Policy Watch: On Slippery Ground

POLICY WATCH: OIL
On Slippery Ground

With crucial issues remaining to be tackled, the deregulation of the oil sector could skid out of control.

By Ashish Gupta

The clock has started ticking. If finance minister Yashwant Sinha really meant what he said on February 28, next April should see the end of all price and distribution controls on petroleum products. The curtain will also come down on controls on the sourcing of crude, refining and marketing margins, re-sellers' commission, and marketing and distribution.

That's good news for companies eyeing the sector. Says Anil Ambani, Managing Director, Reliance Industries: ''With the Administered Price Mechanism (APM) gone, we can plan our business better.'' Companies could, he adds, then decide what to produce and how to sell.

Roadblocks in the roadmap

Roadblock 1: No sign of a regulator yet. It takes nearly a year for a regulator to become fully operational.
Implications: Opening up without a regulator can lead to distortions in the market.
Roadblock 2: Subsidy on products with controlled prices is still high. Sudden and steep hikes will be not be politically feasible.
Implications: Government will have to bear the subsidy burden putting a strain on finances. Cross subsidisation will continue.
Roadbock 3: No decision yet on how to reduce the oil pool account deficit.
Implications: Fiscal deficit projections will go haywire if the entire deficit gets transferred to the general account.

But there are serious doubts about whether the government can stick to the deregulation schedule drawn up by the Strategic Planning Group on Restructuring of Oil Industry (the R-Group report) in 1996. Says R.K. Pachauri, director, Tata Energy Research Institute (TERI): ''The government has not even looked at the financial implications, operational problems, and administrative hiccups that will emerge.''

Take, for example, the establishment of an independent regulator to oversee the functioning of the sector post-APM. A committee headed by special secretary in the petroleum ministry Naresh Narad has been working on this for two years now. A concept Bill on a Petroleum Regulatory Commission of India was prepared in 1998. But there's no sign of the regulator. Says Sandeep Biswas, senior manager, Accenture India: ''Chaos and confusion will prevail in the absence of a regulator.''

The Regulatory Road

The mess in the telecom industry, where the Telecom Regulatory Authority of India (TRAI) was set up more than a year after the sector was opened up, is ample proof of that. And the smooth transition to a deregulated market was possible in the case of the insurance sector because the Insurance Regulatory Authority (now the IRDA) was formed three years before the industry was opened up.

BEHIND SCHEDULE

Phase 1: (1996-98)
1) Rationalisation of tariff structure.
STATUS: Partly done. Customs duty on crude was to be brought down to zero per cent and excise duty on petro products to 12 per cent. Customs duty is around 15 per cent and excise ranges between 12 and 16 per cent.

2) Withdrawal of the concept of a retention margin for refineries
STATUS: Already done

3) Decanalisation of furnace oil and bitumen
STATUS: Already done

4) Partial deregulation of the marketing sector including freedom to appoint dealers/ distributors
STATUS: Has happened for all products except kerosene, diesel, petrol, ATF and LPG. But the government still appoints dealers/distributors for all products

5) Removal of subsidy on diesel/reduction of subsidy on kerosene, LPG and fertiliser feedstock
STATUS: Diesel subsidy reduced but continues. Subsidy on kerosene and LPG reduced. No cut in subsidy for fertiliser feedstock.

Phase 2: 1998-2000
1) Pricing of indigenous crude oil on the basis of average FOB price of comparable imported crude
STATUS: Oil producers get only 80 per cent of the import parity price of crude and there is a cap on the per tonne price of crude.

2) Rationalisation of royalty and cess
STATUS: Partly done. Royalty revised to Rs 800 per metric tonne for states.

3) Further deregulation of the marketing sector
STATUS: Five items continue to be regulated

4) Further reduction of subsidy on kerosene, LPG and fertiliser feedstock
STATUS: Not done

Phase-3: 2000-2002
1) Decanalisation of ATF, diesel and petrol
STATUS: Not done

2) Total deregulation of upstream and downstream subsectors of the oil sector
STATUS: Not done

The regulator for the oil sector will have to ensure genuine competition, fair pricing of products and their availability even in remote areas, and prevent cartelisation. In a deregulated environment, wholesale and retail prices can vary on a daily basis in tune with the movement of international prices. The regulator will then have to set a price band within which fluctuation is acceptable.

All this certainly cannot be done overnight. For one, the government needs to define the broad parameters under which all oil companies should function. And the regulator itself needs at least six months to a year to lay down the necessary ground rules and get ready to work.

The government could, at a pinch, convert the Oil Coordination Committee (OCC) into a regulator. The OCC, provides technical and operational support to the ministry in formulating and implementing policy. But even that requires a legislation and the OCC would need some time to lay down the rules of the game. Says an Indian Oil Corporation official: ''A regulator cannot start functioning effectively in less than a year.''

There are other, equally vexing issues that could send the dismantling process skidding. What, for instance, will happen to the prices of the five controlled products-petrol, kerosene, aviation turbine fuel (ATF), liquefied petroleum gas (LPG), and diesel? The R-group had recommended that these products move towards import parity prices, with ATF being decontrolled by March 2001 and the subsidies on LPG and kerosene being retained at 15 per cent and 33.3 per cent respectively post-deregulation. But both products continue to carry huge subsidies-40 per cent in the case of LPG and 50 per cent in the case of kerosene.

Reducing the subsidy drastically in the course of one year is politically explosive and, hence, impractical. The only alternative, then, is to continue with the subsidies, squeezing government finances.

As it is, the government is still grappling with the oil pool deficit, currently hovering at Rs 12,500 crore. Post-APM, the oil pool account will be transferred to the general budget, along with whatever deficit it carries. The deficit is likely to touch Rs 18,500 crore by March 2002, thanks to the increase in excise duty on diesel and petrol from 12 to 16 per cent and the levying of customs duty on imported kerosene.

The Oil Pool Trap

That's assuming oil prices hover around the $35 per barrel levels. If the Organisation of Petroleum Exporting Countries (OPEC) does cut back production, prices could soar, adding to the deficit. Taking this entire burden on to the general budget could upset the government's fiscal deficit projections. The finance ministry hopes to gain some relief by imposing a cess on petrol, but that will not be enough to take care of the entire deficit. Asserts Ambani: ''The state of the oil pool account will be crucial to the dismantling of the APM.''

State governments could also queer the pitch. Right now, domestic airlines pay sales tax on ATF while foreign airlines don't. In order to provide a level playing field to domestic players, a Bill to exempt them from paying sales tax is pending in Parliament. However state governments are loath to forego revenue worth Rs 17 crore. If they don't come around, the central government may just confer 'deemed export' status on ATF exempting it from sales tax.

But the question of paying royalty on crude defies such a neat solution. The royalty, paid to oil producing states, is currently fixed at Rs 800 per metric tonne. State governments want this to be calculated as a percentage of international crude prices, as is done in Canada and Britain. A committee is grappling with the issue but the solution is not going to be an easy one.

Precious little is being done to prepare public sector oil companies for competition. For instance, there's no word on whether the government will continue to control the price of crude paid to Oil and Natural Gas Corporation and Oil India Ltd, currently fixed at 80 per cent of the import parity price or Rs 5,570 per tonne of crude and Rs 2,150 per tonne of gas, whichever is lower. Such controls prevent domestic producers from getting international prices for crude, affecting their competitiveness.

The government, of course, insists that all these issues will be tackled in time. Unfortunately, it's not a confidence that other players in the sector share.

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