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Alok Raj Gupta

"The move from regulation to the deregulation of the diesel price will have to stand the test of time as it is determined how the economy will be impacted with the upward change"

Ashish Suman Partner, J. Sagar Associates

From Regulation to Deregulation - Diesel Pricing

January 30, 2018

By Ashish Suman

The traces of deregulation of diesel prices could be seen as early as 2002, however, Administered pricing regime, made a back-door entry towards the end of the first quarter of 2004 when crude prices started creeping up. Now the deregulation of diesel prices has been made effective from October 19, 2014 (Deregulation). Pursuant to this, the Public Sector Oil Marketing Companies (OMCs) started pricing diesel in line with international prices and related market conditions.

Prior to Deregulation, the pricing of petroleum products was as per the Administered Price Mechanism (APM) effective July 19, 1975. APM was based on cost plus principles wherein the oil refineries and OMCs were compensated for operating cost and return at 12% post tax on net worth. Thereafter, APM was dismantled effective April, 2002, but OMCs’ modulated diesel price ensured that international oil prices do not affect the consumers. This lead to huge ‘under recoveries’ incurred by OMCs which were compensated by ‘Burden Sharing Mechanism’- partly by government through their budgetary support, partly by Public Sector Upstream Companies namely, Oil and Natural Gas Corporation, Oil India Limited and Gas Authority of India Limited through price discounts and by OMCs absorbing a part of under recovery themselves.

The government addressed the issue on under recoveries, at first, by partially deregulating diesel prices effective from January 18, 2013 as by allowing OMCs to increase the retail selling price of diesel by small amounts monthly. Subsequently, diesel prices were made fully market determined at the refinery gate as well as retail level from October, 2014. The market determined pricing is also prevalent in Canada, USA, UK, Netherlands, France, Japan, Italy, Germany and Philippines.

Post Deregulation, the pricing of diesel was revised depending on average international prices in the preceding fortnight and the currency exchange rate. However recently, the OMCs have initiated dynamic fuel pricing from June 16, 2017 whereby the retail selling prices of petrol and diesel are revised daily as opposed to rates being revised every 1st and 16th day of the month earlier. This makes consumers more aligned to market dynamics and gives OMCs more control and flexibility.

The impact of Deregulation can be observed at different levels. For the Government, the burden of subsidy on petroleum products and natural gas has been largely eliminated as evidenced by reduction in Government’s subsidy expenditure from Rs. 72,314 Cr in 2014-15 to Rs. 4123 Cr in 2016-17. The savings in subsidies is also utilized for funding anti-poverty and social sector schemes. From the market perspective, it has also resulted in better service delivery due to increased competition in the auto fuel retail sector.

The market players in the sector have also been benefitted to a large extent. The direct beneficiaries of Deregulation are the OMCs, as it has improved their credit profiles. Private refiners such as Reliance India Ltd. and Essar Oil Ltd., which did not receive government support under the Burden Sharing Mechanism are now provided with a level playing field to sell diesel directly into the domestic retail market. The competition resulting from the equal opportunities now fosters better efficiency in oil companies, benefitting the consumers. Subsidy burden sharing of the Public Sector Upstream Oil Companies impaired their ability to invest in domestic field exploration and acquisition of oil assets abroad. Generation of cash surplus owing to elimination of subsidy enables Public Sector Upstream Oil Companies to invest in aforementioned activities now.

Deregulation showcased its immediate effect when diesel prices sharply reduced from Rs. 58.97/litre on August 31, 2014 to Rs. 50.51/litre on December 16, 2014 in Delhi. The reduction in prices owes to the fall in global crude prices.

Deregulation has heavily impacted the Indian economy as diesel constitutes about 40% of the total consumption of petroleum products in India and is consumed majorly as an intermediate product affecting the prices of other goods and services. The fluctuations in diesel prices affects the sectoral consumers including farmers and has direct bearing on food prices. Diesel price reduction helps reduce inflation as the use of diesel is linked to major sectors of the Indian economy, primarily agriculture sector (which contributes to about 17% to India’s GDP) and transportation sector. The reduction in inflation also enhances the purchasing power of the consumers and results in the currency rate cut increasing demand in the market. With reduction in subsidies to be given by the government, government borrowings have reduced resulting in lowered interest rates.

Hence, it can be inferred from the above that the fall in crude oil prices in past four years has helped in pacifying inflation and has bolstered the Indian Economy. On the other hand, it can also be seen from a point that at present the market linked diesel prices are affected by the international prices and the increase in international prices (which may arise due to various factors, as for instance, the oil exporting countries curtailing supplies) would effectuate increase in diesel pricing in India and risks in government’s finances. It cannot be totally negated that the APM regime may again be revisited by the Government in case the international crude oil prices see a drastic increase. Therefore, the move from regulation to the deregulation of the diesel price will have to stand the test of time as it is determined how the economy will be impacted with the upward change in the global oil prices. Further, apart from the environment standpoint even from an economic standpoint it is the need of the hour to consider an energy mix which is substantially contributed by the renewable sector to reduce the effect on the economy in case of any drastic increase in the crude oil prices.

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