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December 10, 2008
Derivatives in Public Finance | Oil prices in India
The following analysis and the suggested solution is largely specific to the Indian context. However, parts of the following may be relevant to crude oil producing countries and/or to those countries which do not have a market based oil pricing mechanism for retail customers.
Is the government subsidizing petroleum products? The contribution of the oil industry to the central and state exchequers in 2005 was Rs 573 billions and Rs 432 billions respectively. These figures exclude corporate taxes and dividends(and dividend taxes paid by State owned or partly State owned oil companies). These figures are available in the Report of the Committee on Pricing and Taxation of Petroleum Products, February 2006. Let us consider a modest 10% increase p.a. (compounded) for four years. The combined contribution to the government exchequer would then be Rs 1.47 trillions for 2009. However, this figure is an underestimation since the upstream oil companies in among the State owned/partly State owned(ONGC,OIL) sell indigenous crude oil at market prices. As per US’ Energy Information Administration the average global cost of finding(exploration) and lifting of crude oil was US$ 23.19 per barrel in 2006. India's Ministry of Petroleum & Natural Gas gives the budgeted expenditure on exploration and production by public sector oil companies(‘Basic Statistics’ document at the Ministry’s website) for the year 2009. Even if we conservatively assume that the entire cost of exploration and production by all public sector oil companies (except GAIL and ONGC Videsh) is for crude oil, the cost of indigenous crude oil would not exceed US$ 23 per barrel in 2009. At US$ 123 per barrel( the average of India’ international crude oil basket in Q1 of 2008-09 was US$ 118.1) these public sector companies would make a gross profit of Rs 1 trillion approximately. Thus, the a very conservative estimate would be that the government would make Rs 2.47 trillions approximately. This exceeds the gross under-recovery that the Oil Marketing Companies(OMCs) are expected to make. The Ministry of Petroleum & Natural Gas expects the OMCs to have gross under-recoveries of Rs 2.45 trillions if the international price were to stay at US$ 123 per barrel. Since the oil pool deficit(surplus?) mechanism is not subsidizing the consumer on a net basis when oil prices are at record levels, we can only infer what might be the case at lower prices of crude oil such as prevailent today(sub US$ 50 per barrel).
The Planning Commission’s Integrated Energy Policy(August, 2006) suggests market(trade parity) based prices be used. It notes that :
‘…the prevailing pricing and taxation policies and the market structure provide significant protection to the private refineries.’
If you were a private oil company, you would sell petroleum products in the domestic market when domestic prices are higher than overseas prices and vice-versa. We need to ensure a level playing field for the public sector oil companies . This report also explores the possibility of the government adjusting taxes and duties in a revenue-neutral way, or alternatively introducing price adjustments based on lagging of 1-3 month average prices in an attempt to protect the domestic economy from short-term volatility caused by speculators and manipulators.
An alternative solution may be considered.
Even if its becomes administratively feasible to update product prices on a fortnightly or monthly basis, we must bear in mind that poor people in our country are not in a position to face this volatility (risk) in prices, since to bear financial risk one needs financial capital ---and by definition poor people have negligible or no capital. There exist forward markets overseas, wherein crude oil and petroleum product prices are available (Platts prices are benchmark prices for crude and petroleum products, and are widely used). The government while preparing its annual budget for the next financial year can use the forward Platts prices and the corresponding INR/US$ exchange rate in the forward market to calculate the crude oil and petroleum product prices which may be frozen in INR terms by way of forward contracts(or swap). If these fixed prices (for crude oil and each of the petroleum products) are higher than what the government feels appropriate for the end-consumer then lower fixed prices could be put in place. The difference between the prices would be made good by the government to the oil companies by reimbursement (or oil bonds) in a gradual manner throughout the year. The prices would be fixed for the whole year. In fact it would only be prudent for the oil companies to actually enter into these forward contracts so that they do not suffer from adverse movement of prices in international markets. However, this would be best left to the managements of the individual oil companies. Of course, oil companies would be free to sell at prices lower than the fixed prices, if they wish to do so for competitive reasons.
The above system would be transparent, would allow stability in retail prices through the year, would introduce market based pricing which in turn could promote healthy competition between oil companies. Moreover, such a system would allow de-politicisation of petroleum product prices.
Besides, the Ministry of Finance will be able to forecast revenues better. A level playing field will now be available to public sector oil companies. Stable retail prices of petroleum products would help in anchoring general inflationary expectations.
Posted by amgodbole at December 10, 2008 10:11 AM
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