal; oil contributes 34-35 per cent.

Paradoxically, though oil is the second major source of energy in the country, much of it is used as transport fuel. Over 75 per cent of oil is used as transport fuel. It is true that cost of transport fuel has a greater impact on the price line as many of the goods are transported by trucks due to slow growth in rail transport. But the commendable improvement in the oil saving technology in auto engines has helped to check the spurt in the oil demand. Therefore, the availability of abundant non-oil energy resources has insulated India's poor sections and farmers from oil pangs. Oil is generally the energy for the urbanites and better-off of the country. Oil is no more a big burden on balance of payment, unlike in the 1970s.

About one-sixth of oil import bill is offset by export of petro-products. India started exporting oil products big way since 2000. By not raising prices of petrol, diesel and LPG, the government is taking on the responsibility for curbing the profitability of oil companies.

The oil companies face under-recoveries of about Rs 14,000 crore this year with LPG and PDS kerosene prices kept unchanged for two years. The unchanged petrol and diesel prices since January have added to this burden.

Do we really require to subsidise LPG, which is used by only 38 per cent of the population living in the urban areas? How long can the government control prices as a political expediency? Can it sustain its control over pricing after the private sector oil companies enter the market next year and prices would need to be determined by market forces?

(The author is Senior Researcher in a Japanese MNC in New Delhi.)