The Hindu Business Line : No alarm bells over rising oil prices

Crude oil price jumped to an all-time high towards the end of October. Growing tensions in northern Iraq, supply outages from Nigeria and the worries over Iran’s nuclear programme will continue to fuel oil price increases. There is unlikely to be any relief even in the next year.

Analysts forecast that the average price in 2008 will be $70 per barrel. During January-September 2007, the average Brent price was $67 per barrel.

While oil price surges cause oil-import-intensive economies to panic, India, which is also in the same bandwagon and depends almost entirely on imported oil, seems almost unfazed.

The country depends on imports for 80 per cent of its crude oil requirement. The average price of imported crude rose by a whopping 22-plus per cent during the past two years. Notwithstanding this, the country’s GDP grew at an impressive 8-9 per cent against the world average of 5 per cent.

There are basically three factors which have helped insulate the Indian economy from the impact of rising oil prices.

Effect on manufacturing

First, the manufacturing sector, the key driver of economic growth over the past few years, is not oil-sensitive. According to FICCI, a survey of 417 medium and large firms revealed that the energy bill constituted 20 per cent of the production cost. Of this, oil energy accounted for only 20 per cent. This means oil made up only one-fifth of the energy bill. Thus, oil prices have not had much of an impact on manufacturing growth.

Exports offset import burden

Second, the recent spurt in oil product exports have cushioned the impact on the balance of payments. Petroleum product exports have emerged the biggest foreign exchange earners, notwithstanding the substantial dependence on imported crude. During the past two years, petroleum products were the biggest item among the single group of exports in the export basket. They accounted for about 11 per cent and 15 per cent in the total exports during 2005-06 and 2006-07 respectively. Petroleum product exports grew by 67 per cent and 59 per cent during 2005-06 and 2006-07 respectively. This largely counterbalanced the heavy burden of crude oil imports on the balance of payment.

While imports of petroleum products (mainly crude oil) amounted to $45 billion and $57 billion in 2005-06 and 2006-07, respectively, exports of the same rose to $11 billion and $18 billion respectively. This helped offset over one-third of the oil import burden on the balance of payment.

Global hub for refining

India is emerging as a global hub for oil refining. The cost-effectiveness of oil refining has drawn the attention of several MNCs. This is because India is logistically well-placed for refineries in terms of oil imports from West Asia and is better placed to help serve the large consumption needs of petroleum products of adjoining countries.

To become a global hub for petroleum product exports, India plans to add about 60 per cent to its existing capacity over five years. The present refining capacity is 149 million tonnes per annum. Another 90 million tonnes are proposed to be added by 2012. The domestic consumption is estimated to touch 196 million tonnes by then. This leaves a balance of 43 million tonnes, which are to be exported. At the average export price level of 2006-07, petroleum product exports may touch $23 billion.

Controlled price mechanism

Third, the prices of petroleum products are not determined by the free market mechanism. The prices of certain petroleum products which have larger bearing on inflation are kept artificially low.

Even though the Administrative Price Mechanism (by which the prices of petroleum products were controlled by the government since oil nationalisation in the 1970s) was done away in April 2002, the prices of major petroleum products still continue to be under control regime through backdoor. About 60 per cent of the petroleum product prices are controlled by the Government.

The prices of four products, which have an impact on inflation, are petrol, diesel, kerosene and LPG. These account for 60 per cent of the total petroleum product consumption in the country.

Currently, over 95 per cent of the marketing of these four price-sensitive products are controlled by the Government through its public sector oil marketing companies — Indian Oil Corporation, Bharat Petroleum Corporation and Hindustan Petroleum Corporation. These companies are not free to set prices based on the crude oil prices; the prices are decided by the Ministry of Petroleum and Natural Gas.

Social, political reasons

The Ministry, while fixing the prices, takes into consideration, besides economic reasons, several social and political implications. For some petroleum products, social and political reasons overshadow the economic implications.

There is a huge subsidy on kerosene and LPG prices. LPG and kerosene prices have not changed since early 2005, whereas petrol and diesel prices have been tinkered with eight times. The huge subsidy on LPG and kerosene have resulted in their prices ruling at less than half of that in Pakistan; this despite Pakistan importing crude oil at a preferential rate. While the prices of kerosene and LPG are Rs 9.09 per litre and Rs 294.74 per cylinder respectively in Delhi, they are sold (in Indian rupee terms) at Rs 23.64 per litre and Rs 427.90 per cylinder respectively in Karachi

As public sector oil marketing companies continue to control the prices and distribution of petroleum products, the fear of any major impact on the economy seems unfounded.

(The author is Adviser, Japan External Trade Organization (JETRO), New Delhi. The views expressed are personal.)