Should petrol and diesel prices have been cut?

DEBATE

While the impact on consumer sentiments is obviously positive, the issue is of what this does to under-recoveries of oil companies and competition.

ARUN UNNI,
Manager, Advisory Service, KPMG

"Whether this will cut inflation is doubtful, but this will worsen under-recoveries for oil firms and, to that extent, will also lower competition as private sector firms will be worse off".

Moving too fast from a controlled price scenario to a market mechanism may have its pitfalls, as evidenced in the California energy crisis as well as the European gasoline crisis. The transition of India to a deregulated market needs to learn from such experiences. In the meantime, while a controlled price scenario prevails, as is the case today, it is important to ensure that an appropriate policy framework drives decision-making, to ensure that equitable distribution of the adverse or beneficial impact occurs across stakeholders.

While the impact of such a price decrease is likely to be different for different stakeholders, an overall assessment indicates that such a move may be detrimental in the medium- to long-term.

While prima facie, it appears consumers are likely to benefit, the impact on inflation is not very well established and the likely reduction of private competition is not a positive indicator. Currently, petrol and diesel form only a small part (less than 14 per cent) of the WPI, and inflation may not come down purely by virtue of these price cuts. In a fast-growing economy like India today, a number of factors impact inflation, other than energy prices. As a result, the expected impact on the consumer in the medium term due to reduced inflation may not really materialise.

The negative impact on the consumer in the long run is likely to be felt much more subtly, through the resultant impact on the oil marketing companies. In an environment where oil retailing becomes synonymous with sustained losses, competition from private players is likely to reduce, thus depriving the consumer from competition-driven efficiencies and benefits, as well as reduced reach due to the unwillingness on part of the marketing companies to open more outlets.

In the short-term and the long-term, this zero-sum game also tends to be unfavourable towards the oil marketing PSUs, who were just recovering from significant losses piled up over the last year, by making up to Rs 4.20 per litre on petrol, while still losing money on each litre of diesel, before the price cut. Apart from the impact on shareholder value, continuing periods of losses are also likely to have an adverse impact on the ability of these organisations to invest in capacity-building and efficiency improvement measures. In the long run, the cost of lack of capacity as well as inefficiencies is likely to be borne by the consumer.

Private oil marketing companies, in contrast to PSUs, do not have the support of the oil bonds and are likely to face even harder times with lower end prices. For them, retailing may not appear an attractive proposition in the short term, thus depriving the consumer of competition-driven benefits.

The only winner in the short term is the government. The first is clearly through the goodwill it generates from its allies as well as the end-consumer. The second is more subtly through the fact that the government is likely to feel a lower pinch of the overall under-recovery as compared to oil marketing companies. In a number of cases, states which had reduced their sales tax to offset the burden on the consumer might raise it again.

However, in the medium term, the government too would be impacted by the need to develop a mechanism to apportion the additional under-recoveries which might arise due to a price decrease, putting further pressure on any or all of the stakeholders.

In summary, while the idea of passing on benefits of lower crude prices to consumers seems like a good one, it is also important to understand the long-term impact of such price cuts. The objective should be to drive such decision-making through a balanced policy framework, so that such price cuts do not have a distorted impact on any one stakeholder. In the long run, such distortions tend to develop into roadblocks on the way to a market-driven mechanism. If the price cuts are likely to increase under-recoveries, reduce competition, and not significantly reduce inflation, a deeper study of the intended objectives may be required.

D S RAWAT,
Secretary General, ASSOCHAM

"The move to cut prices of both petrol and diesel will lower inflation, and help consumers "" in any case, when global prices are falling, there can be no case for not cutting prices".

We at the Associated Chambers of Commerce and Industry of India (Assocham) support the Rs 2/litre and Rs 1/litre cut in the prices of petrol and diesel respectively, for which the rationale is that the common man who has been under heavy pressure because of the price rise will gain the maximum out of it.

Second, the transportation and railway freight costs to industry would also drop with the price adjustments for petrol and diesel.

Third, with the rationalisation in the prices of petrol and diesel, the prices of essential commodities will come down to reasonable levels.

As a matter of fact, we had been supporting the demand of some of the political parties to bring down the prices of petrol and diesel ever since the crude oil prices in the international market started softening a couple of weeks ago.

Assocham had, in fact, even supported the heavy price rise of petrol and diesel a few months ago, arguing that when the government, way back in 1998, introduced the concept of import parity for fixing the prices of petroleum products, it was fully justified in hiking prices, given how crude oil prices per barrel had hardened to a large extent.

The government, however, deferred the price hike then, anticipating that the crude oil prices would soften in the international market and adjustments would happen to compensate for the losses of the oil marketing companies.

That, however, did not happen, but we at Assocham certainly advised the government to hike domestic petrol and diesel prices. We had also demanded that the prices of LPG be upwardly revised "" indeed, LPG continues to be underpriced, and some amount of the existing subsidies on it should be shared by public at large to reduce the burden on government.

It is a sheer coincidence that a few days ago the government reduced petrol and diesel prices and prices of crude oil in the overseas market have started hardening marginally.

It is correct that the government did not reduce the price when it should have, and so the oil marketing companies like Indian Oil, Hindustan Petroleum and Bharat Petroleum have made some more money, but this seems all right at one level. For, when the government needed to raise prices, this was also delayed. That is, the oil marketing companies made up for some of their under-recoveries in the past.

Now that the government has taken a decision, which we have welcomed for the reasons I have just stated, we hope and are even confident that in due course of time, the government, particularly the ministry of petroleum and natural gas, will empower its marketing companies to adjust prices of petroleum products on the import price parity method so that these do not suffer any losses and their balance sheet remain healthier with increased profitability.

As long as oil companies, particularly oil marketing companies, are kept at the mercy of the government for increasing and decreasing the prices of petroleum products, particularly those of petrol, diesel and LPG, it will be difficult to predict that their balance sheet would show better results, especially when the competition has already ushered in the downstream oil sector.

Lastly, we concur with the view that, though the margins of the oil marketing companies are under pressure, it is a competitive world in which the government and the oil companies also have to look at the social angle to fulfill their social responsibility for which some adjustments, negative or positive, will have to be accepted in the best interest of our society by and large.