Oil the machine

The most telling comment on the increase in oil prices, announced at long last by the government on Monday, is provided by the movement of the IOC stock price, which fell on Monday as well as Tuesday, in spite of the Sensex rising smartly on both days.

The market knows that the price hike is not enough to neutralise the increased prices of crude. The price of the Indian crude basket has breached $50 a barrel, compared to an average price of $27.96 per barrel in FY04 and $39.21 a barrel last fiscal.

Some of the pricing gap has been filled by adjusting duties, but the oil companies have taken a substantial part of the hit.

What is particularly inexplicable is the approach to cooking gas pricing, since surveys have shown that only the top 30 per cent of households, classified by income, use LPG.

Surely this is not the category to be pampered with expensive state subsidies. The other problem that has been made worse is the wide gap between the prices of diesel and kerosene, which has led to rampant adulteration. That adulteration will now increase.

An oblique commentary on the government's ability to take the required decisions came from the bond markets, which rallied on Monday in spite of the price hike.

The cynical impression in the market is, now that the government has mustered the courage to raise fuel prices, it'll be a long time before the next round of hikes comes along.

The other reassuring factor for the bond market was the fact that the increase was well below what was anticipated, and estimates of the impact on the Wholesale Price Index range from 30 to 40 basis points.

The secondary effects are not expected to be felt immediately, since transporters have decided not to raise freight rates straightaway. The timing of the hike has also helped, with inflation having dipped last week to a low 4.22 per cent.

While the bond market may heave a sigh of relief, the fact is that the government's pusillanimous behaviour has serious long-term implications both for the health of the oil-marketing companies and the country's energy security (the latter because the oil companies no longer have the resources to invest in oil and gas exploration).

Indian Oil Corporation's profit fell over 50 per cent in the fourth quarter of FY05, compared to the same period in the previous year, and the company would have had a net loss in the current quarter if fuel prices had not been raised.

The oil-marketing companies were losing as much as Rs 72 crore per day before the price hike, and the extent of revenues notionally lost by these companies on account of the government's policy has been estimated at around Rs 20,000 crore in FY05.

That notional loss may be even greater this year, for the new prices are well below what is needed to offset the impact of higher international crude prices, the hike in excise duty on petrol and diesel, and the increase in the road cess as well as the cost of supplying cleaner fuel from April 1.