The Hindu Business Line : Petro-product prices — Soft-pedalling can hurt govt hard

THE United Progressive Alliance (UPA) Government appears to be treading on thin ice on the issue of oil price adjustment even as the crude price zooms relentlessly.

How else does one describe the Government's dilly-dallying when at the end of the crucial Cabinet Committee on Economic Affairs (CCEA) briefing on October 15, the Minister for Petroleum and Natural Gas, Mr Mani Shankar Aiyar, first said the Government has proposed duty cuts on petro products but later recanted saying that as key Cabinet Ministers — Food and Agriculture Minister, Mr Sharad Pawar, and the Railway Minister, Mr Lalu Prasad Yadav — were away in Maharashtra, the decision had to be deferred, leaving petro-product prices unchanged for now.

Even as crude prices are on a high $55 a barrel, Mr Aiyar said oil companies would have to carry the burden till the next revision, due by October 30, by which time the Government may also have got the report of Dr Ashok Lahiri, Chief Economic Adviser, studying the duty restructuring issue.

The status quo on petro prices must have come as a disappointment to Indian Oil Corporation (IOC) which reported a 21.5 per cent jump in the oil import bill to $4.4 billion in the first half of this fiscal.

Even as prices headed northwards, IOC imported about 16 million tonnes (mt) of crude in the first half of 2004-05 against 14.9 mt in the corresponding previous period. This could either reflect a rising industrial production, or flat growth in domestic crude output, or no conscious effort by the Government to propagate austerity and energy conservation measures.

Estimating the full year import at 33 mt, IOC said this would rise to 37 mt next fiscal as the company is doubling the capacity of its Panipat refinery to 12 mt to process more crude. Last year, the country imported 90.434 mt of crude, which translates into an import dependence of 70.7 per cent.

To modulate the impact of rising crude prices on petrol/diesel rates, a band mechanism was put in place which allowed the Oil Marketing Companies (OMCs) to revise prices based on the previous fortnight's average international price, provided the exchange rate adjusted C&F (cost and freight) product price was plus or minus 10 per cent around the mean of (i) last three months' rolling average prices, and (ii) last one year's rolling average prices.

In case the C&F price breaches the ceiling (as happened in recent days when the crude price pierced the $50 per barrel ceiling and is headed towards $55), the OMCs would keep the prices in the band. The Government may then adjust the duties on petrol and diesel so as to contain the impact on the prices of petro products.

With this objective in view, effective midnight of August 18/19, the Customs duty on petrol and diesel was reduced by 5 per cent each and the excise duty by 3 per cent each.

The Government had earlier cut the excise duty by 3 per cent on diesel and 4 per cent on petrol effective midnight of June 15/16. For the Government this meant a sacrifice of Rs 5,438 crore.

In the light of the constraints on the OMCs not to keep the prices in the band in the face of escalating crude prices and the difficulty of not getting the duty cuts with the Government referring the issue to a committee to rebalance tariffs, the consumer may have heaved a sigh of relief. But not the oil companies.

Though the administered pricing mechanism (APM) has been dismantled, the oil companies have really not had the pricing freedom. If the National Democratic Alliance (NDA) government, led by the Bharatiya Janata Party, did not allow the OMCs to market-relate the prices, the UPA Government has fashioned its own strategy of tinkering with the duty structure, with the exchequer cushioning the impact which otherwise would have been on consumers.

Though the APM has been dismantled, in a comparative study of the retail prices of gasoline and gasoil in Malaysia and Thailand, IOC found that it is governed by another APM, the Automatic Pricing Mechanism, whereby the Government, keeping in view the global market prices, determines the retail selling prices of the products.

The costs to the oil companies for the sales, including transportation costs, dealers' commissions and marketing margin, are then worked out and compared with the retail prices fixed. The Government fixes the ceiling price and the duty element. The duty element is adjusted depending on the product cost. As there is under-realisation for the OMCs under the extant pricing mechanism based on price band, the options they seek include modulation in excise duty rates, flexibility within the price band and review of gross margins.

Regardless of what happens to the fine-tuning of the pricing mechanism of the oil companies, after the current review, if the Government hums and haws on an issue that is best left to the OMCs, the price it may have to pay for this short-sighted policy may be high considering the way crude prices are zooming.

As it is, oil imports during the first half of 2004-05 fiscal (April to September) cost $14.44 billion, against $9.21 billion in the corresponding previous period.

Instead of coming out with a set of measures to moderate demand growth, the Government can ill afford to persist with molly-coddling consumers in the mistaken notion that oil prices will come down or that it will be able to work out duty-cut programmes to deflect the impact of crude price flare up. For the Government this is the time to act.