Deregulation Dilemma

<?xml version="1.0" encoding="UTF-8"?><root available-locales="en_US," default-locale="en_US"><static-content language-id="en_US"><![CDATA[TOTAL CONTROL? Deregulation of fuel prices may mean that petrol and diesel prices will change frequently (Pic by Tribhuwan Sharma) Mumbai transporter Manpreet Singh, who runs a fleet of 28 trucks, cannot even imagine a scenario where diesel prices would fluctuate by the day. &ldquo;My drivers take off to distant parts of the country with a fixed sum in their pockets for fuel and food. What will they do if diesel price fluctuates?&rdquo; he asks. He was reacting to the petroleum ministry&rsquo;s move to partially deregulate fuel prices in two months. Singh&rsquo;s confusion over whether such a deregulation will actually happen is shared by consumers, oil producers and marketing companies across India. As the Congress party shored up its numbers in the general election, stocks of PSU oil marketing companies (OMCs) shot up in anticipation of implementation of the B.K. Chaturvedi Committee recommendation to free fuel prices. The process of dismantling the administered pricing mechanism (APM) had begun in 2002 but was halted by the then NDA regime due to political compulsions. Deregulated fuel prices would allow oil companies to align domestic retail fuel prices with international prices (after adding a normative margin of around Rs 1.4 per litre). &ldquo;The deregulation can improve our earnings due to marked- to-market pricing as the realisation becomes faster and more transparent,&rdquo; says S.K. Joshi, director of finance at Bharat Petroleum. Currently, fuel prices are determined on the basis of refinery transfer prices (RTPs), which on paper are supposed to be reviewed every fortnight, but are rarely changed without the government&rsquo;s nod. In its quest to dismantle the APM, the government is considering the following options of hiking retail prices periodically to give ad hoc margins to OMCs or pay upfront all under-recoveries so that OMCs can improve their margins. &ldquo;It would be interesting to see how the ministry balances each product, given the complexities,&rdquo; says Joshi. Easier Said Than Done If the fuel prices are indeed freed, the immediate beneficiaries will be the OMCs and upstream companies such as ONGC, GAIL and OIL, which will get an opportunity to clean up their balance sheets of politically induced losses such as under-recoveries (the difference between actual cost and the selling price of fuel). On its part, the government will be able to shave off the oil subsidy, which mounted to Rs 1,06,000 crore in the last fiscal. &ldquo;The ideal time was when the crude was at $40 a barrel as it would have been prudent politically and sensible economically,&rdquo; says a industry source. Even though Petroleum Minister Murli Deora is giving priority to the health of the OMCs, whose under-recoveries have already hit Rs 1 lakh crore in fiscal 2009, freeing fuel prices is easier said than done. &ldquo;Stability in crude prices is key to even a partial deregulation,&rdquo; says Deepak Pareekh, analyst at Angel Broking. And crude has swung wildly between $32 and $65 per barrel in the past eight weeks. {mospagebreak} &nbsp; Even what is being proposed today is only partial deregulation. Consider this: while cooking fuels (LPG and kerosene) will remain untouched, OMCs will be allowed to fix auto fuel (petrol and diesel) prices daily or over a 15-day period as long as international crude prices do not breach $75 per barrel level. Beyond that point, the government would control prices. For oil companies, this means little. Subsidy on LPG and kerosene alone was Rs 45,000 crore in 2008-09 while that on auto fuel was around Rs 57,500 crore when the Brent crude fluctuated between $85 and $97 per barrel last year. Kerosene got a subsidy of Rs 28,200 crore and LPG around Rs 17,800 crore whereas diesel got Rs 52,300 crore. Now, with Brent hovering at $60 a barrel, the subsidy burden towards cooking fuels for 2009-10 is likely to be lower at Rs 21,619 crore whereas that on transport fuel will be Rs 6,348 crore. Thus, partial deregulation may cut the overall under-recovery by barely 26 per cent, say analysts. Source: Antique Stock Broking The Crude Connection The government fears that kerosene being the fuel for the poor and LPG a middle-class cooking fuel, any hike in those would be sorely resented. Auto fuels, on the other hand, are at near break-even levels (petrol has negative margin of Rs 3.50 per litre, but diesel has a positive margin of 2 paise). Though the subsidy burden may come down to Rs 20,000-25,000 crore this fiscal, crude must remain at $50-55 per barrel range for any deregulation to be effective. Analyst Ballabh Modani of Enam Securities says crude oil below $50 per barrel makes under-recoveries nil while anything above that would pinch the OMCs. Diesel is equally sensitive. Given India&rsquo;s high reliance on the fuel for transportation and agriculture, if deregulation results in a spurt in diesel prices, it will raise inflation, affecting GDP growth. &ldquo;Diesel is the major global fuel, and we should not subsidise but encourage more efficient use of it. If deregulated, it will be a good beginning,&rdquo; says Deepak Mahurkar, director, PricewaterhouseCoopers. Yet, the government may not leave diesel prices to market forces alone, says a source in a leading OMC, making the deregulation exercise a non-starter. For the government, deregulation means lower oil bonds and lesser fiscal deficit. But the government remains wary of turning it into a political hot potato. Last fiscal, the high subsidy burden was met through Rs 71,292 crore worth of oil bonds (over 70 per cent of gross under-recoveries) and Rs 32,208 crore upstream discounts (30 per cent), as OMCs suffered huge inventory losses and poor refining margins. This may come down to Rs 10,000 crore. The oil bond route too has several shortcomings. Analysts say banks do not show much interest in these because they do not have SLR (statutory liquidity ratio) status and have very low yield. The Life Insurance Corporation, the largest subscriber, has cut intake due to regular liquidation of bonds by OMCs. The oil bonds also compete with bonds of Food Corporation of India and fertiliser companies, and are invariably placed at a discount to their face value. In a deregulated scenario, OMCs can improve their earnings as their oil bond based earnings will be replaced by direct cash flows. Private sector players such as Reliance Industries and Essar invested heavily in retail operations, but curtailed expansion (Reliance, in fact, wound up its retail operations) due to mounting losses. They are eagerly awaiting a complete deregulation to resume operations. At its peak, Reliance had captured around 14 per cent of the diesel market. For public sector companies such as ONGC and GAIL, the only positive seems that the subsidy burden may decline partially with the under-recoveries getting limited to cooking fuel price only &mdash; during 2009-11, ONGC, GAIL and OIL may save around Rs 3,414 crore collectively, say analysts. But the caveat is that OMCs and exploration companies benefit only if crude stays at $60 per barrel or below. So long as the government spares cooking fuel, OMCs will remain dependent on oil bonds and upstream discounts. &ldquo;Despite all the hype over deregulation of the fuel prices, future earnings of OMCs will remain bleak,&rdquo; says analyst Pareek. With inputs from Kandula Subramaniam s dot menon at abp dot in (Businessworld Issue Dated 9-15 June 2009) &nbsp;