OIL SECTOR: Uncertainty likely in fuel prices

OUTLOOK 2008

The new year is expected to witness the trend of volatile crude oil prices continue, which was seen in 2007, when global prices ranged from $50 per barrel to $99 per barrel, and this volatility would result in continued uncertainty on domestic pricing of fuels, which is controlled by the government.

The recent surge in global crude oil prices has been attributed more to speculative trading rather than weak demand-supply fundamentals.

"The speculative trader cannot be wished away. While demand continues to be strong and from multiple sources, supply from the conventional sources is weakening. But there is enough oil in the world to meet the demand, which means the fundamentals are strong. This should cause global prices to ease in the medium- to long-term," chairman of the Shell Group of Companies in India, Vikram Mehta, said during a recent interview with Business Standard.

Petroleum Secretary MS Srinivasan said last week that prices of crude oil are expected to come down to around $60 per barrel. "Although it is very difficult to make a prediction, we must remember that prices cannot keep rising. What goes up must come down," he said.

It is a view that some analysts agree with. JM Financial ASK feels that an economic slowdown in the US, which consumes 25 per cent of world oil, will slow demand and hence lead to decrease in crude oil prices. It sees oil prices at around $70 per barrel over the next two years.

"We also see the average price of crude oil over the next 10 years at $65 per barrel," Rohit Ahuja, research analyst at JM Financial ASK, said.

Then there are the peakists, who are of the opinion that crude oil production around the world has peaked. If the peakists are proven right, then new, large oil discoveries would be few and far between. This would result in short supply and surging prices.

"A year back, oil at $100 was not imaginable. Today, even $150 is a possibility," another top official with a global oil company said.

Recently, Videocon Industries had put in an expression of interest to buy UK-based company, Burren Energy. A top official of the company had said that current oil prices at $90 per barrel had made oil assets expensive, but he saw oil reaching $150 per barrel, which made the $90-mark seem cheap.

Volatility effect
The government has cited this volatility in crude oil prices as one of the main reasons why domestic fuel prices have been raised even as oil has crossed $90 per barrel.

Petroleum Minister Murli Deora recently said that petrol and diesel prices "cannot be raised in line with the global surge in crude oil prices as it continues to remain highly volatile".

Oil prices have a direct effect on domestic fuel pricing. As crude oil remains at the $90-per-barrel mark, the government-owned oil marketing companies "" Indian Oil Corporation (IOC), Bharat Petroleum Corporation and Hindustan Petroleum Corporation "" are losing around Rs 300 crore per day as they sell petrol, diesel, LPG and kerosene at subsidised prices.

It is not just economics. Fuel pricing in the country is more about politics, and governments. At a time when crude oil prices have siniffed $100 per barrel, the government continues to "insulate the aam aadmi from the surge in oil prices".

Pricing of fuels was freed by the government with the dismantling of the administered pricing mechanism in 2002, when the National Democratic Alliance was in power at the Centre. The dismantling never really took place and prices of fuels continue to be administered by the present United Progressive Alliance government.

"That is what fuel pricing is about. With each successive government policies change, reforms in fuel pricing cannot take place," another oil ministry official said.

One of the ways in which the oil ministry is attempting to reduce the burden of revenue loss of the oil marketing companies is by rationalising taxes.

"The finance ministry is unwilling to reduce taxes on fuels as it earns huge revenues," said a senior official with IOC, the country's largest marketer of fuels.

Inflation fallout
Inflation has been brought down to around 3 per cent from over 5 per cent records in mid-2007. "In an effort to contain inflation, the government, which could face mid-term polls, would be reluctant to fiddle around with fuel prices," the oil ministry official said.

Raising prices of petrol and diesel results in higher transportation costs which inflate the prices of essential commodities.

"The government knows that there is a case for raising fuel prices. Economics, however, cannot influence this decision," the official said, adding that uncertainty in fuel pricing would remain.

Everyone is keeping their fingers crossed. Shell's Mehta spells out the hope. "Pricing has to be freed. Only if the government wants to kill its oil marketing companies can the subsidy scheme continue," he said.