Falling crude prices set stage for big-bang fuel price deregulation in Oct-Dec quarter

Thanks to benign global crude markets, the Modi government is likely to be able to wipe out the diesel subsidy burden in a month or two from now.

This means October-December is the period for big moves on fuel price deregulation.

The Petroleum Planning and Analysis Cell (PPAC) still shows a diesel subsidy of around Rs 1.78 a litre, this is because it tries to average out prices over a few days. With Brent crude prices falling to just over $101 a barrel - its lowest since June 2013 - the chances are that the oil companies will stop making losses after September or October. In September, the oil companies are likely to raise diesel prices by another 50 paise a litre.

If the Modi government’s luck holds and crude prices stay at this level for a while - a lot depends on the approaching winter, when oil prices generally tend to spike globally - 1 October would be a good time to decontrol diesel prices. With consumers already used to monthly increases, a limited decontrol where oil companies are free to change prices up or down by 50 paise to Re 1 a month would be politically feasible. Full decontrol can follow a few months down the line.

With elections to four state assemblies (maybe five, if Delhi also joins the race) due in the October-December period, one cannot expect any major reform moves in the more sensitive household fuels of cooking gas and kerosene.

This means after 1 October, the hump would have been crossed on diesel, leaving LPG as the biggest subsidy mountain to bring down. The PPAC projected LPG losses at Rs 12,129 crore in the April-June quarter, and kerosene at Rs 7,524 crore. If the same level of subsidy is maintained through the rest of the year (three more quarters), the year could end with a total fuel subsidy burden of around Rs 90,000 crore -Rs 48,500 crore on LPG, Rs 30,000 crore on kerosene, and the balance being diesel subsidies due till September end,.

Rs 90,000 crore would still be too high for comfort, given that the year’s budgeted fuel subsidy is Rs 63,426 crore - and a significant chunk of this outlay was used to pay last year’s spillover bill of around Rs 24,000 crore. This leaves only Rs 40,000 crore for this year’s subsidy bills. Since the oil and gas producers (ONGC, Gail and Oil India) pick up nearly 40 percent of the subsidy tab, it means they will pay around Rs 36,000 crore this year.

With Rs 40,000 crore still left in the kitty, it means around Rs 76,000 crore of the estimated Rs 90,000 crore subsidy bill is available.

There is a good chance that post-assembly elections, subsidy bills on LPG and kerosene may be capped to some degree, which could help Finance Minister Arun Jaitley make his budget sums work.

But if oil prices spike this winter (it happens whenever western winters turn out to be colder than expected), these sums could go awry.

It means Jaitley may have to do the P Chidambaram trick of rolling over his dues for this year to next year and claim he has met his fiscal deficit and subsidy targets mentioned in the budget.

However, to be really counted as a reformist, Jaitley needs to do more. It is no longer fair to expect ONGC, Oil India and Gail to carry the subsidy can. He has to bring this part of the subsidy bill into the budget from next year. This can only happen if he moves ahead with subsidy reforms in LPG and kerosene.

He needs pluck more than luck. Just as the UPA took the bold decision to allow diesel prices to rise steadily every month, Jaitley has to take the bull by the horns on LPG and kerosene - which will be big losers well into the future.

He could convince his boss on one of these two measures - or both.

One, the LPG and kerosene subsidies can be capped in rupee terms (the current subsidy is Rs 33 per litre for kerosene, and Rs 448 per LPG cylinder). If the subsidy element is capped at current levels, prices would move up or down depending on global crude prices.

Two, a better way would be to adopt the diesel strategy: this would be to let LPG prices rise by, say, Rs 10 a per month till subsidies are either eliminated or limited only to the identified poor. Kerosene prices could be raised by 10-25 paise per litre a month, till they reach a sustainable level of subsidy.

As the diesel example shows, Indian consumers have begun to accept the reality of paying market prices, if it is done slowly and evenly.

The time to move ahead with steady market pricing is right. The less it is delayed, the better the shape of the exchequer by the time of the 2015-16 budget next February. It could just create the space for a bigger bang budget than the one Jaitley presented on 10 July.