Oil may stay below $92: If Modi gets it right, diesel deregulation is just 2 weeks away

Fortune has smiled on Narendra Modi in the form of a quick and sharp decline in global crude prices. Modi should smile back at Lady Luck and do the right thing - which is to deregulate diesel prices after the election season is over on 19 October.

Brent crude has fallen below $93 a barrel and our oil marketing companies have actually started making money on diesel - possibly around Rs 2 per litre. This is cause for some cheer, but not political stupidity. Modi will reap later what he sows now. UPA sowed nothing for eight years in terms of oil price reforms, and reaped a stunning defeat in 2014. Its belated efforts to raise diesel prices by 50 paise a month from January 2013 - its best decision in 10 years of economic misrule - was too little, too late.

For the Modi government, the timely drop in global crude prices is a godsend but it would be thoroughly undeserved if the wrong decisions are taken now. Good luck is not forever and the thing now is to use favourable oil prices to sow the seed for better economic harvests later. If it does not do so, the government may well reap a bitter harvest in 2019. Bad luck has a way of biting you in the butt at the wrong time.

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There is, of course, no such thing as the one and only right answer in a situation, and Modi really has two options before him. One is politically easier, and the other is politically tougher. Both are doable.

Policy one is to deregulate diesel only on the upside. The economy has adjusted to the higher price of diesel and so the government could say this is the minimum price at which diesel should be sold, but oil companies will be free to raise prices if global crude prices were to rise this winter or later.

This deregulation on the upside has two major benefits: if oil prices fall, the subsidy bill will fall as oil companies can cross-subsidise LPG and kerosene with higher profits from diesel. Government, ONGC, Oil India and Gail will save on subsidy support to oil marketing companies (OMCs) like Indian Oil, HPCL and BPCL.

If oil prices rise, the OMCs can hike prices from the current threshold. If they fall, they will make higher profits on petrol and diesel and cut the subsidy bill further. This is politically pragmatic and economically bankable.

The better option would be to do two things simultaneously. Deregulate diesel and propose a monthly increase in kerosene and LPG prices by say, 25 paise a litre and Rs 10 per cylinder, till we ultimately reach market prices or a sustainable level of subsidy. In any event, the government needs to use the Jan Dhan bank accounts to offer cash subsidies instead of lower prices on kerosene and LPG. This means deregulating kerosene and LPG and paying the difference between market and regulated prices as cash into beneficiary accounts. This will remove spurious recipients of subsidy and also force economies in the use of kitchen fuels.

The first option is politically easier and economically defensible; the second option is politically tougher but economically the best thing to do.

Whichever option Modi chooses, we are probably just about two to three weeks away from diesel price deregulation. If we are not, Modi would have squandered his good fortune away.