The oil price opportunity

The oil price opportunity

Even after the Organization of Petroleum Exporting Countries’ Friday decision to cut oil production by 1.5 million barrels a day from December, crude prices have continued to fall, to below $65. The prices are now less than half of July’s peak prices of $147 a barrel. Demand has dropped by around 6% in the US since then—since the US consumes around 24% of global production, this is a drop of 1.2 million barrels straightaway, not even taking into account the slowdown in Europe, Japan and China. Speculation in the New York Mercantile Exchange on crude futures is at very low volumes, and one can reasonably expect low oil prices at least as long as the economic slowdown lasts—in fact, some analysts are predicting prices in the $55 range.

This situation presents an opportunity as well as a challenge for India. We import about 70% of our oil needs, and the government tells us that the public sector oil basket is priced at around $65 per barrel presently. One question here is if anything can be done to make this procurement more efficient. As Reliance Industries Ltd’s results published last week indicate, the private company’s crude procurement basket is priced at around $8-10 less. It is important to find out why, and see how public sector procurement can be made more cost-efficient.

Away from this, there are major policy-level issues. The government had several opportunities, right from 2004 onwards, to correct imbalances in prices. But these opportunities could not be availed of due to political opposition. Over the last three years, therefore, there has been a huge overhang of oil bonds, capped by the recent budgetary approval for a further Rs65,000 crore worth of bonds (in terms of lack of fiscal prudence, this year will take the cake, with overall fiscal deficit exceeding the worst ever figure of 9.3% in the past, states and Centre taken together).

Unfortunately, there appears to be pressure on the government to reduce prices of petrol and diesel, with the premise that it will make a favourable impression on voters. There is a clamour for a cut by as much as Rs10 per litre. Of course, this can now be done only after the state elections. But, the fact is, any such move would only make the public sector oil companies ask for continued support, while at the same time making little difference in terms of consumer prices. It is by now clear that the easing of inflation is more due to a softening of prices of commodities and metals, and not food articles and vegetables and meat, which are the prices likely to weigh heavily with the citizen as he goes to vote in the states. As stated in an assessment published in Mint last week, the citizen is no better off than he was 28 months ago.

Pertinently, the expected poor kharif crop (due to floods in Bihar and elsewhere) and higher procurement prices announced by the government will together maintain a strong pressure on food prices. Any sharp reduction in petroleum product prices would, therefore, only exacerbate the fiscal pressure in 2009. Besides, by keeping product prices unchanged, the better recoveries for oil companies with a declining crude bill can help make their balance sheets stronger, and create a little fiscal room for the government next year.

There are other areas where some policy changes can provide relief. Some ill-conceived decisions in 2006 and 2007 have rendered the local markets short of diesel and cooking gas, or liquefied petroleum gas (LPG), while product exports have multiplied. This should be set right immediately. Now that global demand for petroleum products is softening, and there is more than adequate refining capacity at home, it is important to ensure that domestic supplies are safeguarded—and commercial arrangements between refiners and marketers could ensure there are no product imports at least for the next five years. This is feasible and very relevant today, to protect supplies from the vicissitudes of future volatility.

There is yet another opportunity, of getting away from the rising LPG subsidy burden. The KG basin gas is to be made available for city gas supplies, and 24 cities have already been identified for this. This gas is likely to be supplied at close to current LPG prices. If the policy of allocating and distributing city gas is finalized quickly in consultation with the states, it would relieve pressure on LPG supplies. This would be an opportunity of, first, expanding LPG delivery to all unserved areas and customers, and simultaneously capping subsidized supply to a limit of, let us say, 10 cylinders per family per annum, and making available LPG at market prices in abundance to all those who want more. A correction of this type would release the pressure of subsidies, and again provide relief to the oil companies and the government.

Finally, there remains the opportunity of looking at how prices are being fixed and at the various taxes and tariffs that make the products far more expensive than even in our neighbouring countries in South Asia.

S. Narayan is a former finance secretary and economic adviser to the prime minister. We welcome your comments at