Here's how oil cos can cut their diesel sale losses from Rs 2.80 to 86p per litre

The under-recovery on diesel has ostensibly narrowed to Rs 2.80 a litre (actually it's much lower as I shall show later on). With a hop skip and jump the government should be able to eliminate the whole thing. Yet just when market pricing of diesel and an end to subsidies is tantalizingly near, we hear government voices saying 'not now'.

We have heard this before and come to grief. In his 2010 Budget Speech, Finance Minister Pranab Mukherjee (now President) said an expert group headed by economist Kirit Parikh had given its recommendations on a 'viable and sustainable system of pricing of petroleum products,' and that the petroleum minister would decide on its advice 'in due course.'

In a post-Budget interview to me, Pranabda candidly admitted that the previous NDA government had deregulated petroleum pricing to quite an extent, but his own UPA government had stalled that reform - of course, in his unique style, he said they had 'regulated the deregulation'. He then made another startling assertion, saying if he changed his stance again, it 'would be interpreted as if you did not apply your mind' when the switch was made!

At the time of the interview the price of Indian mix of crude oil was $73.69 a barrel. The government should have used the opportunity to raise the price of diesel in small increments, as the NDA had done (33 times over six years, according to editor Shekhar Gupta). Unfortunately it waited, hoping that somehow the events would resolve themselves. But when huge import imbalances threatened a credit rating downgrade in February 2013, a desperate government plucked some courage to raise diesel prices by 50 paise a litre every month. By then, crude had already climbed to $112.68 a barrel - now imagine if the government had done this when crude had fallen under $50 a barrel after the global economic crisis of 2008. What a horrendously missed opportunity.

Petroleum pricing in India has seen many twists and turns. Before 1975, the pre-independence policy of import-parity pricing was applied. After the first major oil shock, a cost plus pricing policy was adopted. This included the cost of crude oil, refining margin and a certain return on capital employed. In 1984, the administered pricing mechanism was adopted and the oil pool account came into being. In 1998, the prices and markets of industrial raw materials and fuels like naphtha, furnace oil, bitumen and paraffin were decontrolled. During the first NDA regime, in 2002, petrol and diesel prices were decontrolled. Administered pricing mechanism was officially dismantled. But for all practical purposes the minister's influence prevailed. Though prices of petrol and diesel were revised several times in small increments, they were never set free. It was a missed opportunity. The average oil price in 2002 was $22.54 a barrel.

But worse was to follow. Soon after the UPA took over in May 2004, it re-introduced complex controls. The cabinet allowed oil companies to increase prices of petrol and diesel within a ten percent band of two moving averages; but the petroleum minister of the time, being of Leftist persuasion, decided to consult the government's Communist partners. It was a ploy to keep prices unchanged in the name of the poor. The price per barrel was $36.09 then. Just imagine again if prices had been decontrolled at that time - so much of later pain would have been avoided.

Alas, prices never returned to that level, though they fell under $50 a barrel as the global banking crisis of 2007-08 led to a dip in oil prices in the wake of an economic slump. Again there was inaction. And before the government could even begin to mutter "decontrol", the flood of cheap money to stimulate western economies firmed up oil prices to a peak of 123.61 in March 2012.

I am aware of the argument that the basis for calculating under-recoveries is flawed. India is a significant exporter of diesel. In the last financial year, net exports were worth $24.66 billion, or eight percent of India's total exports. This is not a new development. India has been exporting diesel since 2000-01. The quantity of diesel exported has increased from 1.60 million tonnes that year to 22.46 million tonnes in the last financial year.

Experts say that export prices should be the basis for determining retail prices. If oil companies can supply diesel at Rs 44.42 a litre at Indian ports for export, they can also supply it for sale domestically at that price (with adds on for marketing costs, dealers' commission, inland freight and taxes), they say. But instead of the simple export price, India has chosen a complex formula using an 80:20 mix of import and export prices. The rationale was that eighty percent of crude is imported for production of diesel.

But if the simple (and common sense) export price is used, oil companies will lose only 86 paise on a litre of diesel they are selling in Delhi and not Rs 2.80 as they now claim.

Only 86 paise, and so much fuss!

Updated Date: Jun 18, 2014 18:07 PM

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