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How Will The Government Handle Oil Subsidies

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The worries of the government with respect to Oil Subsidies has been growing by the day. With global Oil prices still volatile, the regulated pricing is hurting the Oil Marketing companies and the government both big time. So much so, that the losses born by Indian companies like HPCL , Indian Oil etc run to thousands of crores in Rupees.

Oil Marketing Companies in India need to follow a regulated pricing mechanism. What this means is, that they have to sell Oil at a pre-defined rate irrespective of the international crude prices.

However, the losses made my these companies on account of under-recovery are to be compensated for.The losses made on auto fuel are borne by refineries like ONGC and on cooking fuel by the Government.Now, the government has been issuing bonds to these companies to compensate their losses for sometime now.

But, the finance ministry has only agreed to release Rs 12,000 crore in cash which according to the petroleum industry is already going to create a shortfall of 9,000 crore for the Oil Marketing Companies for the first three quarters this fiscal. Now, the petroleum ministry has an uphill task to ensure that the OMC’s do not run into losses.It is on this account that the Petroleum Minister is going to meet the Finance Minister to reach a solution to the problem.

Now, the regulated pricing is a tricky one at that when it comes to Oil.The regulated price means that the common man does not suffer from fluctuating prices. More so, an increase in fuel price will add a huge burden to commodity prices which will worsen the already high Inflation.However, the OMC’s and the government is losing huge sums of money.

Unregulated prices will mean that the Oil companies will be able to sell Oil at prices which are aligned to market prices. This will ensure that they will not have to sell fuel for loss. However, as mentioned above it could disrupt the smooth functioning of the economy. Oil is one of the basic elements for any industry and high prices will jeopardize their prices in return.

I wonder if a Free Trade policy is a viable option. One hypothesis that I can think of is that the Government lets the OMC’s operate on unregulated prices and then subsidize the fuel for the common man.The increased revenues from the companies will mean more taxes for the government.The amount of tax money may not be the same but then the government already pays these Oil companies either in the form of cash or bonds.

So, why let the company bear losses in the first place and then subsidize them.Why not subsidize the common man directly and let the OMC’s fend for themselves.

I am sure that my hypothesis may not be viable given the economic intricacies which i am ill educated to talk about. However, I wonder if a regulated pricing mechanism hinders the growth of the OMC’s. Would it not be de-motivating for the decision makers when they know that they need to bear losses no matter what.

The markets are speculating a possible change in the regulated pricing mechanism. The Stock Markets reacted positively to the speculations and Oil Stocks rallied to a certain extent. However, today will the day when the picture will be clear.

What are your thoughts on the whole regulated fuel prices issue ? Do you think it is inevitable given the shortage of fuel? I would be glad to have the readers refute my hypothesis and provide reasons for the same.

  1. Ankit Agarwal says

    I just lost the comment i wrote:-(

    Anywas thanks for the clarification.I stand corrected , ONGC only supplies crude.
    But, its good to hear that decontrolled pricing is a feasible solution.As per you example it may not work at a mass scale but yes, sector wise segmentation can be one alternative.
    Moreover, for the reactive junta like us, we will understand the value of fuel only when we feel the price pinch.Not that it aint there already, but since there is a notion that we are going to pay a fixed price, a casual attitude creeps in.
    Lets see what the able minsters are able to come up with :-)

  2. SiD... says

    very correct…. presently the sharing mechanism of the losses are 1/3rd each by govt, upstream co.s and the oil marketing co.s (source: presentation given to us when we joined IOCL)
    just a small correction… ONGC does not refine petroleum products.. it provides OMCs with crude oil.. co.s like Indian Oil then refine the crude oil (both imported and domestic) in their refineries.. and then market them..

    Of course freeing up the prices is very very difficult as the whole industry survives on it.
    The solution you outlined is feasible. For some products like Kerosene, coupons or smart cards can be issued to the needy people through which they can buy the product at normal prices. Misuse of Kerosene is an open secret. It being available at rs 9 is an excellent adulterant for diesel.
    May be once the UID is implemented, this can be easily feasible.
    Some specific industries like agriculture can be given relaxations but overall at large to the public, the prices can be decontrolled.
    It may also help in environmental issues with less use of fuel due to higher prices.

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