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Paranjoy Guha Thakurta

An oily affair

Date published: August 26, 2014Publication: Asian Age, The Link to original article

It is sometimes said that not even God can predict the price of oil. As a humble mortal, that too a practising atheist, one must confess at the outset that the dip in the international prices of crude oil has taken me and many others completely by surprise. Iraq is in a turmoil, almost on the verge of imploding.

The situation is similar in Syria except that the civil war in that country has been going on for more than three years. Gaza is burning. The political crisis in Libya shows no signs of an early resolution. Ukraine remains a hot-spot. Analysts have argued that the face-off on economic sanctions between the West and Russia is the worst global crisis since the end of the Cold War in the early 1990s.

Not all the countries or regions mentioned are major producers and exporters of crude oil. But many countries in West Asia and North Africa are. The battle between Russia and Ukraine over the Crimean Peninsula was expected to disrupt the flow of natural gas from Russia to Europe, thereby increasing energy prices. But wait! Crude prices had touched $115 a barrel in the third week of June, the highest in nine months, but thereafter prices have come tumbling down and are currently ruling below $100 a barrel. World oil prices are lower than they have been in more than a year. One of the reasons for the decline in oil prices is the rise in the availability of shale gas in the United States.

The fall in oil prices is great news for finance minister Arun Jaitley who had reportedly assumed that oil prices would be in the region of $110 a barrel. If present prices prevail, the arithmetic of the Union Budget — which had been described by some as excessively optimistic — could well prove to be accurate. But that’s a big “if”.

The reason why international prices of crude oil are extremely important for the Indian economy is simply on account of the fact that the country currently imports around 80 per cent of its total requirements of oil. When domestic prices of petroleum products, especially diesel, go up, it exerts strong inflationary pressures. In the recent past, international oil prices have been extremely volatile. During 2008, crude oil prices jumped from $40 a barrel to $147 a barrel before collapsing again to $40 a barrel. Through 2009 and 2010, prices rose steadily to around $90 a barrel before spiking to a 30-month high of $120 a barrel in February 2011, after the so-called Arab Spring began. Over the last few years, the short-term demand-supply imbalances were sought to be bridged and oil prices stabilised by Saudi Arabia, a monarchy which has been America’s closest ally in the Arab world.

India’s oil imports account for approximately a third of its total imports and around a third of the country’s imported crude oil comes from countries located in and around the Persian Gulf region. Whereas the government deregulated petrol prices in 2010, diesel prices (as well as those of kerosene and liquefied petroleum gas) continued to be officially administered. India has been particularly fortunate that crude oil prices have been benign over the last few years. This enabled the government to not just decontrol prices of petrol but also allow the prices of diesel to go up gradually.

Diesel prices have gone up at least 18 times since January 2013, albeit in small doses, usually 50 paise a litre. If world crude oil prices remain stable, the domestic price of diesel will be more or less equal to international prices. There is speculation that the Union Cabinet may soon “decontrol” or “free” diesel prices, the way petrol prices have been. Thus, diesel prices would go up or down depending on whether international prices rise or fall.

What would be the implications of decontrolling diesel prices? Diesel is the largest selling petroleum product in India in terms of tonnage as well as value, accounting for roughly 40 per cent of the total value and around 60 per cent of the total volume of all petroleum products sold. Importantly, diesel is the main fuel used for transportation. Higher diesel prices have a cascading impact on the prices of a very wide range of articles of mass consumption, especially food items. While petrol is largely consumed by the affluent sections, many two-wheelers used by the middle classes also use petrol.

There would be another important fallout if diesel prices are decontrolled. Companies like Reliance Industries Limited (RIL), Essar Oil and Shell India would be greatly benefited as they would be able to re-open the retail outlets that had been shut down. Take the case of RIL. In March 2008, the company decided to shut down all its retail outlets for petroleum products (owned directly by it or through franchisees and/or associates) as international prices of crude oil had surged. (RIL has essentially been a refiner of crude oil at its Jamnagar refinery, exporting its entire output of finished products like petrol, diesel and cooking gas.)

While the Government of India has been subsidising the products sold by public sector oil refining and marketing companies like Indian Oil Corporation, the absence of subsidies to private companies apparently made their operations “unviable”. In 2008, RIL was operating 1,432 retail outlets all over the country. As the difference in the prices of petroleum products sold by private retailers and public sector companies kept widening, the former started shutting down their stations, much to the chagrin of their franchisees and associates. Before it shut down its retail outlets, the price of diesel sold at RIL outlets at that juncture was a hefty Rs 14 per litre higher than the prices charged at outlets of IOC, Hindustan Petroleum and Bharat Petroleum.

Reliance started shutting down its retail outlets before Essar Oil and Shell India. In August 2010, there were reports that RIL was planning to re-open all its fuel stations in the country on expectations that the government would decontrol all fuel prices. That was, however, not to be. Along many highways, one can still see derelict and run-down establishments that were once operated by these private companies. Will these now get a new lease of life?

There is, of course, a real and present danger in decontrolling diesel prices. If oil prices flare up in the future, it will not be possible for the government to control inflation in general and food prices in particular.

Date posted: September 14, 2014Last modified: September 16, 2014Posted byParanjoy Guha Thakurta