Saturday, June 26, 2010

Petrol De-regulation

Event : EGoM decided to free petroleum prices from government control. 


Announcement

EGoM decided to free petroleum prices from government control, meaning gasoline and diesel prices will move in response to global fuel prices rather than government fiat. The panel didn't reveal any details about how this will work. However, the panel hasn't freed some fuels like subsidies for cooking gas and cheaper kerosene, vital to low-income households. 

The government's decision to hike fuel prices follows a recommendation to that effect by the Kirit Parekh committee appointed by the government earlier this year. The committee had recommended linking the prices of petrol and diesel to market rates. 


Impact on Economy 

Diesel and petrol consumption has been growing at 10-15% per year even during the global economic turmoil. Around 92% of the market is with state-owned companies, which are bedevilled with issues such as corruption, bloated infrastructure and adulteration of their products by their agents. 

To describe the government's decision to deregulate petroleum and diesel as an act of raising prices is to get it completely wrong. It is one of the most major reforms of recent times and should have beneficial effects on the entire economy. What is being done is to put both diesel and petrol prices on a float. Prices will rise and fall in step with the international prices. For diesel, there will still be a per-litre subsidy from the government, to keep the domestic retail price below market level. But what is important is that it will no longer be a fixed price. 

The fiscal deficit definitely is going to look down now from the current levels. At $75 per barrel kind of a crude oil price at which government would have ended spending full year about 75,000 crores just to fill this particular deficit part for the under recoveries. Now, in a given situation it will be down anywhere between 53000 crores to 47,000 crores that means what we are talking off is close to about 25,000 crores worth of saving in the fiscal deficit situation and the most important part is that going forward in subsequent years now onwards this worry would be kept aside because these prices are driven by the market factor and if it is going to be linked to the market that means government will not had to bear that particular cost. 

The petrol price hike will cause an increase of 100bps in the monthly WPI inflation. But since these changes will cause the fiscal and revenue deficits to decline, they will exert a downward pressure on prices. Hence, though the immediate impact of this policy will be to increase inflation, in six to nine months will have lower prices than what would have happened in the absence of this much-needed reform. 

Kerosene and LPG would continue to drag government into this particular game to a certain extent but by going forward it will also find its way into partial deregulation. So from a view point government has gathered the courage to bring down the fiscal deficit, it would get a thumbs up in form of winning the confidence of the investors including global investors. 


Impact on Industry 

Market determined pricing is expected to attract higher investments in the fuel retail sector, and by spurring market competition, encourage OMCs to reduce costs, improve efficiency and service standards. Market determined pricing will also incentivise fuel conservation and encourage the consumer to adopt fuel efficiency practices. 

The move would save around Rs 6,500 crore on petrol under-recoveries for government and around Rs 15,000 crore on diesel under-recoveries. Once the diesel is fully deregulated, it will further lead to a Rs 9,000 crore saving 

Till last year, 31% of the under-recoveries were borne by the upstream companies, about 12% by the downstream companies and the rest by the government. Extrapolating the numbers based on last year's formula, upstream companies like ONGC, GAIL and Oil India would save Rs 4,000 crore, Rs 600 crore and Rs 700 crore, respectively, leading to a 10-13% increase in earnings per share. Similarly, among OMCs, BPCL, HPCL and IOC would see 23%, 15% and 7% addition to their bottomline. 

Total under-recoveries in the system will come down substantially. Though the earnings would significantly improve for all the oil companies, the exact extent would depend on the final subsidy sharing formula, which the government has not come out with till now. 


Impact on Private Players 

Deregulation of petrol prices has cleared the way for private fuel retailers to reopen petrol pumps that had become unviable owing to government cap on prices and could eventually lead to a price war between them and the state-run oil marketing firms. 

The Centre provided subsidy to its own companies, no such comfort was available for private firms. While Essar has continued to operate its 1,342 outlets throught the control era, Reliance Industries and Shell had shut down most of their petrol pumps some years back when they could not compete against the government-capped price being offered by the public sector firms. 

In a decontrolled environment, private retailers may be able to offer cheaper rates since they do not have historical baggage of location or manpower and enjoy the advantages of new technology, more efficient operation and competitive sourcing of crude. They are able to keep their crude costs down through hedging and high-sea trading, which state-run entities are not allowed. The private refineries also have the latest technology that allows them to extract more high-value products from inferior crude varieties that come cheaper and maximise returns on refining. 

The move has opened up one of the world's fastest growing hydrocarbon markets to private sector players like Reliance Industries, Essar Oil and Shell, three years after they were virtually forced out of the market. These private players, who entered the Indian retail market in 2003 when the government scrapped the controlled prices policy the first time, had been forced to shut down most of their outlets three years ago due to spiralling prices of crude oil. 

The price of crude oil, which was around $25 per barrel when the administered pricing formula was abandoned in 2002-03, reached levels of up to $147 by early 2008, forcing the government to bring back price controls on petrol and diesel and pushing private players out of business. 


Impact on State Run OMCs 

Public sector oil marketing companies are expected to be major beneficiaries from the government's decision to free petrol prices. The companies were expected to lose a whopping Rs 1,10,000 crore this year, 

The re-entry of private retailers is expected to ease off the pressure on resources of the public sector oil marketers and will allow them to redeploy manpower and operate infrastructure such as terminals, depots and pipelines more efficiently. 

The re-entry of private firms will also bring back to life their idle infrastructure, built at huge investments. This will take off pressure on state facilities, though they are sure to lose market share. However, even at a lower market share returns on their investments will be much better if they did not have to stretch manpower, finances or infrastructure to unviable options. They may now also take a rationalise their outlets. 

The government compensates the state-owned oil marketing companies for some of their losses. It was on track to spend $17.7 billion on subsidies for such firms this year, but with the move means the total will likely drop to $13.5 billion 

The state-run companies will also benefit as their cash flows will improve and revitalise financial health. Though the petrol volumes, at 5-6 million tonnes a year, are half of the diesel or kerosene, profitability in the motor fuel and reduced losses in kitchen fuels will certainly shore up their financial muscle and may resurrect many expansion projects. 


Impact on End Users 

This move will benefit the consumer in the long run through competitive pricing of fuel and an offering of better services across outlets. The move will also rationalise the way end user spend money, the kinds and amount of energy end user use. It is an important step in making India a more efficient, global player. 


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