But India has some choices and must make key decisions. Should it import crude oil or import refined petroleum products? That question was, apparently, answered years ago by a series of government committees which decided in favour of building up refinery capacity. But the governments follow-up hasnt been effective and the result is that very few refineries have come up.
So, where does the government go from here? If India decides to import crude oil then it will still have to find ways to add huge refining capacity. If it settles for importing petroleum products it will need to set up import infrastructure (like ports).
One way or another, Indias policy makers will need to move quickly. It is estimated that by the turn of the century, total demand for petroleum products will increase to 120 million tonnes from the current 80 million tonnes. Unless the government makes up its mind quickly, there could be serious implications for Indias energy security.
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The importance of indigenous crude to a nations energy security is beyond doubt. But is it necessary to have indigenous refining capacity in the absence of sufficient domestic crude? There is surplus refining capacity globally and in the Asia-Pacific region in particular. New refineries will be uncompetitive in the initial years because of high capital charges. Thus, it may be cheaper to import petroleum products rather than producing them locally using imported crude.
But on the other hand there are equally compelling arguments in favour of domestic refining. Local refining means value addition in the country which leads to investment and employment in ancillaries and the infrastructure such as ports and the downstream sectors. Also, it is economical to import large parcels of crude oil compared with lots of small parcels of various refined products.
However, the investments have to be protected either through guaranteed returns (as in the administered price mechanism (APM)system) or through protective tariffs to support domestic refining. In both the cases, the cost of energy for consumers goes up. Thus, policy-makers need to weigh the gains of value addition against the loss on account of high cost energy.
Confronted with a similar dilemma, Japan, the fourth largest energy consumer in the world, decided in favour of domestic refining, although it depends almost exclusively upon imported crude.
Various committees constituted by the government, especially the Sundarajan Committee have documented the pros and cons on this subject. Finally, after all this debate India too has decided to increase domestic refining capacity. Thus, implicitly India preferred investments and local value addition to the gains of cheaper energy.
Subsequently, in the last budget, the government permitted duty free imports of capital goods for the refinery sector.
Despite these positive signals, investments have not materialised. Six years after the sector was thrown open to the private sector, only one project in the joint sector, Mangalore Refineries and Petrochemicals Limited (MRPL), has been commissioned and only two projects in the private sector Reliance and Essar have made some progress.
The reason for this is an unclear policy in this over-regulated sector. It is still not clear when and how the APM will be dismantled. Equally crucially, what will tariff policies be in a deregulated scenario?
Also, there are other unresolved questions such as who will be permitted to enter the retail end. Unless all these issues are resolved, investment will not flow into this capital intensive, low margin business. A few incentives such as the duty free imports of capital goods are not sufficient to make projects attractive and bankable.
While the government has announced that it prefers local refining, it now needs to chart out a viable policy for the sector. The single most important policy initiative required to clear the uncertainty over implementation of refinery projects is the pricing and tariff regime that will govern new refineries.
Obviously, some decisions are tough and have political overtones, such as pricing of LPG and kerosene. But, others such as tariff rationalisation can be implemented without much political opposition. The differential between tariffs on crude and petroleum products would clearly signal whether the government is keen on domestic refineries on not. The current tariff structure neither serves the purpose of protecting investments (they are protected through guaranteed returns) nor minimises the cost to the consumers (the duty on diesel is 30 per cent). Besides, the duty on crude is very high at 25 per cent offering little scope for value addition.
The government needs to realise fast that tariffs have other purposes than revenue generation. And, even though protection is a taboo word in this era of free trade, India would not be violating its commitment to the WTO, if it wished to protect domestic investment in this sector through tariffs. The WTO permits tariff barriers for sectors of strategic importance to a country.
In this article we are not trying to espouse the cause of domestic refineries. The point being made here is that vital sectors of the economy have to bear the cost of indecision on the part of the government. The slow pace of power sector reforms have already wearied investors and it now threatens to stymie the development of the LNG sector. The government needs to take a view on tariffs now to give a clear direction to petroleum sector policy in India.
The government has assumed an addition of 69 million tonnes of refining capacity addition in the ninth plan at an investment of Rs 70,000 crores. The private and the joint sectors are not only expected to bridge the refining capacity gap but also create the infrastructure would be needed whether refineries come up on not, since India would have to depend upon import of liquid fuels.
If the government does not wish to promote refineries, then it should develop an alternative policy for speedy creation of this infrastructure. The whole logistics planning would need to be re-done since the proposed refinery sites were chosen to service different consuming markets in the country. Besides, the government would need to come out with a policy that clearly lays down the terms of entry in import and retailing markets. However , a reversal of policy in this important sector would affect the confidence of potential investors in the infrastructure sectors in India.
If on the other hand, the government wants to promote refineries then it needs to provide tariff protection that offers a reasonable rate of return to the refineries. Half measures which do not benefit either the consumers or the industry, will not suffice. To prevent high energy costs in the long run, the government could progressively reduce tariff barriers and eventually withdraw them altogether in a phased manner. It is not necessary for policy makers to bring radical overnight changes in the tariff structure. What is necessary is to establish a clear timetable of reforms so that investors know what to expect in future.
Thus, the main issue is determination of the direction in which the Indian petroleum sector would head and not whether India should have domestic refining capacity. Only when this is clearly established can a cogent and rational energy policy can be formulated.
(IMA India, a research and business information company, is the Indian associate of the The Economist Group Asia-Pacific Ltd)