The Hindu Business Line : Skidding on oil policy

The Government cannot frame its oil policies based on the weekly yo-yo in global prices; it must take note of the long-term trend and tailor its policies accordingly.

"... an immediate adjustment of prices and subsidies is an urgent imperative. The economic and financial costs of continued inaction will be alarmingly high as the financial position of the oil companies will rapidly deteriorate. The government will not only forfeit the taxes and dividends that it has been getting from these companies but will have financially crippled companies on its hand, which will be unable to make the much needed capital expenditure required for expansion and modernisation."

These words of warning on the pricing and taxation of petroleum products were served by the Rangarajan Committee, which submitted its report to the Government in February. Predictably, the Government chose to ignore the report and its recommendations in the hope that oil prices would retreat and the situation would correct itself.

Sadly for the Government, things have not turned out that way. Three months since the submission of the report, oil prices are back on their upward journey. And the Rangarajan Committee report has come back to haunt the powers-that-be.

Prices of benchmark Brent crude touched $75 a barrel before retreating marginally towards the end of last week. It would be wrong to take comfort from the minor pullback because the long-term trend is one of rising prices. The Government cannot frame its policies based on the weekly yo-yo in global prices; rather it will have to take note of the long-term trend and tailor its policies accordingly. Sadly, there appears to be no such strategic thinking at the moment; worse there is no consensus on the course of action to be adopted. While the Petroleum Ministry would like taxes and duties to be pegged down, the Finance Ministry would like retail prices to be increased. Given the extent of rise in global prices, what is required is probably a combination of both.

Handling under -recoveries

As per the calculations of oil companies, the under-recoveries are Rs 9.80 on a litre of petrol, Rs 10.20 on a litre of diesel, Rs 125 per cylinder of cooking gas and Rs 16.60 per litre on kerosene. Under-recovery happens when a refiner is forced to sell products at prices less than cost.

Clearly, passing on the entire under-recovery on these products to the consumer is not a workable idea. Apart from the political costs of such an action to the governing coalition at the Centre, passing on the entire increase can stoke inflation.

The only reason inflation has been manageable despite the rise in oil prices is because the load has not been passed on to the consumers and the oil companies have been acting as a buffer. There will be a cascading effect across the economy if the entire under-recovery on diesel is passed on to the consumers, which is something that the Government may not really desire. Therefore, a restructuring of duties on the lines of the Committee's recommendations is probably inevitable. A reduction in the import duties on petrol and diesel, combined with a switch from ad valorem rates to specific excise duties, is desirable. These measures will minimise the extent of retail price increase necessary.

The issue of funding the subsidies on cooking gas and kerosene also has to be addressed immediately.

Overdue action

Clearly, action is now overdue from the Government. The oil marketing companies are bleeding, and badly. Indian Oil is losing Rs 100 crore a day in under-recoveries on the four products — petrol, diesel, cooking gas and kerosene. Its short-term borrowings to cover up the loss of cash flows are also increasing.

The first flush of Q4 2005-06 results is also not very encouraging. Kochi Refineries has returned a loss for the fourth quarter. Bharat Petroleum has managed to show a profit for the same period, but its earnings are down 87 per cent to Rs 1,298 crore. The picture is likely to be much the same when the others come out with their numbers.

Even assuming that the Government acts immediately after the State Assembly elections, which is quite likely, the first quarter report card will be a bad one for the oil companies.

It is indeed an irony that at a time when oil companies elsewhere are reaping in the moolah riding on the price boom, Indian oil companies are fighting to post normal profits.

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