Diesel subsidy down, but free pricing some time away

Till about two years ago, diesel was the darling of the automobile industry. Thanks to its substantial price difference with petrol (nearly 25/litre), customers did not need too much goading to buy a diesel car. As a result, manufacturers like Honda, which only had a petrol portfolio, could only watch helplessly as the market shifted dramatically towards diesel.

The big losers in this lopsided fuel consumption pattern were the oil companies which had to bear the subsidy burden on diesel which was causing them losses of over ₹75,000 crore annually. The Government realised the pragmatic option was to increase price of the fuel in small doses to soften the blow (against imposing higher excise levies on large cars and SUVs). This is when the monthly price hikes of 50 paise came into effect from January last year.

Present scenario

Fast forward to August 2014 and the subsidy element in diesel is now down to barely ₹1.50/litre which means it will be completely wiped out by November. In the process, the differential vis-à-vis petrol will also reduce to ₹15/litre which explains why customers are making a beeline for petrol cars all over again. Honda, interestingly, kicked off its comeback script with the diesel Amaze last year which, along with the City, surpasses sales of its petrol siblings.

There is no question that falling crude prices globally have played a big role in rapidly eliminating the subsidy component in diesel. It now remains to be seen if the Government will make the most of the situation and seek Cabinet approval to officially deregulate the fuel. Once this happens, the oil companies will be free to take a call on its pricing as is the case with petrol right now.

Such a move will also send the right signals to automakers about a cohesive fuel pricing policy being in place after decades of procrastination by successive governments at the Centre. The reluctance to free diesel prices stems from the fact that it is inflationary in nature and a steep hike can wreak havoc with essential commodities which are transported by trucks.

“Cars are only a small part of the overall diesel script. Trucks, tractors, construction equipment and generator sets use the fuel too and end-users cannot be subject to steep price hikes,” an oil industry official told Business Line. Yet, there is also no denying the fact that the current price levels offer the Government the best opportunity to free diesel prices and rid itself of a cumbersome compensation mechanism to the retailing oil companies.

Middle ground

Perhaps, the best bet is to go in for an ‘in-between’ solution where the Government can step into the picture for price hikes beyond ₹3/litre. Even in such extreme cases, it could prevail upon the oil companies to stagger any relatively steep increase in phases so that the diesel user is not inconvenienced.

What also needs to be borne in mind is that while global crude prices have softened considerably, there is no telling when a spike will happen. Five years ago, crude had touched an all-time high of $148/barrel and crashed subsequently to $40/bbl. With the Middle-East still in a state of uncertainty, it is very likely that crude prices could rise again which will make it doubly difficult for the Government to free diesel prices.

From the auto industry’s point of view, it is already clear that petrol is back in favour since the monthly price hikes came into effect for diesel. During that time, petrol has also seen prices being slashed, a clear reminder of the benefits of deregulation.

Manufacturers would ideally prefer a differential of ₹20/litre between the two especially in a market where SUVs are doing well. The Government, likewise, would not risk stoking inflation which is already burning a hole in household budgets across India. In such a scenario, deregulating diesel prices could still be sometime away though it could continue to fall in the coming months keeping in line with international prices. Nobody, be it the oil companies or the customer, will have any reason to complain till then.

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