The Hindu Business Line : The balancing act with trade parity oil prices

Petro pricing
Where there is no domestic manufacture of a product, the cost of supplying it in the domestic market would be the landed cost, which would be the import parity price.
The Rangarajan Committee has suggested the adoption of the trade-parity pricing model for diesel and petrol, which would be a weighted average of the import parity and export parity prices in the ratio of 80:20.

The official press release on Monday's Cabinet decision to increase "marginally" the petrol and diesel price "in the face of (an) unprecedented increase in international oil prices" says that the Government had the benefit of the recommendations of the Rangarajan Committee on Taxation and Pricing of Petroleum Products (February 2006), adding that the decision reflected the "essence" of the recommendations.

The release said that, as suggested by the Committee, `in principle' approval was given to the policy of "restricting PDS kerosene supplies to BPL families". This apart, the Committee's suggestion to use "the trade parity concept and lower Customs duty for petrol and diesel" was also accepted to "reduce the impact of increasing prices on the consumers". Hitherto, the import parity concept has been used to determine benchmark prices of petroleum products after the administered pricing mechanism (APM) was given a notional burial on April 1, 2002.

Import parity concept

What is this import parity concept? As the Rangarajan Committee report explains, the argument in favour of the concept is that in a situation where there is no domestic manufacture of a product, the cost of supplying it in the domestic market would be the landed cost, which would be the import parity price. In a situation (as in India) where there is domestic manufacture, the import parity price can be taken as the international competitive price that sets the ceiling for the domestic price. The oil marketing companies were to adjust their product prices automatically and periodically under this system during a three-to-five year period following the dismantling of the APM. It is common knowledge that the system could not work because of the steep rise in the international crude price, which would have led to politically unacceptable domestic price increases.

Trade parity pricing

It is against this background that the Rangarajan Committee has proposed trade parity pricing which, importantly, takes into account the emergence of India as an exporter of products like petrol and diesel. As the Committee says, there is a need to review the pricing system relating to sensitive products like petrol and diesel so as to provide relief to consumers and also rationalise pricing in the context of exports of the order of 20 per cent of production of these products.

Accordingly, the Committee has suggested the adoption of the trade-parity pricing model for diesel and petrol, which would be a weighted average of the import parity and export parity prices in the ratio of 80:20. The Committee adds that the fact that a part of domestic production is exported indicates that domestic refiners working with modern technology and having location advantages are not at a disadvantage compared to foreign refiners.

In this situation, it would be improper to extend the export parity pricing mechanism to all refiners, which is why the Committee has opted for a weighted average of import and export parity prices to be called the trade parity price. The further point has been made that the trade parity pricing mechanism will apply to the refinery gate price as well as the retail price, the prices being port specific against the system of weighted average import parity prices currently followed for fixing consumer prices for petrol and diesel. The Committee says that the relative weights of exports and imports used in the trade parity pricing concept — which should result in an indicative price ceiling — should be reviewed and updated annually.

Price setting

Crucially, the Rangarajan Committee also says that, having established the trade parity basis for setting petrol and diesel prices, the Government should keep away from the actual process of price setting. It adds that the marketing companies should be allowed flexibility to fix the actual retail prices subject to the indicative ceiling, which would introduce an element of competition among the oil-marketing companies to the advantage of the consumer. It remains to be seen whether the Government will abide by this last suggestion, which was an integral element of the immediate post-APM pricing system, observed more in the breach than otherwise.