The Hindu Business Line : Has easing of price control made oil boil?

World over analysts have welcomed the steep rise in crude oil price. They argue that only this will have a welcome effect of reduction in energy consumption and improve the economics of development of efficient technologies.

The most important ill-effect of shielding consumers from high crude price is that we are depriving price to act as dampener on consumption.

MR DEEPAK MAHURKAR, ASSOCIATE DIRECTOR, PRICEWATERHOUSECOOPERS.

The task of pricing fuel in India would be equivalent to accomplishing the great Indian rope trick without a blemish. On one side are consumers (also the voters) and, on the other, are companies such as refiners, fuel marketers, etc. Can price control help?

At an OPEC meet organised in Saudi Arabia recently, the Finance Minister, Mr P. Chidambaram, suggested crude oil price be regulated by means of fixing a price band. While suggestions such as these may be borne out of sheer desperation for a country fighting with inflation at a 13-year high, experts see solid reason behind such a step, if implemented.

For one, volatility would be taken away and so would be the daily oil shock of the commodity surpassing one record after the other. "Oil producers or OPEC do not ostensibly exercise any price control. Slackening of control has actually commoditised crude even further," says Mr Deepak Mahurkar, Associate Director, PricewaterhouseCoopers, Gurgaon. He would know better as the leader of the oil and gas industry practice at PwC.

When Business Line probed him further, Mr Mahurkar explained why oil as a commodity is behaving differently. To know more, read the Q&A done over email.

Edited excerpts from the interview:

Why are crude oil prices going up?

Weak dollar and thus gradual weakening of single point USD currency control on crude demand market have added to the recent rally. Oil has become a commodity which unlike other traded commodities is (over)sensitive to currency movement, big speculations, energy sufficiency and security, geopolitical tension and even to the economic growth of individual countries like the US.

All these variables, which are uncontrollable by any defined means, have infused more errors and thus have taken the product pricing driven away from the market fundamentals or simple supply-demand dynamics.

But why are the petroleum prices going up only now?

Most of the developing countries, especially India, had not aligned the petroleum prices with crude prices although a correction was due. The so-called `correction' in crude prices has turned out to be a subject of speculation and the upward trend is not showing any signs of easing any time soon. It has become impossible to keep a lid on petroleum prices, even under the aegis of populist politics.

Are prices in other countries lower than in India?

Let's speak of the US where the fuel market is characterised by intense competition and the prices of the products reflect that. The pump prices in the US have remained low as compared to not only India but all countries not subsidising fuels. Taxes levied on diesel and petrol are on an average low in the US; amongst the states Californians pay the highest of about 70 cent and Alaskans the lowest of about 30 cent.

Even in other smaller countries where sufficient competition exists and market decides prices, the prices have remained low. Such competition is absent in India. Purchasing power also makes a difference; in India for the price of a litre of petrol one can buy a lot more of other basic necessities than one can in the US. Therefore, Indians in effect pay much more for fuel than the Americans.

What about Europe?

All across Europe, fuels are taxed at high rates; in some countries at significantly high rates and these are passed on to consumers and, therefore, European consumers pay higher than Indians.

In Venezuela, Turkmenistan, most of the Middle-East, including Saudi Arabia, and North African countries of Algeria, Egypt and Libya, fuels are highly subsidised and sold much cheaper than in India.

Thus in India prices are higher than in the US, much higher than in the oil-producing countries, but lower than in the Europe.

What will India lose if the prices are not passed on to consumers?

As most of us know, the health of oil marketing companies would deteriorate; the Government's subsidy burden would grow substantially; public upstream companies and their shareholders would need to continue to share their windfall profits with downstream companies; tax collections would go down since tax rates are being moderated; consumers of products other than diesel, petrol, LPG and kerosene would continue to cross subsidise these products; and so on.

Some say high prices will dampen demand.

The most important ill-effect of shielding consumers from high crude price is that we are depriving price to dampen consumption, resultantly missing on ability to develop efficiencies in demand side and invest in technology.

The unabated growth in consumption of fuels is not healthy for the economy; and especially if the opportunity to reduce consumptions elastic to price are not utilised. On the one hand, the forex and cost burden will grow and, on the other, investments for energy projects would not be supported.

Europe pays high taxes on fuels. But what's the rationale for keeping the tax rate in India high?

Reducing taxes to allow higher recoveries to oil companies while keeping price-caps low, is not the best solution. Taxes are revenues for the Central Government and the States. Reducing them when consumption and production are growing will create imbalance. Generally speaking if uniform VAT is introduced in States and tax is levied only on value added at various stages in the petroleum value chain, that is, from the oil well to the car tanks, most of the anomalies in taxes will be reduced. Some States with abnormally high tax rates surely need to rationalise them.

China recently raised fuel prices by 17-25 per cent. Is there something we can learn?

Apart from the current hike, China raised prices in November 2007 and taxes in February 2008. The State Administrator of Taxation in September 2007 had clarified that collecting fuel tax and adjusting oil prices are two different things, and that they will not be introduced in tandem. The measures were taken for different purposes - to increase recoveries to refiners and as a next step in tax restructuring. The Chinese government was also aware that these steps would also curb consumption growth.

Isn't the Indian situation peculiar? On the one side taxes are high and, on the other, oil bonds are being given.

Stakeholders, very rightly, question the rationale of the Government collecting heavy taxes on petroleum on one side and doling out subsidies and oil bonds on the other. Unfortunately, this will continue as the Centre provides for majority of the subsidy but States collect major part of the taxes.

Worse though, the Centre is not planning to bring petroleum products under the Goods and Services Tax (GST) regime which is to be introduced.

Crude oil futures are trading at $135-139 a barrel. At what level would crude price stabilise?

The oil market is drawing strength from demand and geopolitical issues triggering supply and/or logistics constraints. The producers draw strength from the argument that the current prices are still lower than inflation and currency adjusted historic prices.

Therefore, when you adjust for inflation and by energy intensity, the equilibrium would be reached. I think we are probably headed towards that state now, although temporary spikes would be witnessed.

Can India make a difference?

The factors I mentioned for crude price rise are hardly under the control or influence of India. The best we can do is to control the impact. Consumers must pay the economic price of fuels they consume than the artificially controlled one. Only then would they contribute to reducing the impact; currently it is a problem only for the Government and oil companies, who by themselves are finding it difficult to contain the damage.

How would you rate our pricing mechanism?

When a distress situation arises, the Government evaluates burden sharing amongst stakeholders. The main stakeholder continues to be the Central Government - the exchequer collecting taxes, the shareholder of downstream and upstream companies collecting dividends, and provider of subsidies through budget allocations and oil bonds.

The other stakeholders are the State governments which collect taxes, the consumers who pay for fuels and the downstream companies which have been made to bear under-recoveries, the upstream oil companies that have been made to forego their windfall profits and, finally, the dealers operating retail stations and remunerated through commissions. India's transport and domestic fuel pricing mechanism is neither defined, nor is the decision-making process transparent.

Why are consumers reluctant to bear the cost?

Most of the consumers are not aware of the complex pricing and fiscal structure. Therefore it is obvious that consumers will continue to feel that they are being made to pay for others' benefit. The imperative is to roll out a well-defined self-governed pricing mechanism, in conjunction with mass awareness programme for necessity to bear the cost now than postponing adversities to the next governments or generations.

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