Singapore spot market, not production costs, driving Indian petrol price

Have you ever wondered why when petrol prices go up or down they do so uniformly across the retail outlets of the three oil marketing companies — Indian Oil, Hindustan Petroleum and Bharat Petroleum? If they are three different companies with their own refineries and distribution systems, then surely their costs and selling prices must be different?

Welcome to the strange world of petroleum product pricing in the country. A world where the laws of economics are turned on their heads, where there is no competition between the different players and where the price that we pay for petrol (or for that matter diesel or aviation turbine fuel) has no resemblance whatsoever to its cost of production.

It is a complicated world of subsidies and strange concepts such as “under-recoveries.” It is a hybrid world of controls and freedom — the oil companies have the supposed “freedom” to revise prices, yet that is subject to a discreet government nod.

The oil companies adopt a strange pricing policy that is linked neither to their costs nor to the competition in the market. The prices of the products that they sell in the domestic market are driven by the prices of the same products in the global markets; currently domestic prices are determined by the price swings in the Singapore oil market.

This is unlike in any other industry. Let's take the case of steel. The price of finished steel produced by an Indian company will be determined by its cost of raw materials such as iron ore and coking coal, the cost of power used to produce the steel plus other items of cost such as salaries and other overheads. The competition that the company faces in the market will determine how much margin it can add to this cost base.

The oil companies simply take the price of petrol in the Singapore market, apply the rupee-dollar exchange rate to that price, add other costs such as freight and import duties and lo, there comes the price that they should charge domestic consumers. Interestingly, not a litre of the petrol that these companies sell in the market is imported from Singapore; they are all produced here in their own refineries.

Now, the problem is that most often the price that they so arrive at has no relation to the prevailing domestic retail price, which is invariably lower. Thus is born the concept of “under-recoveries,” something that is unique to our oil companies. You should note that they don't call this loss, simply because it is not a loss. A loss will be caused when a company is forced to sell a product below its cost of production. In this case, we have no idea what the cost of production is for petrol or diesel or, for that matter, any petroleum product.

Under-recoveries are therefore bogus numbers that bear no resemblance to reality. Yet, pricing decisions for the domestic market are based on these numbers.

A careful reading of the statements that the oil companies put out whenever prices are revised will be enlightening. Here is an extract from the latest one released on November 30. “Review of international oil prices and INR-USD exchange rate of relevant fortnight for prices effective 01.12.11 brings out a further downtrend in international oil prices and a further weakening of the exchange rate. Thus, while petrol international prices have moved down significantly from $116/barrel approx. to $109/barrel approx., the exchange rate has deteriorated from Rs. 49.32/USD to Rs 51.50/USD. The combined impact of the two factors is an over-recovery of Rs. 0.65/litre. It has therefore, been decided to revise the petrol prices downward by Rs.0.65/litre (excluding state levies) w.e.f 1st Dec. 2011.”

Simply put, what this statement from Indian Oil Corporation says is that petrol prices have dropped in the global markets and despite the depreciation in the rupee, there is still room to reduce the domestic retail price. Of course, it goes without saying that if there is a rise in petrol price in the Singapore market and the rupee continues to depreciate, domestic prices will be revised upwards.

The question is: why should we in India pay for petrol a price that has no resemblance to either the cost structure of Indian Oil (or Hindustan Petroleum or Bharat Petroleum) or to competition in the market? Prices in Singapore dance to various tunes ranging from fundamental reasons such as consumption levels by countries in the region or shutdown of refineries or pipelines to market-related reasons such as levels of speculation and money flows into the commodities market. How are we in India affected by these when we do not import a litre of petrol or diesel from Singapore?

This flawed pricing model is a legacy of the control era when we had the administered price mechanism in place. The model does not belong in a liberalised market where the prices should be free and be determined by the costs of refining petroleum products and market competition, say analysts.

A senior official in a leading oil company concedes that this model is flawed and interestingly, says his company is all for a cost-plus pricing structure with competition between the three oil retailers — Indian Oil, Hindustan Petroleum and Bharat Petroleum.

The collusive pricing policy of the oil companies is an anti-competitive practice and has come under the radar of the Competition Commission in the past. Would the government tolerate a situation where MRF, Apollo Tyres and Ceat collude on pricing their tyres? So why should we allow oil companies to collude?

These problems arise because the winds of change that led to serious reform in industries such as telecom have largely bypassed the oil industry. What we need is a strong dose of reform in the form of freeing of pricing of petroleum products while simultaneously encouraging competition. We also need a strong regulator for the retail market; the existing Petroleum and Natural Gas Regulatory Board is not tasked with regulating the retail market.

These are important issues that need to be addressed sooner than later by the government.

Keywords: fuel price hike