Pricing of Petroleum Products in India and Parekh Committee Report

India’s consumption of petroleum products has grown at an annual compound growth rate of around 4% during 2002-03 and 2008-09. At present domestic production of crude oil meets around 20% of domestic demand for petroleum products. India’s dependence on oil imports is projected to rise to 90% by 2030. As a result, domestic costs and prices of petroleum products will be increasingly aligned to prices of oil in the international market. With this in view, the Government had notified in March 2002 that consumer prices of all petroleum products except LPG for domestic use and kerosene for public distribution system (PDS) should be determined by market factors. However, this competitive market structure envisaged in the 2002 oil sector reforms was jolted by the sharp rise in oil prices since 2004-05.

In March 2002, price of crude oil in the international market was US$23.3/barrel: it rose to US$39.2/barrel in 2004-05, US$72/barrel in July 2007 and further to US144/barrel in July 2008. Then it fell sharply. In December 2008 oil prices fell back to July 2004 level. Since then oil prices have bounced back to US$75/barrel in December 2009.

In order to shield the Indian economy and consumers from the adverse impact of a volatile international oil market, the government decided to fix the consumer prices of four sensitive petroleum products, viz. petrol, diesel, domestic LPG, PDS kerosene. As the prices of these products were below their cost, government devised a compensation mechanism for the public sector oil marketing companies (OMCs). This mechanism essentially involved financial support to OMCs from other public sector upstream companies, viz. ONGC, OIL and GAIL by way of price discounts and from the government through issue of bonds.

During the period 2003-04 to 2008-09, the OMCs suffered under-recoveries of Rs.2,99,222 crore, which were partly compensated by the Government through issue of Oil Bonds of Rs.1,42,203 crore while the upstream oil PSUs contributed Rs.1,01,285 Crore. Fixation of prices of these essential commodities by the Government at different points of time led to speculations, hoarding, temporary shortages and above all diversion of diesel, LPG, Kerosene to unintended uses. Particularly, the demand for petrol and diesel zoomed even during 2008-09 and 2009-10 when other free products faced lower consumer demands due to industrial slow down.

The financial strength of the public sector oil companies weakened considerably. They could not avail the opportunity to retain the above income for investment in the crucial E&P sector.

Besides, the substantial time taken by the government in processing the proposals for issue of bonds resulted in sever cash flow constraints for the OMCs.

The government policy approach on pricing petroleum products since 1970s has moved between cost-based pricing and import parity pricing (IPP). In the past, the first major policy shift in pricing of petroleum products occurred in 1976, when the Government replaced IPP of the 1960s by cost-plus pricing. This came to be known as Administered Pricing Mechanism (APM), which was applied to the entire oil sector. APM was completely abandoned in April 2002.
The period from 2004 to 2008 saw distinct policy phases: first, a price band mechanism, then trade parity pricing (TPP)

Recommendations:

A viable long-term strategy for pricing major petroleum products is required. It should limit the fiscal burden on government and keep the domestic oil industry financially healthy and competitive.

We recommend that petrol and diesel prices should be market determined both at the refinery gate and at the retail level.

The price of PDS kerosene needs to be increased by at least Rs.6/litre so that the share of
expenditure on kerosene in the total consumption expenditure of rural households remains at the
same level as in 2002. Thereafter, price of PDS kerosene be raised every year in step with the
growth in per capita agricultural GDP at nominal price.

Our analysis shows that prices of domestic LPG can be increased by at least Rs. 100 per
cylinder. Thereafter, the price of domestic LPG should be periodically revised based on increase in paying capacity as reflected in the rising per capita income.

Criticism:

Parikh Committee’s recommendations are bad for the country and worse for the aam aadmi. Bad for the country because the recommendations do not address the problems of petroleum pricing in their entirety and appear to be driven by the desire to allow private sector refiners, originally set up for export of products, an entry into the domestic market under the garb of liberalising price of petrol and diesel. This would be detrimental to the public sector refiners in the current context.

The Parikh Committee recommendations are worse for the aam aadmi because inclusive development shall remain a pipe dream without ensuring access to lifeline levels of modern commercial energy for all. Barring public distribution system (PDS) kerosene, the rest of the petroleum products are currently priced outside the reach of the bottom two-thirds of Indians and the report of the committee talks of further inflationary price increases.

The latest Parikh Committee does not propose “bold” reforms – it proposes bad reforms.

Source: Parekh Committee Report + EPW March 27, 2010