Oil industry: Waiting for a regulator

The more things change, the more they remain the same. From All Fool's Day this year, the Union government was supposed to have dismantled the administered pricing mechanism for petroleum products. However, not too many were fooled.

The politicians and bureaucrats who control the ministry of petroleum & natural gas housed in New Delhi's Shastri Bhavan seem most reluctant to give up their awesome powers over the working of the oil industry.

Companies in this sector, which include some of the largest corporate bodies in India, curiously do not seem particularly unhappy. Thus, for the time being, this oligopolistic industry (comprising a few large players) continues to function not very differently from the manner it had for almost three decades since the petroleum sector was nationalised in the early-1970s.

The government, as is its wont, has initiated reforms in the reverse order. When the power sector was deregulated, the authorities started by inviting private investments in electricity generation instead of distribution and transmission.

Similarly, the Securities and Exchange Board of India was strengthened after stock-market regulations had been liberalised and only after the Harshad Mehta scam that had broken out in 1992, instead of the other way around. This upside-down policy has now been repeated in the oil industry.

The government has half-heartedly deregulated the industry but has dragged its feet (deliberately?) on setting up the proposed petroleum regulatory board - to replace the erstwhile oil coordination committee and sundry other bureaucratic structures.

Let us begin with the ham-handed manner in which the oil companies were "allowed" by the government to increase the prices of petrol and diesel from the midnight of June 3-4.

First, the whole world and his brother knew that prices were going to rise. Every newspaper had been writing about it, presumably on the basis of conversations with proverbial "sources" close to the Union minister for petroleum & natural gas Ram Naik and/or top officials in his ministry.

Worse, during the afternoon of Monday, June 3, Naik himself addressed the media one floor below his Shastri Bhavan office, that is, in the conference hall of the government's Press Information Bureau.

The minister told journalists about the impending hike in the prices of petrol and diesel from midnight. And, not surprisingly, soon after 4 p.m., there was a mad scramble among motorists to fill their fuel tanks.

By the early evening, most petrol and diesel outlets claimed they had run out of fuel. In the past, there used to be an element of secrecy in the way in which such decisions were announced.

Typically, the PIB officer in-charge of information pertaining to the petroleum ministry would call up 'beat' journalists late in the evening and tell them to be prepared for an important announcement.

The concerned journalists would curse the PIB officer and land up in Shastri Bhavan, only to be kept waiting till an hour (or even less) before midnight. It was only then that the increase in the prices of petroleum products would be formally announced.

Those were the bad old days of the APM. Welcome to the bad new days of the post-APM regime.

None else but Minister Naik himself should be held responsible for the confusion and chaos that prevailed on the evening of June 3.

Leaving aside such 'minor' goof-ups, one can now proceed to more substantive issues relating to the dismantling of the APM.

During the two months of April and May this year, the four public sector oil marketing companies - Indian Oil Corporation Limited, Hindustan Petroleum Corporation Limited, Bharat Petroleum Corporation Limited and IBP (formerly Indo-Burma Petroleum) Limited - together lost around Rs 20 billion.

The loss was simply on account of the fact that the prices at which products like petrol and diesel were sold to consumers were way below their costs of production that, in turn, were determined by international prices of crude oil.

India currently imports roughly 70 per cent of the country's requirements of crude oil.

Whereas the government had assumed that average world prices of crude oil would be in the region of $20 a barrel when the Union Budget was presented on the last day of February, actual prices shot up to an average of around $ 24-25 a barrel during April and May on account of a variety of reasons entirely beyond the control of the Indian government, including the tension between the Israelis and Palestinians in the Middle East.

Now, since there was no APM, the oil companies should have been free to hike retail prices to cover their production costs and earn 'normal' profits.

But wait! This did not happen. What happened instead was that thanks to a bit of gentle arm-twisting by minister Naik, the oil companies held the price line - all, of course, in the interest of the hapless consumer.

Naik had clearly told the bosses of the public sector oil companies that they should not lose their sleep because of the government's political compulsions to shield Indian consumers from price shocks administered by a volatile and unpredictable global crude oil market.

It has been calculated that every one dollar increase in the per barrel price of world crude implies a Rs 2-billion monthly loss for all the public sector oil companies put together.

So what if during April and May IOC had to lose around Rs 10 billion, and HPCL and BPCL, around Rs 4 billion each? These companies actually had little or nothing to lose in the brave new post-APM world.

Sure enough, on June 3, Naik proclaimed that the government had decided that the oil companies would be reimbursed this amount of Rs 20 billion and that the ministry of finance would work out the modalities of making the payment.

It subsequently transpired that the finance ministry would, in all probability, issue revenue-neutral bonds to the oil companies that could show these tradable bonds as assets in their books of account.

While it was claimed that this extra outgo would not have an impact on this year's Union Budget, what was left unsaid was the following - depending on the validity period of these bonds, the money would eventually go out of the Consolidated Fund of India.

In lay language, the government would (yet again) be picking the pockets of the tax-paying citizens of the country.

What Naik also announced was that the finance ministry would be reducing by 2 per cent the excise duty on petrol (from 32 per cent to 30 per cent) and diesel (from 16 per cent to 14 per cent). Incidentally, these are the two largest-selling petroleum products in India.

It was also decided that the new per barrel 'benchmark' rate for imported crude oil would be $24 and not $20 and that there would henceforth be an 'automatic mechanism' linking the excise duties on petroleum products with world prices of crude oil.

Such a mechanism of floating excise duties, it was argued, would protect domestic consumers during periods of volatility in global oil prices.

All of which is excellent, except for one rather obvious question: Should such an 'automatic' mechanism not have been put in place before the APM was dismantled on April 1? If the media-savvy petroleum minister Ram Naik has an answer to this question, he certainly has not made it public so far.

What is also noteworthy is the fact that although in theory the four public sector oil companies besides private players like Reliance Petroleum and Essar Oil are supposed to be competing with one another to provide lower prices to consumer, on this occasion, as in the past, all companies increased product prices at the same time and by identical proportions.

This phenomenon provides clear evidence of the existence of a cozy cartel or oligopoly - government oil companies have signed so-called 'hospitality agreements' with one another to protect their bottomlines.

At one stage, the petroleum ministry had suggested the imposition of 'ceiling' prices for products, with companies free to sell at prices below the ceiling.

This suggestion was, however, shot down by both the oil industry as well as the ministry of finance: both claimed that such a system would militate against the very spirit of a market-forces-dominated post-APM regime.

The fact of the matter is that few in the industry are really keen on a regime in which profitability is clearly linked to the competitive abilities of particular oil companies.

Whereas there are no legal or commercial barriers for new players to enter the fray, the reality on the ground is somewhat different: on the refining and marketing side, the oil industry is dominated by IOC with a 60 per cent market share and on the crude oil exploration and production side, the big operation is, of course, that of the Oil & Natural Gas Corporation.

The only major private players on the refining side are Reliance Petroleum (with its refinery at Jamnagar) and Essar Oil. Both know the entry barriers rather well, despite the fact that they have received official permission to market petroleum products.

They know that it is hardly child's play to set up a marketing and distribution network to match those of the public sector oil companies. It would take Reliance at least two years, perhaps longer, to put in place a distribution network to match that of HPCL or BPCL, leave alone IOC.

Little wonder then that these private players would be lasciviously eyeing the controlling shareholding stakes in HPCL and BPCL, as and when the government decides to divest its stake in these public sector companies.

Till competition intensifies in the oil industry over the next few years, it suits everyone concerned (including the private companies) to let things continue as they have for decades.

Thus, the mutual back-scratching continues. As minister Naik had remarked during a press conference when asked why oil companies were not increasing product prices though world crude oil prices had shot up: "India's oil companies belong to the government. If the government is happy, they should also be happy."

Coming now to the question of the absence of a regulatory body after the dismantling of the APM, the Petroleum Regulatory Board Bill, 2002, had been introduced in the Budget session of the Lok Sabha and was thereafter referred to the standing committee of members of Parliament attached to the ministry of petroleum & natural gas. Section 12 of the bill outlines the functions of the proposed board that can be summarised thus:

It would protect the interests of consumers by fostering fair trade and competition; it would authorise entities (oil companies) to market notified petroleum products -- mainly kerosene and liquefied petroleum gas whose prices are heavily subsidised; lay, build, operate or expand common carriers like pipelines; and ensure equitable distribution of petroleum products.

In addition, the proposed Board would maintain a databank on the oil industry and 'perform such other functions as may be entrusted by the Central government…'

Till the regulatory body comes into being, Naik has said the petroleum ministry would perform its functions. As is common knowledge, the basic function of any regulatory body can be broken into four broad components related to pricing, competition, quality and dispute resolution.

In a recent newspaper article (The Economic Times, June 6, 2002), an officer of the Indian Administrative Service K B S Sidhu argued against the need for an oil industry regulator. He pointed out that the Bureau of Indian Standards has laid down quality norms for petroleum products.

In order to minimise the impact of fluctuating world oil prices on domestic consumers, he suggests that the finance ministry consider imposing customs duty on imported crude on a volumetric basis rather than on ad valorem basis as is the current norm. (Excise duty and sales tax too are levied on ad valorem basis in the oil industry).

In addition, oil companies should create their own systems to hedge against risks by going in for 'futures and options' while contracting for crude oil purchases, says he.

Even if the government is serious about keeping itself at a 'arm's length' distance from the industry, Sidhu claims that formal authorisation by the proposed board for marketing 'notified' products is akin to a kind of return to the 'licence control raj' in a new avatar.

The counter-argument is that even if half or three-fourths of the kerosene sold in India does not reach the poor in villages and those living in remote areas because of corruption, that in itself is not a good-enough reason to completely do away with a system in which the government subsidises sales of fuel meant for the cooking and lighting requirements of underprivileged sections of society.

Nevertheless, Sidhu too concedes the need for a regulatory body for the oil industry to act as a dispute settlement authority.

The proposed board is meant to be a quasi-judicial tribunal to settle major inter-se disputes between prominent players in the oil industry, while minor disputes could be dealt with under the provisions of the Consumer Protection Act of 1986.

The proposed regulatory authority is needed to prevent precisely the kind of spat that had taken place earlier this year between Reliance Petroleum and IOC.

Reliance had decided against setting up a joint venture with IOC to market half the output from its 27 million tonnes per annum Jamnagar refinery for which a memorandum of understanding had been signed.

The IOC and other public sector oil companies then refused to lift products in excess of the already committed quantum of 12.5 million tonnes.

Eventually, the babus and netas of Shastri Bhavan had to intervene to sort out the unseemly quarrel and a new sales agreement was drawn up.

The proposed regulatory board is need for at least two other important reasons. It needs to work out the detailed modalities for use of 'common carriers' like oil pipelines as well as terminals and depots.

Currently, almost the entire length of oil and gas pipelines, besides terminal and depot facilities are owned and controlled by public sector oil companies. The board would have to decide how such facilities can and should be used by private companies.

Finally, the board has to decide on the highly contentious issue of what would constitute 'abnormal' or 'extra-high' profits, in the absence of a new competition law to replace the outmoded and discredited Monopolies & Restrictive Trade Practices Act.

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