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Oil pool account can redress petrol price burden(Commentary)
June, 16th 2008

By Nandakumar J and A. Vinod Kumar

Just before inflicting a burdening oil price hike on his countrymen, Prime Minister Manmohan Singh had hinted that no solution exists for this tangle, supposedly created by a global surge in oil prices. The situation was worsened by the precarious financial health of oil marketing companies (OMCs), which had to bear the brunt of escalating global prices by subsidising the final product to the consumer.

By declaring OMCs would no longer be allowed to bleed, the government has finally decided to pass on what is claimed to be a share of the burden to the end-user, the resultant political aftermath notwithstanding.

However, it would be imprudent to argue that no solution exists to tide over this crisis. In fact, the answer to this problem lies in the revival of a dismantled system, namely, the oil pool account (OPA) and its administered pricing mechanism (APM) for petroleum products.

For years, the APM and OPA served as the two pillars of Indias oil trading and domestic distribution.

But the two mechanisms were to be dismantled in a phased manner starting with the APM for high-speed diesel (HSD) and aviation turbine fuel (ATF) from 1997, and for petrol by April 2002.

Since then, Indian OMCs are distributing petroleum products in the domestic market at rates based on the international crude prices, with the government reviewing prices on a timely basis.

For the purpose of funding the international purchases of the OMCs and to cushion them from price inflation, the government decided to issue special bonds and allow prices of petroleum products to be governed by import parity, along with freight and local taxes.

Crude prices have been steadily on the rise since the 9/11 attacks, but have been cushioned often by increased production and other measures.

However, ever since the global crude crossed the $100-a-barrel mark, the situation has worsened, not just in India but across the developing and developed world as well.

The impact on developing economies like India, whose dependency on overseas oil has been steadily increasing, is more severe.

Though the dismantling of APM had placed domestic petroleum prices in tandem with international prices, political sensitivities and fear of public opposition restricted the government from reflecting global prices on the domestic market, resulting in added burden on the OMCs.

With the situation now moving beyond control, it is imperative to think of adequate damage limiting measures to cushion the great Indian consumer from global prices shocks without disturbing the financial health of OMCs.

Global oil trading is no longer solely driven by consumption demands, but more through speculative trading by stakeholders including oil majors and financial institutions.

On the other hand, the growing demand for energy in developing countries is influenced by two factors. First, their booming growth rates as a result of higher economic activities, and second, the transferred demand for energy.

Transferred demand is the demand for energy by various industrial activities which were originally located in the developed world and were transferred to developing countries as part of their globalisation drive.

While developing countries like China and India have benefited from the incoming investments for building up new production facilities, to a great extent the demand for energy also was transferred to these economies.

Apart from that, Indias growing economy has created a new class of high-income professionals and entrepreneurs who have kicked off an automotive boom, leading to a radical rise in demand for petroleum products.

Though this has added to the demand within the country, the vast majority of the population would find it hard to afford the oil prices if constantly subjected to international market dynamics, not to mention the impact it would have on inflationary trends.

Despite dismantling the APM, domestic oil continues to be subsidised to cushion against price fluctuations in the international market.

However, the issue of oil bonds to the OMCs, to compensate for the loss incurred through the subsidised domestic sales, does not provide substantial relief to these companies to meet their immediate expenses.

These bonds can only be redeemed by the OMCs after seven years while an immediate sale of the oil bonds to financial institutions might only fetch a much lesser percentage of the actual value.

As a result, oil companies are facing major financial problems, which would potentially affect their sustained operations in the long run. In fact, the Indian Oil Corporation recently suspended all new projects due to the financial crunch.

Hence, one is forced to ask whether the dismantling of the oil pool account has benefited either the Indian customer or the oil marketing companies. To cushion the Indian consumer from international price pressures the government has been virtually controlling the pricing mechanism, which it had been doing through formal structures prior to 2002.

For that matter, the idea of doing away with the oil pool account was seemingly a result of the sudden price fluctuations created by volatilities in West Asia, starting with the 1991 Gulf War.

After dismantling the oil pool account, one of the first steps was to issue oil bonds to compensate the oil companies for part of their dues then estimated to be over Rs.1,300 billion.

However, this is only one side of the picture.

When international crude prices were low, the oil pool account reportedly had surplus funds in the early 1980s and during the mid-1990s. Experts argue that if the government had sustained that surplus, it would have been sufficient to cover the deficits when the international prices would go up, as is the case now.

Analysts believe that the current oil price rise is not driven by high demand and hence a sudden fall could be expected. However, any reduction in domestic prices might be nominal, as the emphasis would be to generate surplus funds for the oil companies to withstand future price hikes.

In the current condition, it would be judicious to channel these funds into an oil pool account to fund future crude demands and formally restore the APM, which was theoretically in existence by other means.

Unlike the economic situation in the mid-1990s, when the decision to dismantle the OPA and the APM was taken, the current growth rate of around nine percent places the country in a better position to afford and operate an OPA.

Moreover, tax collection also has grown significantly over the past few years, adding to government revenues. The finance minister had recently stated that the direct tax collection for 2007-08 was Rs.3,144.68 billion, a 36.62 percent over the previous fiscal, and 117.56 percent of the original budget estimates.

This higher tax collection contradicts the argument that the government would not have the fiscal strength to maintain the OPA. Though such decisions would be purely taken on the basis of political discretions, the fact remains that the government has now totally or partially withdrawn from major expenditure areas including infrastructure sectors like telecom, transportation and power.

While Indian Railways can sustain on its own by its strengthened revenues, the major expenditure of the government today goes in defence, internal security, social welfare and salaries.

Being unburdened from high-investment infrastructure areas, it would not be an unfeasible proposition for the government to restore and operate an oil pool account.

For a country like India where the vast majority of the population remains middle class and below, cushioning the masses against energy price volatilities is pertinent to sustain social and economic stability in the country.

However, this would need a subtle shift in neo-liberal policies by adding a tinge of socialism when it comes to oil prices.

(Nandakumar J is Senior Energy Analyst with DMV Business and Market Research Pvt Ltd, a UK based Energy Research firm in Hyderabad. A Vinod Kumar is Associate Fellow at the Institute for Defence Studies and Analyses, New Delhi. The authors can be contacted at....

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