ISSN (Print) - 0012-9976 | ISSN (Online) - 2349-8846

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Dithering on Oil Prices

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The rise in global oil prices creates problems here that it does not cause in other countries, because of the restrictive regime governing the marketing of oil products at controlled prices – it sends oil companies scampering for loans, puts upward pressure on interest rates and leaves consumers without any incentive to moderate energy consumption. The solution is for the government to open up marketing and dismantle the administered pricing mechanism. After the price of oil climbed to historical highs recently, the government is finally contemplating revision of retail prices of petroleum products. It should, instead, decide to get out of fixing oil prices altogether. This would leave the macroeconomic balance, the oil companies’ finances and the consumers of energy all better off. The minister for petroleum, Ram Naik, has been pushing for lower excise and customs duties on oil as an alternative to a hike in retail prices. This has met with stiff opposition from the finance ministry, for obvious reasons. However, the ruling coalition has a reason for postponing a price hike – some key assembly elections are due early next year: in Uttar Pradesh, West Bengal, Tamil Nadu and Kerala. However, reducing duties to keep retail prices unchanged would leave the exchequer poorer and contribute to a widening of the fiscal deficit.

Even if oil prices do not go back to the $32 level that they touched recently, the average price of oil for the current year is quite likely to be above $25 a barrel. In other words, there is no escape for the government from raising retail prices of petroleum products. But the government does not have the stomach to raise prices. Instead it has allowed the oil pool account deficit to bloat. The present arrangement is that the oil refineries get import parity prices at the refinery gate. The retail prices are fixed by the government. If these prices are too low to generate the revenues needed to cover refinery gate prices at import parity and the cost of transportation and distribution, the difference is supposed to be made up by payments from the oil pool account. If the oil pool does not have any money in it to make such payments, it runs into a deficit and gives the oil companies IOUs. The oil pool account deficit had come down to as low as Rs 3,000 crore in March 1999. Since then the government’s pusillanimity in raising retail oil prices has pushed up the deficit to Rs 7,500 crore as of June 2000. If the government persists in dithering on oil prices, the deficit for the whole financial year could easily climb to over Rs 15,000 crore. Because the pool account does not have the money to pay oil companies their dues, the companies raise a like amount from the market. Thus the oil pool account deficit represents a draft on the available supply of credit in the system to finance a consumption subsidy. It adds to the gross public sector borrowing requirement, whose chief component is the combined fiscal deficit of the central and state governments. The greater the public sector borrowing requirement, the higher the competition for funds between the public and private sectors and the higher the rates of interest. Obviously, a mounting oil pool account deficit is not good either for the health of the oil companies or for the macroeconomic balance.

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