The Hindu Business Line : Unleash oil sector reforms, now

The obsession with keeping petroleum product prices artificially low has meant reforms could never enter the agenda. The present circumstances are conducive to reforms and dithering now will mean losing an excellent opportunity, says RAGHUVIR SRINIVASAN.

The issue of subsidy on kerosene and cooking gas has to be revisited and an effective way of delivering the subsidy worked out.

Expectations from the new Government are running high as it settles down to business after the heat and dust of the elections and Cabinet formation. With the Left millstone no longer weighing him down, Dr Manmohan Singh is expected to move forward with full force on reforms.

Indeed, the first signals coming out of the Government point in this direction. The Finance Minister, Mr Pranab Mukherjee, said on Wednesday: “We need to seize the opportunity presented by the current circumstances for pushing long-pending reform measures in financial and real sectors…”

Mr Mukherjee and Dr Singh could start with the one industry that has been completely left out of the reforms bandwagon: oil. Given its perceived political sensitivity, the oil industry, over the years, has been showered with excessive attention of the wrong kind.

The near obsessive pursuit of keeping petroleum product prices artificially low has meant that reforms could never enter the agenda, thus leaving the industry caught in a maze of subsidies, cross-subsidies, discounts and oil bonds. The net result is that the industry is in a mess. The public sector oil companies, once cash-cows, are now pale and emaciated, reduced to borrowing from the market at high rates to finance even their working capital. Forget capital investment in new refineries or oilfield development, they are struggling to keep the red ink off their balance sheets.

The private oil companies such as Reliance Industries, Essar Oil and Shell, which entered the petroleum retailing market in a big way, have been left licking their wounds after beating a hasty retreat.

With their public sector counterparts retailing fuels at artificially low, administered rates, their market was completely taken over. It is another matter, though, that the public sector oil companies were losing money on every extra litre of fuel they sold due to the retreat of the private players.

In the last few months, with global oil prices falling, the private retailers are becoming competitive once again and are tentatively reopening their outlets. Yet, the bottomline is that the retail assets were lying idle in this period.

Who benefited?

If you thought that the Government benefited from all this then you only have to consider the mind-boggling debt that it has taken on in the form of oil bonds to keep the public sector oil companies afloat. Just how serious this is will be evident from the fact that the value of the bonds that it issued in 2008-09 is almost as much as that issued in the three preceding years put together.

The Government’s oil bonds commitment for 2008-09 is Rs 61,000 crore. In comparison, since 2005-06, the Government has issued oil bonds totalling Rs 71,000 crore. In total, this is about 1.3 per cent of GDP and would add almost two percentage points to the fiscal deficit.

If the oil companies, the private players and the Government have all lost, who has gained? The consumers?

Well, partly yes but by keeping oil prices artificially low, the Government lost the opportunity to instil consumption discipline. There was no incentive for consumers to pare consumption as their wallets were protected. Clearly, there are no winners from the policies followed by the Government; nor have they served to protect the country’s oil security. To the contrary, the policies have probably compromised oil security by weakening the national oil companies and putting off multinationals that were eyeing an entry.

Propitious time for reforms

Fortunately, the present circumstances make the atmosphere very conducive for reform. First, oil prices are at manageable levels. Yes, they have almost doubled since the start of this year, yet they are at levels where the Government can free prices without the consumer feeling the pinch.

Second, inflation is no longer the demon that it was even four months ago. Even assuming that freeing of fuel prices causes a cascading effect on prices across the economy, they can still be managed comfortably.

Finally, the Government does not have to watch out warily to the Left for forces that may constrain its reforms agenda.

Given the nature of the electoral verdict, it pretty much has a free hand to unleash reforms so long as they are well thought out and benefit the country.

Delay can be dangerous

Dithering now on reform will mean loss of an excellent opportunity because at least two of the three factors mentioned above can change very quickly. Oil prices are at manageable levels now but they may not be so for long.

Assuming a tentative global economic recovery by the end of this year as many predict, oil prices are sure to run up again quickly. Supply continues to be a constraint and if prices are relatively soft now, it is due to lower demand. Once the latter picks up, oil prices will begin their journey back to the stratosphere.

Second, inflation is negligible now but given the amount of money unleashed on the system (Rs 4,20,000 crore from the RBI’s measures alone since September 2008) and the effect of the two stimulus packages, expectations are that inflation will again raise its head as early as the beginning of 2010. The Government will find its hands tied in such a scenario.

The agenda is thus, very clear for the Government.

It has to liberate pricing, which means that the oil companies will be free to adjust pump prices based on global price movements. Whether it will be on a daily basis, as is the practice in developed countries, or on a weekly or fortnightly basis is a matter of detail. While doing this, the Government should also clearly define what “price” means.

The present definition of “price”, as followed by the oil companies, is not a true reflection of their costs. The pricing formula adopted by them assumes the price of petrol or diesel in West Asia or South-east Asia, to which are added elements of cost such as freight, duties, insurance and finance charges.

The reality is that India does not import transportation fuels and there is no reason why the oil companies should follow such a pricing policy. The “under-recoveries” that they complain about are a direct fallout of this pricing policy.

The B.K. Chaturvedi Committee, which submitted its report last August, has elaborated on this and suggested that we should follow export-parity pricing instead. In other words, the mechanics of free pricing have to be worked out to the satisfaction of both the oil companies and consumers.

The issue of subsidy on kerosene and cooking gas has to be revisited. There is no arguing the fact that the poor need to be subsidised for their lighting and cooking fuels but an effective way of delivering the subsidy has to be worked out.

From the problems that we face of adulteration of diesel with subsidised kerosene and diversion of domestic gas cylinders, it is clear that the present system is faulty. The Chaturvedi Committee has delved into this issue in depth and the Government would do well to dust out the report and read it.

Once the delivery mechanism is worked out, the Government should find a way to fund it from its Budget if necessary, through a transparent cess on all petroleum products. The system of asking the oil companies to fund the subsidy has to be dispensed with.

It all really seems so simple in the end but what it needs is will on the part of the Government. This may be the best opportunity to clean up the oil mess.

( blfeedback@thehindu.co.in)

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