Political economy of petroleum prices in India – Sailaja Akkem

July 3, 2012

Pricing of Petroleum in India:

The history of pricing of petroleum in India dates back to 1920’s. During the colonial period, the pricing of petroleum was free from Government intervention and was determined mainly by the market forces. After the Second World War, the Government started to regulate the pricing the petroleum products. As a part of this, it appointed several committees. One among them is the Dalme committee (1961) and Talukdar committee (1965) which suggested import parity pricing scheme for petrol, as majority of products were imported from West Asia. In 1974, Government appointed Krishnaswamy committee which looked into the import parity pricing scheme, and suggested Administrated pricing mechanism for pricing (APM) petroleum products, mainly because, the domestic industry of petroleum refining was growing at that time. Government accepted these recommendations and introduced administrated pricing mechanism for petroleum in 1976. As per this scheme, a part of the administrative costs of petroleum refining would be reimbursed back by the Government. But this did not create much incentive in petroleum refining companies to reduce costs, as the costs were partially compensated anyhow by the Government. And based on the recommendations of the Sundararajan committee, Government phased out APM by 2002, and gradually decontrolled petroleum sector, with the main intention that subsidies for other petroleum products like diesel, kerosene etc., are transferred to their intended beneficiaries without any diversion.

Current Pricing & contributing factors:

Now the petroleum is a totally deregulated sector, where in the prices of the petrol are fixed by the oil marketing companies, depending on the international crude oil prices. During the recent times, these companies have been complaining about under-recoveries and are frequently increasing the prices of petrol. Under recoveries does not essentially mean that the OMC’s are not extracting profits, it means that they are not recovering the same amount of money had they priced the product at the international price. Of late, the international crude oil prices had been on an increasing trend due to turmoil in WANA (West Asian and African countries) countries, because they are the countries holding more amounts of oil reserves. Hence the domestic price of petrol was on a rise. Another major factor contributing oil price rise in India is the falling Indian rupee exchange rate with respect to US dollar. This has contributed a steep increase recently in the petroleum prices, the price touching 82 rupees per liter in some states.

When we compare the prices of petroleum in other developing countries to India, we find that petrol is exuberantly priced in India. The major reason for this difference is the taxes imposed by the central Government and State Government on the petrol. The final burden of the taxes has been falling on the consumer of the petrol. Even the differential prices of petrol in different states are due to the differences in the sales tax in different states.

Of the above factors contributing price rise in petroleum, the international crude price rise is something Indian Government can least provide a remedy about, rather than bear the burden of the price rise. This burden has to be shared among all the intermediate agents in the petrol economy, including the OMC’s, the Government and partially on the consumer as well. But due to the Government being unwilling to bear the burden, the Oil Marketing Companies have become the final bearers of the burden and most of the OMCs account books show losses because of this. The Government justifies this by hiding behind the cover of deregulation of petrol sector and plays its politics in deciding when the OMC’s have to bear the burden and when they have to transfer the burden.

The second factor contributing price rise in petroleum is the depreciation of rupee. This is more about the economic policy issues of the Government. Insecure portfolio investors pulling back their investments to safe havens due to rising current account deficit is the main reason to this. A possible solution to this is to attract direct investments from foreign countries, on which the Government is unable to progress mainly because of the domestic coalition politics. It is resorting to alternate economic policies like raising the ceiling of external commercial borrowings, increasing FDI caps in various sectors, bringing about crucial regulating policies in sectors like telecom, pension reforms etc., But these are proving to be of little use as rupee value did not rise significantly.

The third factor contributing is the taxes imposed by the Governments at the centre and the state, which the Governments are unwilling to do, as this contributes significantly to their revenues.

The possible solutions to the Government on the sharing of oil price rise burden can be:

Increase the retail prices of the petrol
Reduce the taxes it imposes on the petrol. Of late, Goa has evolved a unique strategy where in it reduced the tax imposed on the sale of petroleum in the state, thus making the petrol to be cheaper in that state. But the financial position of all the states may not permit this.
Impose additional taxes the profit making corporate sector and high end vehicle consumers/users
Tax the profit making petroleum products export sector companies.
Borrow money to insulate the OMC’s from the losses.

With the international pressures mounting on the country to follow the sanctions imposed on other countries like Iran, the fall in the price of petroleum does not seem to be a reality in the near future. In addition to the above provided solutions to the Government, it should also use its diplomacy to resist these pressures, and should look into the prospects of actualizing the India-Pakistan-Iran pipeline. Similarly, it should also resist transferring the ultimate burden on the consumer, with steep price rises, as it recently did (i.e., Posing the burden on the Oil Marketing companies till the crucial elections in few states are over, and then transferring all the burden to the consumer on one fine day). Ultimately, politics have to be used by the Government for the benefit of the ordinary people and not to burden him.

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