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Updated: November 25, 2012 00:22 IST

‘Cost-based methodology not viable’

Sujay Mehdudia
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R. S. Butola
R. S. Butola

IOC Chairman R. S. Butola outlines the rationale behind the current pricing policy in an interview to Sujay Mehdudia

Why are domestic prices of petrol and diesel linked to Singapore and Dubai market prices when we don’t import from there?

The current methodology of calculating the import parity price for petroleum products is based on the one approved by Petroleum Planning and Analysis Cell and has been in vogue since the refineries were taken out of the administered price mechanism (APM) in 1998. At the same time, when India was in net deficit for petroleum products, the Arab Gulf was the primary source for imports to the country and the region also had large physical volumes, except for Motor Spirit (petrol). Therefore, the Arab Gulf market was considered a benchmark for pricing of all products, except MS. In the case of MS, the Singapore market had more physical as well as paper trade and was adopted as benchmark for pricing. The market is also deep-rooted in Singapore for MS. But we net it back and bring it to the Arab Gulf level. At present, because of the ramping up of refining capacity in India, there are minimal imports of petrol and diesel. However, crude oil imports have increased significantly and more than 80 per cent of crude processed in India is imported. Of this, the major portion, 65-70 per cent is sourced from various countries of the Middle East. Further, from India, the Arab Gulf is the closest assessment centre for trade in petroleum products. Therefore, it is logical that the Arab Gulf is adopted as the benchmark for the pricing.

Why are petroleum product prices not set-based on the prices of crude oil, the main input, and the costs of refining it?

At present, the country has a very dispassionate pricing method. If the prices are set-based, where is the incentive to improve? This was the system followed till 2002 when the APM was dismantled. Refining industry works on a complex process, networked as it is to numerous process units such as distillation units, cracking units and alkylation. In a refinery, crude oil is processed through a series of primary and secondary processing units to produce various petroleum products. Some products are directly produced, while others result from a blending of two or more streams coming out of primary or secondary processing units. Paramount complexity of the refining process results in conversion of a single input to multiple finished products with varied market value and chemical properties. Thus, the allocation of joint costs of raw material and processing costs to individual petroleum products at refinery accurately is not possible. In the global scenario too, in the downstream oil industry, the established principles are not used for pricing and trading of petroleum products. Thus, the cost-based methodology for pricing of petroleum products is not viable because of the nature of the industry.

Are not IOC, HPCL and BPCL acting like a cartel by raising and reducing prices together throughout the country?

In the case of sensitive products, the prices are controlled by the government, and the three oil marketing companies (OMCs) maintain the same level of prices for them. As for MS, the government de-regulated it on June 25, 2010, both at the refinery gate and at the retail level. Thereafter, OMCs have been determining the selling prices of petrol independently with the approval of their managements. The same methodology is applicable to other decontrolled products. Since most decontrolled products are being marketed primarily by these OMCs, any marketing initiative by one company may lead to a response from the other players to protect their market share and as a reaction to changing market conditions. This happens in any industry and is not peculiar to petroleum products and cannot be termed cartelisation.

Why don’t we have a system of differential pricing of products based on coastal and inland areas and distance from refinery?

The sensitive products constitute 65 per cent of the basket of petroleum products being sold in the country. The government has kept control on the prices of these products with a view to protecting the vulnerable sections from higher prices and volatility. At present, the freight has been equalised on an all-India basis and the same basic price of these products is being charged all over the country. The main reason for the difference in prices could be attributed to the State levies. Had freight equalisation not been done, the freight differential would have led to lower prices on the coast and significantly higher prices in remote and hilly areas. Such products are essential for the economic and social development of the local population and keeping freight and therefore prices at higher levels may have an adverse impact on these areas. Therefore, there can be no justification for changing the current system of freight equalisation.

It is not a fact that duties and taxes constitute a significant part of selling prices of petroleum products?

Currently, Central and State taxes constitute 17-38 per cent in the case of petrol and 12.5-27 per cent in the case of diesel. Further, the OMCs contributed significantly to the Central and State exchequer. During 2011-12, the total contribution of the three OMCs to the Central exchequer was Rs. 54,000 crore and to the States, Rs. 92,000 crore. Rationalisation of Central and State levies will be a big welcome step for the OMCs, as it will boost their liquidity, enable them to plan their cash flows and reduce their dependence on borrowings.

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