The problems in petroleum pricing stem from a flawed method, and will cause immense harm to the oil companies and endanger energy security.
A DEBATE without data would be a meaningless exercise. But a debate with faulty or fudged data would be positively dangerous. The prolonged national debate over the need to increase petroleum product prices is exactly that. One of the most important arguments of the government was that the move was urgently needed to stem the bleeding losses of the publicly owned oil companies.
Prime Minister Manmohan Singh, in his televised address to the nation after the hike in the prices of petroleum products, justified it by citing the losses of the public sector oil companies, which he claimed amounted to about Rs.2,45,000 crore. He was, of course, careful in his choice of words; he termed them under-recoveries. In commercial parlance one hears of profit and loss, but not of under-recoveries. What, pray, are under-recoveries? The answer to this question would reveal the dirty secret that lies at the heart of the Indian petroleum-pricing regime.
Some simple arithmetic can set the record straight, but the Prime Minister has chosen to constitute a high-powered committee to examine the issue. Among the terms of reference of the committee is the task of revisiting the notion of under-recoveries. It has also been asked to examine the reported deficit and real deficit faced by the OMCs [oil marketing companies].
This implies that the actual deficit of the oil companies may be lower than what the government has stated to demand an increase in the price of petroleum products. Does the nation need another committee when all that is needed is simple arithmetic?
Officials in the Ministry of Petroleum and Natural Gas also made the unprecedented hike appear reasonable by pointing out that although the oil companies needed a hike of Rs.21.43 a litre in the case of petrol, the government was only increasing the price by Rs.5 a litre. A price of Rs.71 a litre would be reasonable, they said, if crude oil prices were about $130 a barrel.
Now, consider the following: India is dependent on imported crude oil, but not entirely. About one-fourth of the nations requirement comes from fields within the country. Indeed, the Oil and Natural Gas Corporation (ONGC) supplies its crude to Indian refiners at a discounted price of $55 a barrel. Logically, the weighted price of the Indian crude oil basket should be about $111.25 at a time when the international price is $130 a barrel.
A barrel of crude is equal to 158.987 litres, which means that the weighted price of $111.25 works out to about 69 cents a litre of crude, or Rs.29.39 a litre. (Incidentally, a large part of the confusion in the media about the losses is caused by the fact that the price of crude is expressed in dollars per barrel, while Indian consumers feel more comfortable handling it in rupees per litre.)
The cost of refining crude oil, which is essentially the process of converting it into products such as petrol and diesel, varies a lot depending on a host of factors. But it depends critically on the grade of crude used and a refinerys vintage. One assessment, by Tapan Sen, a Rajya Sabha member of the Communist Party of India (Marxist) and a member of the Standing Committee of Parliament on petroleum and natural gas, mentioned in a letter he wrote to the Prime Minister recently, is that the cost of crude comprises 93-94 per cent of the cost of the finished product. He pointed out that if refined products were to cost Rs.71 a litre, crude would have had to cost $256 a barrel.
A senior official in a public sector oil company told Frontline that refining margins do vary, but at the most from about 20 paise a litre for Reliance to about one rupee for an old refinery run by his company. Thus, even if one uses the latter figure as the cost of conversion, the price per litre of petroleum products such as diesel and petrol would not be more than Rs.30.39 a litre. Incidentally, both petrol and diesel cost roughly the same at the refinery gate; it is only the rates of duties that cause the differential in prices that consumers pay for the two fuels.
It turns out and this has been in the public domain for a long time that under-recoveries result from a notional and normative price that is not only unrealistic but also opaque and arbitrary (Frontline, July 29, 2005). The fact is that although India is heavily dependent on import of crude oil, it is almost completely self-sufficient in petroleum products.
The long and sustained investments made in public sector refining capacity are a major reason for this, although in recent years private companies such as Reliance Industries Limited (RIL) have established capacities, such as the one in Jamnagar, Gujarat, which are comparable with the best in the world.
The determination of a notional price for petroleum products is a result of the dismantling of the administered pricing mechanism (APM) in 2004. It was decided on the basis of the import-parity pricing principle and has much to do with the mounting under-recoveries of the oil companies. The method of pricing arises from a fundamentalist mindset that requires domestic prices to be linked to international prices even when the petroleum products are not imported. Since these products are not actually imported, the method uses the next best option: assume that these are imported.
It takes the average fortnightly international price of petroleum products, adds ocean freight rates, customs duties and other charges such as insurance and ocean loss to arrive at the import-parity price, which is supposed to reflect the cost that any petroleum product purchaser anywhere in the world would pay for the fuel.
This fantasised price is the base price on which the oil companies compute their under-recoveries, irrespective of what the cost of the fuel actually is at their refinery gates.
In fact, private oil companies like Reliance sell a portion of their products to the public sector oil companies, benchmarking the price to the import-parity price, which results in inflated gains. These companies also export significantly large quantities, enjoying all the incentives provided for exporters.
In fact, Reliance enjoys several advantages vis-a-vis public sector oil companies. The private company does not sell kerosene and LPG in the domestic market, which the public sector oil companies have to, incurring losses. Moreover, while public sector oil exploring companies had to pay cess (until the recent hike) on crude oil extracted in India, Reliance is free from such worries.
Added to these are the considerable savings and earnings Reliance enjoys by virtue of having the freedom to export petroleum products, unlike the publicly owned oil companies.
India has a refining capacity amounting to almost 150 million tonnes, which is substantially more than the demand for petroleum products. To benchmark domestic fuel prices to international prices is not merely absurd, it suggests a sinister design aimed at dismantling the energy security of the country. The logic of benchmarking domestic fuel prices to international prices makes a mockery of self-reliance.
Does this mean the problems of the public sector oil companies are entirely fictitious? At present the oil marketing companies do face a problem of accessing crude oil in the international market, especially at competitive rates. However, this appears to be more of a cash-flow problem rather than outright losses. The Reserve Bank of India (RBI) has purchased bonds issued by the government to the oil companies, thereby providing some relief to the public sector oil companies. It is also true that the public sector oil companies sell LPG at lower than market rates, but they are virtually short-changed by the government, which offers them oil bonds, which are in effect a deferred payment.
Between April and December 2007, Indian Oil Corporation Limited (IOCL) revenues increased 52 per cent over the previous year. In the October 2007-December 2007 quarter, the companys net profit increased by almost 17 per cent over the previous year. The other two major refiners, Bharat Petroleum Corporation Limited (BPCL) and Hindustan Petroleum Corporation Limited (HPCL), made a similar showing during this period. All this does not indicate an industry in distress.
The governments concern for the public sector oil companies, particularly the public sector oil refining and marketing companies IOCL, BPCL and HPCL appears to be based on its long-term intention of fattening them before selling them off at a politically more opportune time.