Deregulation Of Oil Prices In India Economics Essay

Over the last fifty years the most significant shift in India’s energy consumption was the replacement of non commercial energy with commercial energy. Share of commercial energy in total energy use went up from 29% in 1953-54 to 68.2% in 2001-02 and is expected to go up to 76.5% by 2001-12.

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More recent trends shows that the initial shift towards commercial energy use was mainly on account of increased usage of oil. Share of oil in total energy consumption more than doubled from 5.5% in 1960-61 to 13.4% in 1970 71. Share of oil in total energy consumption went up slowly to 24.5% in the next two decades and it is expected to stabilize close to that level till 2011-12.

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India’s Oil Economy 2000-2002

A matrix of the Indian oil economy for 2002 shows its heavy dependence on imports of crude oil and gas and its buoyant exports for refined oil products. Share of domestic production of crude oil was only 28.7% while 71.3% were imports. In contrast LPG production was 82% while imports share was 18%. In the case of naphtha the share of domes tic production was as high as 97.7%. However, the share of exports was 20.9%and a part of it was met by imports whose share was 23.2% .

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In the case of residual fuel oil the country was both an importer and exporter with the respective shares being 7.3% and 6.5%. However, in the case of major refined products the country was self-sufficient. Export share of the domestic production of motor gasoline was a high 29.1% while the share of ATF exported was 29.6%. Even in the case of diesel the exports was a significant 8.1% of the production.

The sale and production of Petroleum products in India has varied.

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The Long-term trends show that growth of sales of petroleum production had initially picked up from an average annual rate of 4.8% in 1974-79 (Fifth Plan) to a peak level of 6.9% in 1985-90 (Eighth plan) Since then, the growth rate of petrol sales have slowed down to 4.9% in 1997-02 (Ninth Plan) and is expected to further slow down to 3.7% in the Tenth Plan. Trends in actual consumption of petroleum products also validate the sales projections. Growth of consumption of oil products (including RBF) slowed down from a peak level of 8.9% in 1999-00 to a low of 0.7% in 2002-03 and picked up marginally to 3.8% in 2003-04. Consumption of natural gas has also picked up by a annual average rate of 3.8% in the last five years up to 2003-04.

be4.JPGAnnual compound growth of petrol products sales in India

Impact of Oil Prices on the Indian Economy and Political Intervention

Historically the Indian economy has been shielded against any sharp spike in oil prices. The Administered Price Mechanism in the oil sector ensured that the impact of any sharp increase in international oil prices were dissipated by spreading over the price increase through smaller incremental hikes spread over a period of time. The oil pool account even then ran substantial deficits, which was partially recharged when the international oil prices went into a trough phase. Thus the Indian economy was generally protected against sharp spurt in oil prices Often the Administered price mechanism has been dismantled in 2002 the retail prices of oil products continues to be regulated by the government.

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Trends in global and national oil prices (% change)

Increase in oil price also impacts on agriculture sector mainly through transport costs and through impact on prices of inputs like fertilizers. In the case of manufacturing the higher fuel prices and transportation costs raise cost of production and product prices, which impacts negatively on demand conditions. High oil prices also increase the cost of services especially in areas like tourist, community and personal services. Our analysis of the impact of oil price increase on the Indian economy revealed that among the different sectors of the economy the only sector that had a strong negative relationship with oil prices was the manufacturing sector.

However, though the manufacturing sector is the most susceptible to oil prices increases, a lagged impact spread over four years, allows the manufacturing sector to escape the full brunt of oil price hikes, as a sustained increase in oil prices over two to three years is very unusual.

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Annual figures show only three instances when domestic oil prices have registered double-digit growth for two or more consecutive years over the last 22 year period; in the early eighties (1983-84 to 19984-85), early nineties (1991-92 to 1993-94) and the early part of current decade (2000-01 to 2001-02). Double-digit oil price increase in 2005-06 will mean another high intensity increase in oil prices that extends into the second year.

However, the results also show that the lagged impact of oil prices explain only around one third of the fluctuations in manufacturing sector output over the last twenty years. With two third of the trends in manufacturing sector output remaining outside the purview of oil prices there is considerable scope for propping up the growth prospects of this sector through other appropriate policy packages.

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Impact of increase in oil prices on growth and inflation levels in India

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The major manufacturing industries that would be most affected by the sharp rise in oil prices would include chemicals, transport equipment, textile products, basic metal and non metallic minerals.

Our estimates of the impact of the oil price increases on the Indian economy assume that that sharp increases in the international oil prices is fully transmitted into the domestic prices. However this is very unlikely, as the political pressures would ensure that the government and the oil companies absorb a large part of the increase in oil prices.

This is especially so since the UPA coalition depends on outside support of political groups who have always resisted the charging of market prices in the oil sector. The results show that if international prices of oil go up to $50 per barrel and remain at that level for a whole year the growth rate in the manufacturing sector would go down by 2.1 percentage points and reduce GDP growth by 0.4%. The wholesale price index would also go up by 1.5 percentage points over current levels.

The Recent Oil Price Deregulation

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On 25th June 2010, a major policy decision on country’s fuel pricing was taken by the Empowered Group of Ministers (EGoM). After a long careful consideration of more than a year EGoM freed the Petrol’s price from Government.

Indian imports more than 70 percent of its energy needs. The Indian Government decides the prices of Oil to help control inflation and thus protecting consumers from Sharp Fluctuations in Oil Prices. The policy of price setting effects the revenues of OMC’s, that are forced to sell oil at below market prices for which the government provides certain subsidies to such companies to compensate the sale of fuel at cheaper rates.

Impact

A study on Oil Sector by IIM states, “Reform of the oil sector is long overdue. The problems in the sector emanate from the structure of central taxes and the system of subsidization through prices,” the study said. “The social and fiscal costs arising out of the current method of subsidization, and taxation are very severe.

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The social losses (of present system) include, misuse/wasteful use of scarce petroleum resources, diversion, adulteration, other avoidable negative externalities, improper substitution between products, tax arbitrage, distortion of consumer preferences and input choices of industries, and international cross hauling of petroleum” which serves to highlight the pressing need for this overdue policy change.

The decision taken by Government to deregulate Oil Prices is an effort to lay down a path for Oil Industry.

A huge burden had to be borne by OMC’s.

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Table serves to highlight the magnitude of under recoveries over the last few years

In April 2002 Government had ignored the administered pricing so that retail prices can be linked to market prices which a tremendous impact on the stock prices of the OMCs. Between March 2001 and March 2004, the combined market capitalization of OMC’s expanded at a CAGR of 52%. The profits as well as dividends distributed by OMC’s grew at a CAGR of over 40% in this period. Since then their dependence on the government’s aid increased progressively as their selling prices stagnated despite rising international crude oil prices.

The basic benefit that the marketing companies were getting from Oil price Deregulation was that their Cash Flow improved resulting in decline in borrowings. Finally effecting the Interest Burden and Improving Net Profit.

The Positive Impact of Price Revision is as follows:-

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The Oil industry’s deregulation also helps to maintain the Fiscal Health of the Country, which already has a deficit target of 5.34% of GDP of FY-2011.

Though India’s debt burden hasn’t reached the Greek levels, but in short term concerns on inflationary pressures caused can be discouraging.

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Petrol Prices across the world

Conclusion

The decision of Deregulating the Oil Prices was crucial. But it has somewhat decontrolled petrol, but not Kerosene, Diesel etc. their prices have increased, literally speaking Government’s heart lies with Subsidies not Deregulation. The government continues fearing that deregulation will stoke inflation. It refuses to see that countries without price controls-US, Europe, have just 2-3% inflation while India with all its controls has 10% wholesale price index.

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