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Oil prices are not so free

Hemangi Balse

The government will from Monday start dismantling the administered pricing mechanism that has governed India's oil industry for 30 years.

But the migration from a regime of controls to the free market will take place in stages. How long the transition will take is unclear. A lot will depend on the privatisation of Hindustan Petroleum Corporation and Bharat Petroleum Corporation and on when Reliance Industries enters the retail oil business.

Oil industry executives feel the country's oil companies will continue with the cost-plus formula, but with a major difference.

Prices of all petroleum products now cover the cost of procuring and refining crude oil. But the prices of petrol and diesel subsidise the prices of liquefied petroleum gas and kerosene.

Other costs like freight charges, indirect taxes and octroi are borne by the oil pool account. Many of these costs have been frozen at artificial levels.

Freight costs, for instance, have been frozen for the purpose of reimbursing the oil companies since 1976. After April 1, the consumer will bear these costs.

So will petrol and diesel prices soar? Not really. Petrol prices are high enough to subsidise LPG and kerosene. With this burden off, petrol and diesel prices should logically crash.

However, at best, they'll fall marginally because in an oligopoly, the oil majors are expected to form a cartel and protect costs and mutually agreed upon margins.

Before setting prices, oil companies will first do their sums on the net overall impact of the free market on their margins. This will determine whether prices will move up, down or remain static.

Due to freight costs, prices in the hinterlands may be higher than in coastal areas, though the government is trying to narrow any difference by using the Indian Oil Corporation as an instrument to determine market prices.

However, the rules of the game are expected to change dramatically once Reliance Industries, the country's second largest oil refining major, enters retail marketing.

"We expect indirect competition in prices through discounts to dealers. Traditionally, Reliance is known to be a volume-driven company. We expect it will continue this strategy by pushing volumes through dealers by offering huge discounts," sources at oil companies said.

For example, if petrol and diesel sales are burgeoning by 10 per cent a year, Reliance may set a 15 per cent sales target for dealers, and offer them discounts. Dealers, in turn, could pass on these discounts to big-volume customers.

The volumes game may eventually launch a market-driven pricing system. "We expect this to happen within a year, that is when Reliance sets up its own marketing and distribution network," said an oil company executive.

Another oil company executive said he expected dealers to charge different prices from different customers, with dealers giving discounts to fleet-owners and institutions but not passing them on to the general public because of the maximum retail price stipulation.

The pace of competition will pick up with the privatisation of HPCL and BPCL. However, don't expect to see the dynamic or street-level pricing - where prices differ within localities, seen in the US, Europe and Singapore - for a couple of years, at least.

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