Give oil companies full freedom to set prices

In the Arabian Nights, there is a story of Sinbad the sailor carrying an old man on his back to cross a stream and then being unable to shake him off for days afterwards. The government seems to have got itself into a similar bind with regard to petrol and diesel prices. When the administered pricing mechanism (APM) was dismantled in 2002, Indian refineries were directed to peg their product prices at import parity, with some refinery margin protection by way of customs duty differential between crude oil and petroleum products. Marketing companies were also, ostensibly, given the freedom to set marketing margins on the products that they purchased from the refineries or by way of imports, except for kerosene and liquefied petroleum gas (LPG), which were to be subsidised from the Union Budget. Shortly after these changes were introduced, when crude prices fell, refineries charged lower prices to the marketing companies who, in turn, passed on the benefit to consumers. However, when crude oil prices rose again, the marketing companies were not allowed to increase the prices of domestic and transportation fuels. A great opportunity for the government of the day to allow the market to set prices was lost. Ever since, the central government has had to walk a tightrope between ensuring that marketing companies make decent profits on the one hand, and keeping prices flat and stable due to political compulsions on the other. Though the recent price increases may not fully meet the expectations of the marketing companies, they at last have something to cheer about. With crude oil imports at a level of 70% of our total requirement and likely to go up to 80% in the near future, there are just a few options to moderate domestic prices when international prices shoot up. One, is to reduce the protection enjoyed by refineries by way of custom duty differentials. Indian refineries have been earning margins as high as $7 to $8 per barrel compared to Singapore refineries which do not enjoy any duty protection, and whose margins are less than $2 per barrel. Two, is to change from the ad valorem system of duties, which have a cascading effect on prices when the base price changes, to specific duties based on volume or weight. However, the finance ministry has not taken kindly to this suggestion. Three, is to set up an Oil Price Equalisation Fund, as in some countries, where oil companies contribute to the kitty when crude prices are low and draw from the kitty when prices are high. However, having abolished the oil pool accounts and allowed refineries to price products at import parity, this would be a retrograde step. Though there have been complaints that the recent price hikes are very high and should be moderated, prices have remained flat all these months while crude oil prices were rising. Had prices being allowed to float freely monthly or bimonthly, the revisions would have had a more gradual impact both on the public and political parties. Marketing companies must be allowed to earn their margins and operate profitably. The missing element of true competition in the marketplace will appear once the private marketers are able to establish a sizeable network. At some stage, the government will have to bite the bullet and give oil companies full freedom to set prices. The opportunity may soon arise if crude prices maintain their move southwards. Rolling forward or rolling back should be by the market and not a gymnastics exercise by the government. With a regulator hopefully in place early next year to monitor prices and guard against cartelisation, the government would finally get rid of the old man on its back.