Memo to Dharmendra Pradhan: Five ways to fix petroleum, the ministry that roiled UPA

The new petroleum and natural gas minister, Dharmendra Pradhan, who is minister of state with independent charge, is an unknown quantity. This means he has no baggage to shed and can start on a clean slate.

The first thing he should remember is that it is his ministry that did the UPA in. This may be an oversimplification, but if the UPA’s policy failures can be attributed to one single ministry, it is petroleum. Reason: all the economy’s problems - high fiscal deficit, high expenses on subsidies, public sector wealth destruction and high inflation - can be linked to the UPA’s failures to get energy policy and pricing right. It waited too long to start reducing petroleum subsidies, and towards the end it even worsened the problem by increasing the quantum of subsidised cylinders supplied to 12 per household per year, and aborted the direct cash benefits transfer scheme to limit subsidies only to the deserving.

According to my calculations, the UPA spent Rs 8,00,000 crore in subsidising petroleum products in its 10-year tenure, and this subsidy was the single biggest cause of all the fiscal and current account problems it faced full-blast in 2012-13. By bleeding Rs 8,00,000 crore - Rs 80,000 crore on an average annually - the UPA lost control of its budget and the current account deficit soared.

However, thanks to the UPA’s belated baby steps - mainly allowing the oil marketing companies to raise prices by 50 paise a month - Dharmendra Pradhan has a base to build on. In fact, even without major cuts in subsidies, he can start fixing the problems one by one. Here are five things he can do - some of them low-hanging fruit.

First, he should deregulate the pricing of all petroleum products - diesel, LPG and kerosene - in one shot, rather than in bits and pieces. This will ensure that citizens start getting used to price changes based on global trends. After a while, people will get used to the reality of market pricing - just as they are now used to frequent changes in petrol prices, the prices of daily necessities like vegetables, rice and wheat.

Second, the impact of this change can be limited - which is important politically - by putting a cap on the actual subsidies payable on diesel, kerosene and cooking gas. The current losses of the oil marketing companies are Rs 4.41 per litre of diesel, Rs 34 per litre of kerosene and Rs 450 per cylinder of LPG. If the diesel subsidy is limited to Rs 3 a litre this year, Rs 2 next year, and Re 1 in the year after that, diesel can be deregulated right away. If the kerosene subsidy can be reduced to Rs 30 a litre and LPG to Rs 400, the petroleum subsidy will be permanently capped, and will be eliminated in stages in future years. It will also shrink as a percentage of GDP as the economy grows.

Third, once the subsidies are capped in rupee terms, they can be eliminated from the government’s books by merging the oil and gas producers and the marketing companies. For example, if ONGC and Indian Oil, Oil India and BPCL, and Gas Authority of India Ltd and HPCL are merged into three entities, the limited subsidies can be directly paid by the producing companies to the marketing companies - that is, during the years when the subsidy still exists. These companies are already bearing 48 percent of the subsidy bill this year, so it won’t burden them more. But by merging the production companies with the marketing companies, costs can be pared. Mergers will give the profitable oil and gas producers retail market access, and the oil sector will get vertically integrated, enabling it to improve its operating efficiencies. In three years, the diesel subsidy will be entirely off, and the kerosene and LPG subsidies would shrink as a proportion of their profits. The ideal solution would be to eliminate all subsidies, but in a political economy, this second-best solution is not a bad one. It will steadily chip away at the problem and eliminate it in due course.

Fourth, there is the ticklish issue of gas pricing - with Reliance and ONGC likely to be major beneficiaries if the NDA government accepts the recommendations of the Rangarajan committee, which suggested a price of around $8 per mmBtu, subject to quarterly changes based on prices in three different global markets. However, doubling the gas price will be politically risky, and a better way would be to get the government out of the pricing game altogether. What Pradhan should do is abandon the idea of government-determined prices (it should only ratify them, to confirm there is no unfair pricing done to evade royalties and taxes). He should ask Reliance and ONGC to enter into long-term contracts for gas supplies with their buyers - whether power producers or fertiliser companies, city gas distributors, or ceramic units. In the short term, this will impact fertiliser and power companies, but the government could offer them interest-free investment support to shift away from gas if it is not economically viable. This is the only sensible way out of the gas pricing controversy.

Fifth, it is absolutely necessary to bring competition to the entire oil and gas industry. With price deregulation, private refiners will start marketing their products in the domestic markets - currently Reliance and Essar export their petro-products - forcing the state refiners to become more competitive. Over the long-term, the government should throw open more fields for exploration and increase oil and gas reserves so that there is greater competition even in supply. In the US, the shale gas revolution has brought down prices to around $4 per mmBtu. This can happen in India too over four-five years with the right policy environment. The reason why market pricing is such a political minefield is that some private sector producers like Reliance are seen to be the main beneficiaries. This charge will disappear if several companies are in the game, and not just Reliance and ONGC.

This is what Dharmendra Pradhan should concentrate on. Luckily, he comes with no baggage of being aligned to this corporate group or that. Time for him to focus on policy, and not players.

_Disclosure: The Reliance Group has funded the promoter of Network18, which publishes Firstbiz
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