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Thursday, February 13, 2014

Archaic Oil Pricing Policies

Our oil pricing policies hardly make any economic sense and thus warrant quick correction.

In the beginning, we did not know how to make fire. We did not know how to cook food. Nor did we know how to warm our interiors. Then, fire was discovered. And Lo! What a difference did it make to our lifestyle!

Once fire making became a child’s play, we started looking for alternate sources of energy. And in the process we tumbled on crude oil. Since then, we have jolly well burnt out one half of all the recoverable oil, whose creation took nearly 100 million years. Of course, it is the advanced Western countries that are the major culprits for such mind-boggling consumption: the US alone consumed as much as 25% of the oil produced in the world and that, too, hardly with 5% of the world population. According to one estimate, the world today uses 3-4 barrels of oil per every new barrel discovered. In 2004, China alone accounted for 44% rise in the global demand for oil.

The oil experts had a warning to make on this unabated consumption: oil being finite, the problem associated with its scarcity will not wait for the oil wells to go dry to start mocking at us but when the production simply cannot keep pace with the demand. The looming threat of falling oil reserves is well captured by David Goodstein—a distinguished professor from California Institute of Technology—when he said: “Civilization as we know it will come to an end sometime this century unless we can find a way to live without fossil fuels”.

Next to oil experts, the environmentalists have something different to warn us about on the surging oil consumption. According to them, the increasing emission of greenhouse gases like carbon dioxide is raising the global temperature. The consequent melting of the ice in the Arctic and snow on the mountains is feared to raise the sea level by seven feet by the end of the current century. This may in turn inundate 60% of the world population that lives in the coastal areas. The main culprit for all this is the burning of fossil fuels by energy and transport sectors. The Eco-score developed by a European research agency for measuring greenhouse gases output places the CNG/LPG vehicles at a score of 80 to 100, petrol burning vehicles at 100 to 150, and diesel vehicles at 200 to 700 and it is needless to say here that the lower the score, the lower is the emission of carbon dioxide and better the environment. Hence, environmentalists advise that burning of fossil fuels be brought down. In this regard, China set an example: it imposed environmental taxes on cars, gasoline, and wood products while the US is silent.

Economists have yet another kind of warning to issue on oil consumption, particularly in the context of current soaring crude prices. The International Monetary Fund warns that high energy prices are exacerbating global economic imbalances. According to IMF’s World Economic Outlook, “Global current account imbalances are likely to remain at elevated levels for longer than would otherwise have been the case, heightening the risk of sudden disorderly adjustment”. “If a disorderly adjustment does take place, it will be very costly and disruptive to the world economy,” said Mr. Rodrigo Rato, Managing Director, IMF.

Intriguingly, none of these warnings has any bearing on us. Our oil import bill has hit a record high of US $43.8 bn during 2005-06 vis-à-vis US $29.8 bn of 2004-05. As our annual growth rate continues to be 8% plus, the oil consumption levels are certain to increase further. Secondly, with the current trends in global oil prices which are expected to touch US $80 per barrel, our import bill is bound to touch further heights. Yet, we are, ironically, content to live with our archaic pricing policies. The government’s fiat does not allow passing on the burden of increased international oil prices to domestic consumers. This price suppression is nothing short of “populism”. It simply distorts the relative prices and in the process misallocates the scarce capital. The net result is: oil making companies are suffering losses; profits have fallen from Rs. 11,000 cr in 2003-04 to a negative of Rs. 3,000 cr during the first nine months of 2005-06.

The administered pricing mechanism is giving rise to another problem: the oil companies in their anxiety to tide over the liquidity crunch are borrowing aggressively despite hardening of domestic interest rates. Such surging demand for additional funds from the oil industry is bound to adversely impact the overall interest rate behavior in the country. In other words, for no fault, the other businesses are getting exposed to high cost of capital.

Commonsense dictates that in a globalized and liberalized economy, it is essential to let the real economic value of a commodity reflect in its prices so that market distortions can be eliminated. Despite these known economic principles, government after government is simply failing in taking hard decisions. The political compulsions are perhaps the main reason for governments to dither and procrastinate in dismantling the APM fully and create competitive conditions. The current subsidy on kerosene and LPG is estimated at Rs.15,000 cr and Rs.11,000 cr respectively. Against the commonly held belief that the subsidy is meant for poor, 76% of the LPG subsidy is said to go to urban consumers, while 40% of kerosene is quite often used for adulteration purposes. 

All this necessitates that we bring down oil consumption in the country forthwith and the best way to accomplish it is to discourage the consumer from using it by making him pay its real value rather than subsidizing it indefinitely.

May, 2006


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