The Hindu Business Line : Unravelling ‘under-recoveries’

Why should import prices be considered to arrive at the price to be charged from domestic consumers? Should not oil companies base their pricing on their own cost of production?

Raghuvir Srinivasan

Is the increase in petrol and diesel prices announced on Wednesday a precursor to a full deregulation of the oil industry? It does appear so if the move is seen in conjunction with the statement in the Economic Survey tabled in Parliament on Thursday that the country has to consider ending controls on fuel prices to curb demand. .

Pricing factor

The government should take a holistic view of oil sector reforms and use the opportunity to unravel the pricing structure of the oil companies. It can start with a close examination of the concept of ‘under-recoveries’.

For far too long, the government has been basing its pricing decisions on demands made by oil companies using the concept of ‘under-recoveries’. What are ‘under-recoveries’? It is a system where the oil companies use the landed cost of imported petroleum products to price their domestic output. Such cost would typically include the international traded price of the product, say diesel, and to that will be added freight costs, insurance and import duties, if any. The landed cost so arrived is compared to the price charged from consumers to arrive at ‘under-recoveries’.

Simply put, the oil companies price their domestic output as if they were imported from West Asia or Singapore.

Fuelling competition

The only problem with this system is that India does not import petrol and diesel and imports cooking gas (LPG) occasionally when there is a mismatch in domestic demand and supply. So, why should import prices be considered to arrive at the price to be charged from domestic consumers? Should not oil companies base their pricing on their own cost of production? The B. K. Chaturvedi Committee that examined in depth the perilous state of the oil industry a year ago recommended that oil companies should stop this practice and switch to a system of ‘trade-parity pricing’ which is nothing but a weighted average of the import and export prices for the given product.

However, in the changed environment prevailing now, it may be best to go a step further and leave the pricing to market forces that will be unleashed once the government frees itself of pricing responsibility. Competition is in the best interests of consumers and the government should do everything to fuel a competitive environment in the oil industry. We all know what competition has done to telecom services; it is time we did an encore with petroleum.