Petroleum sector reforms: progress and prospects

The 31 March 2002, deadline of dismantling the Administered pricing mechanism for petro-products is now quite near and the question being asked is whether the Government is prepared for this final step. Seeking to lay these doubts at rest, the Petroleum Minister has declared that he is proceeding according to schedule. However, while inaugurating a seminar organised by TERI on August 31, he pointed out that there were many issues that needed to be resolved. First, what was the implication of higher petroleum prices in the States far from the coast? Second, how would the market ensure adequate inventories and timely supplies to remote areas? Third, was it feasible to cushion consumers from the effects of fluctuating prices? These were some of the important questions he raised. The issues are complex and it appears that four years after announcing the decontrol of prices, the Government is yet to fully work out the economic and political implications of a market-driven petroleum industry. What are the chances that satisfactory answers to these questions will be found in the next few months? The high level of oil prices over 2000-01 added to the difficulties of liberalising the sector. The developments following the terrorist attacks on the US on September 11 have the potential of destabilising the oil market. If such a thing were to happen, would we still see the decontrol taking place as planned? A third difficulty would be in finding Rs 12,000 crore to meet the oil pool deficit. However, according to the Revenue Secretary, this problem would be manageable. Dismantling a gigantic allocative structure can be daunting and it may be difficult to adhere to a predetermined schedule. India's petroleum industry was not always controlled by the Government. During the British Raj, it was basically a free enterprise. At Independence, oil majors such as Shell and Esso dominated the industry. In 1956, the Oil and Natural Gas Commission (ONGC) was set up and discovered oil in Cambay in 1958 -- thus extending India's oil map. The 1970s proved to be the most eventful years for the industry with the oil price shocks, the nationalisation of foreign companies and discovery of the Bombay High field. The Administered Pricing Mechanism was introduced in 1976 and the Oil Coordination Committee constituted to implement the mechanism. The APM and the OCC supplanted the role of the market through command and control. The APM compensated producers, refiners and marketers for operating costs and gave them an assured return on their assets. Prices of petroleum products at all refinery locations were equalised through common accounts, and diesel, kerosene and LPG were cross-subsidised by other fuels. This pricing mechanism clearly undercut efficiency and transparency despite assisting in a massive expansion of infrastructure by underwriting investment risk. The need for private investment, particularly in exploration and production, to supplement the efforts of national oil companies was recognised by the late 1970s. Exploration blocks were offered to international oil companies in 1979 to attract investment and technology. This approach gained momentum and in the second half of the 1980s nine contracts were signed for offshore exploration. The real push came in the 1990s when six rounds of bidding were held for exploration and some of ONGC and OIL's fields were handed over to the private sector for development. The refining sector was opened up with the approval of the joint sector Mangalore Refinery. The marketing of lubricants was freed, and parallel marketing of kerosene and LPG allowed. The Oil Industry Restructuring Group (R-Group) was set up in 1995 to build on this foundation and to recommend a road map for the complete deregulation of the sector. The phased deregulation envisaged by the R-Group was as under: Phase I (1996-98): Rationalisation of the retention margin of refineries; deregulation of natural gas pricing; decanalisation of furnace oil and bitumen; partial deregulation of the marketing sector, with freedom to appoint dealers and distributors; removal of the subsidy on HSD and the reduction of the subsidy on kerosene, LPG and input for fertilisers. Phase II (1998-2000): Pricing of indigenous crude on the basis of average F.O.B. price of imported crude; rationalisation of royalty and cess; further deregulation of the marketing sector; further reduction of subsidy on kerosene, LPG and input for fertilisers. Phase III (2000-02): Complete deregulation, including ATF, HSD and MS; and the subsidy on PDS kerosene and domestic LPG to be transferred to the general Budget. Most of these recommendations were accepted by the Government. The retention pricing for refiners and the cost-plus pricing for crude producers were abolished in April 19?8. The diesel price was set at import parity. The consumer price of gas was linked to the international price of fuel oil. The price of ATF was decontrolled in April this year. The prices of PDS kerosene and LPG have been raised, although not to the extent announced by the Government in 1997. The refinery sector has been delicensed and the refineries given the freedom to import crude oil. The cost-plus policy of fixing freight for crude has been discontinued. The Customs and excise duties on crude oil and petroleum products have been partly rationalised following the recommendations of an Expert Technical Group. With the implementation of the New Exploration Licensing Policy (NELP) in 1999, the terms offered for new exploration acreage in the country are now at par with the best available globally. The NELP also addressed such issues as delays in negotiating production sharing contracts. Yet, the response to the two rounds of bidding under the NELP did not succeed in attracting new private and foreign capital, particularly from large companies. This outcome points to a major institutional weakness in the upstream sector. In today's competitive environment for international exploration risk capital, India cannot bank only on the fiscal and contractual regime but has to address the question of the prospects of the blocks on offer. This is the responsibility of the Directorate-General of Hydrocarbons (DGH), which was set up in 1993 to play the role of upstream regulator. One of the serious concerns of the international investors has been the lack of availability of data on Indian basins. A national geological and geophysical database with maps of the country should be prepared by the DGH and made easily accessible to investors. But what of dismantling the APM itself? The conclusion reached at the Delhi seminar was that it would be possible to do so if the next seven months were utilised to expedite the remaining steps in the chain. The price of HSD should be adjusted to bring it up to the import parity price and the adjustment process delinked from political decision-making, as in the case of natural gas. It is necessary that an interim regulator (perhaps the OCC) starts functioning immediately and the process of setting up the regulator is given utmost priority. The prices of PDS kerosene for families below the poverty line should be adjusted upwards by about Rs 1.2 per litre required to achieve the level of 33.3 per cent subsidy. The subsidy on kerosene for families above the poverty line should be eliminated. Now that LPG has been permitted as an auto fuel, it is all the more necessary that the price distortion is corrected quickly. IBP should be privatised without delay, and the interim regulator should start addressing issues of common access to pipelines, marketing infrastructure and the universal obligation. The constitutional issues with the Gujarat Government should be resolved so that the regulation of gas pipelines and infrastructure can be suitably integrated with the role of the downstream regulator. With swift action on these issues, it can be ensured that it will be freedom at midnight for the petroleum industry in April 2002. Else it may be just another All Fools Day.