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Deregulating oil or price ceiling?

ARTICLE: New and higher oil prices have been announced after fixing very low prices on 1st June. June prices were...

July 01, 2020

ARTICLE: New and higher oil prices have been announced after fixing very low prices on 1st June. June prices were extraordinarily low in the company of 15 lowest price oil producing countries' prices like Saudi Arabia, Qatar and Turkmenistan (and less than half the prices in India). In hind sight, it was perhaps not an optimum decision which caused a price shock and created most of the problems faced by the market, government and the public. A better option could have been of passing on the surplus to the Ehsaas programme and other victims of Corona. Admittedly, one is wiser in the hindsight. Everyone was confused as to how to manage the economic shocks of Corona. Is deregulation a solution or some other variant of it like price ceiling and not fixing? We will examine this difficult issue in the following paragraphs:

Month of June has passed in controversy, oil shortages and black marketing in the wake of a drastic cut in petroleum prices announced by the government. International oil prices plunged due to lack of demand due to Corona. Oil prices became even negative, although for a short while. GoP passed on most of the surplus, it could, to consumers. The political and welfare impact was marred by the subsequent market problems which would annoy any ruling setup.

Oil Marketing Companies (OMCs) blame the shortage on Petroleum Division that it did not adequately project and manage the demand and supply through timely interventions. Petroleum Division, however, argues that there was an abrupt increase in demand in the wake of lifting or easing the corona restrictions. The government circles blame the shortages on OMCs that did not maintain the required inventory of 21 days and hoarded (did not release supplies to the market) the petroleum products. OMCs argue that they were suffering a loss of Rs 17.00 per litre due to the inventory bought by them at higher prices. Similar arguments were proffered by the dealers as well. The special assistant to prime minister on petroleum Nadeem Babar has acknowledged that the current pricing system does not work well in large price changes, up or down. Some times OMCs and dealers make a killing when prices increase and suffer when prices decrease. For consumers, it is the other way round. It is a zero-sum game; OMCs' loss is consumers benefit and vice versa. A need is being felt to bring about changes in the current system; easier said than done, but something has to be done.There has to be a fair and efficient system which promotes supplies and investments and at the same time through reduction of process inefficiencies awards fair market prices to the consumers.

The gasoline price has increased from Rs 74.52 per litre to Rs 100.10. The price increase is as sharp as the decrease was last month. International oil prices have increased and thus the price had to be increased. Petroleum Levy has been maintained in the new price at Rs 30.0 per litre. Last month, international prices were low and thus higher PLD of Rs 30.0 was acceptable by the market. The government had the option of reducing PLD, say, to Rs 20.0 and thus the price increase could have been reduced to Rs 90.00 and the increase could have been of only Rs 15.00 instead of Rs 25.00. However, it may be noted that oil prices are still much lower than elsewhere in the region. Also international spot prices have increased by 50%,while local price increase has been limited to 34% only.

Additionally, there is confusion because transparency is lacking. In earlier days, a complete break-up used to be made known. Experts and other people somehow find out the complete price break-up. The government would do well if it reverts to the earlier system. Also, 40% of Petrol is consumed by low income group of motorcyclers which forms a highly price sensitive market segment, although there are additional options to reduce prices in this segment, other than pricing reforms (these are of blending a low RON -87 fuel out of Naphtha and marketed through a separate low-overhead petrol pump system). Another issue is of reducing diesel prices with respect to the Gasoline as is the situation in most countries.

Towards an automated formula

It may be noted that basic oil price(imported or Ex-Refinery)is already linked to international prices (there is a 7.5% customs duty levied on HSD which requires some rationalization). It is related to Platts Oil-Gram but final price is dependent on PSO actuals, which may be a double-edged sword; besides, it is a time consuming process. A better approach could be interlinking with an appropriate index such as Platts Oil-Gram. Import expenses such as Ocean Transport, insurance, L/C costs, etc., can be based on estimated averages of the past months on the line of OGRA LNG calculations.

OMCs have been demanding a 15-day pricing cycles as opposed to the current monthly pricing cycle to reduce the price risk exposure. This can be reduced, in our view, to even one-week, a la - Malaysian pricing system, which is similar to Pakistan's. The difference is that the Pakistani system is based on a time-consuming calculation of actuals, while in most other places, there is an automatic formula. The regulator can announce a six-month charge of the three items; IFEM, OMC and Dealers Margin which adds up to under Rs.10.00 currently. EX-Refinery price can be announced by Ogra on a weekly basis. Taxation changes may be kept on a monthly cycle. Under such a system, an automatic price calculation system can be established without waiting for Ogra/ECC deliberations and approvals.

Elimination of IFEM?

A lot of criticism has been leveled on IFEM such as transparency and transport inefficiencies. Many demand that it should be eliminated. The main advantage or merit is uniform petroleum pricing throughout the country. For pure economists, location advantage should be reflected in costs and prices to boost optimal resource allocation. However, there are other issues of regional inequalities and poverty which argue in the opposite direction. To be acceptable, it can be considered a location tax; after all it is only Rs.3.19 for Gasoline and Rs.1.46 for HSD. Under a deregulated system, however, such costs are subsumed in marketing costs and are not charged separately. Nevertheless, it is an implicit or explicit cost. In India, there is no IFEM; in India, there is a wide difference in regional prices. However, the difference is not only due to varying transport costs. In India, GST is charged by provinces and the rates are different in every province/state. In Malaysia, there is regional transport cost element.

Towards deregulation or price ceiling?

Deregulation means no control on price. Sellers compete for the market share and in the process minimize prices and maximize quality. However, it requires a real competition and institutional system controls that restrict price conspiracy and collusion and other anti-competitive practices. Markets have not worked efficiently in Pakistan. One would be scared to leave prices of such an essential item free and subject to manipulation. However, an alternative would be to announce price ceilings under which efficient companies may be able to acquire market share under a competitive price-quality supply system.

A competition boosting option could be to allow independent dealers. There are three dealer systems; COCO (company owned-Company Operated), CODO(Company owned-dealer operated and DODO (Dealers owned and Dealers Operated).In most countries, DODO is allowed as well. Filling stations under DODO are independent and are not tied to a particular OMC, which often results in lower prices as competition is boosted, while in the other two systems, OMCs have a large handle on prices. And OMCs are not many, while dealers are in thousands. In Pakistan, no more than 10 OMCs operate effectively, although the number of registered ones may exceed the 40 mark. The market share of these smaller OMCs may increase through competition. In Germany, market share of independent DODO pumps is 15% and in Australia 30%.

(The writer is former Member Energy, Planning Commission)

Copyright Business Recorder, 2020