The Hindu Business Line : Will price-band idea work?

The Finance Minister, Mr P. Chidambaram, has mooted a system of price band that purportedly would work to the mutual advantage of the oil exporting and oil importing nations. The broad contours of the proposal are the exporting nations would give an assurance that the price will not exceed the prescribed level and the importing nations would match this with an assurance that the price will not go below the prescribed level.

In other words, the ceiling and floor would be prescribed by the exporters and importers respectively with the market forces being allowed to discover the price within the resultant band.

No concurrence

The proposal, impressive as it sounds, may not take off for the following reasons:

Oil importers are an amorphous lot. Who will speak for them? Whose voice would be heard? The US and China or for the matter of that India may not see eye to eye. Will this not render the mechanism chaotic at best?

Oil exporters too aren’t constituted as one united body what with there being oil exporters, notably Russia, from outside of the OPEC cartel though admittedly the exporters are any day better organised vis-À-vis the importers;

How frequently would the assurances be given? If a week is too long a period in politics, so too would it be in the volatile business of oil trade;

Who will enforce the contract assuming it is somehow hammered out?

What would be the penalty for its breach?

These are some of the problems that could render the proposal, sincere as it is, stillborn. What Mr Chidambaram has in mind perhaps is the possibility of this regime softening the impact of the speculators in the price discovery process. They may in such a milieu have willy-nilly to operate within the constraints of the price band and not go overboard as they have been accused of going in the past.

Sellers’ market

Be that as it may, the point is speculators or no speculators oil is the sellers’ market what with there being no effective substitute and the oil-exporting nations out to squeeze the best possible out of the importers while the going is good, that is, before the crude reserves dry up which is imminent and inevitable.

‘Little elbow room’

In this context, it may perhaps be useful to draw an analogy between the price band mechanism operating in India in the primary capital market and the suggestion on hand. The extant book-building regime under which a price band is fixed by the company seeking to raise capital in consultations with its merchant banker renders the subsequent price discovery process a farce what with the price having been already discovered by the issuer — a band of Rs 400 to Rs 450 fixed for a Rs 10 share effectively allows ridiculously little elbow room to the players in the price discovery exercise.

The very reverse could happen in the oil market because while the exporters may prescribe a ceiling that is egregiously ambitious, the importers may prescribe a floor that may be rock bottom. In the event, the players in the oil market may get huge elbowroom thus defeating the very purpose of the price band.

If the book-building regime is stacked in favour of the issuing company, especially in a booming market, the price band mechanism mooted by the Finance Minister may end up favouring the exporters, especially in a market marked by scarcity of oil.

(The author is a Delhi-based chartered accountant.)

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