Wednesday, August 19, 2009

What is deregulation?

Under a regulated environment, prices are not allowed to rise and fall with market levels. This means that when prices of crude go up, the government, in a bid to maintain fuel prices, shells out money to the oil marketing companies (OMCs) — Indian Oil, Bharat Petroeleum, Hindustan Petroleum — to compensate for their losses, a subsidy. Thus, when international crude oil prices peaked in mid 2008 to the tune of USD 145 per barrel, OMCs took huge losses but made up for those to an extent when prices subsequently dropped to USD 30 per barrel levels during the economic recession in the later part of the year. Crude oil price, as of May 28, stood at USD 65 per barrel. Deregulated prices are based on an Automatic Pricing Mechanism (APM) formula as approved by the Energy Regulatory Board. Under a free fuel pricing regime, the OMCs would market fuels after keeping a profit margin for themselves — prices of fuels like petrol, diesel, kerosene, liquefied petroleum gas (LPG) would thus depend on crude prices.

Deregulating prices may help to cut revenue losses at IOC, the nation’s largest refiner and its state-owned counterparts and other OMCs, which sell fuel below cost.

The business of deregulation

After the new United Progressive Alliance came into power at the Centre without support from the Left parties, most experts said it would put reforms in various sectors on the fast track. This may be the first concrete sign of it.

The news of a possible deregulation was given a thumbs-up by the stock market and share prices of oil companies rose by as much as 8–11% immediately but later came down on profit booking.

Deregulation would also help the government control the shooting fiscal deficit by cutting down on the thousands of crores of rupees that it shells out for OMCs. If free oil prices remain low, they would also help in controlling inflation. On current crude prices, analysts say prices of petrol may rise between Rs 2–5 per litre from the current regulated price of about Rs 45 per litre.

With the decks looking all clear for a free fuel pricing regime, what is the only roadblock that the government may face? The glitch is:

Is complete deregulation possible?

Complete deregulation of prices may not possible given the volatility in international crude oil prices. If crude oil prices rise substantially — like they did in early 2008 — retail fuel prices may increase substantially too, which may pinch the pocket of the consumer. Sources in the Oil Ministry recently told CNBC-TV18 that the government could consider a free fuel regime till the point crude is below the USD 75 per barrel, after which the regulated environment will kick in. Given the fact that oil prices are set to rise as the global economic recovery is underway, it remains to be seen how long will a deregulated environement sustain.

Also, kerosene, for instance, is sold at a huge subsidy and free prices of kerosene may work out to something the masses may hardly afford — it could well be a political blunder to deregulate kerosene prices.

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