Fix the roof when the sun shines

The time to repair the roof is when the sun is shining, said John F Kennedy in 1962. What the US President had said then to strengthen the American economy would have been equally appropriate for India’s petroleum sector in 2014. Today, the Narendra Modi government should be regretting that it largely ignored that time-honoured advice in the last four years and will be paying the price in the fifth year of its tenure, even as the petroleum sector produces strong headwinds for the Indian economy.

From the middle of 2014, coinciding almost with the commencement of the Modi government’s tenure, international crude oil prices had begun softening. The Indian basket crude oil price ruled at about $109 a barrel in June 2014. Since then, it kept falling almost every month till January 2016, when the Indian basket crude oil price ruled at $28 a barrel. Its positive impact in various areas was evident during this period.

Retail prices of petrol and diesel declined, though not at the same pace of decrease in crude oil prices. Diesel prices were made market-linked, just as petrol was done in 2010. Using that opportunity, oil companies too freed themselves from the debilitating burden of under-recoveries on account of all petroleum products except kerosene and cooking gas. The government managed to reduce its oil subsidies from ~854 billion in 2013-14 to ~603 billion in 2014-15 and further down to ~ 300 billion in 2015-16.

The government’s gains on account of lower prices were no less as these were used to mop up revenues to bolster its fiscal consolidation plan. Excise duty was raised on petrol and diesel on several occasions in this period and the Union government’s excise collections jumped from ~780 billion in 2013-14 to ~ 992 billion in 2014-15 and then almost doubled to ~1,786 billion in 2015-16. If the central fiscal deficit declined from 4.4 per cent of gross domestic product (GDP) in 2013-14 to 3.9 per cent in 2015-16, the revenues from the oil sector played a role in no small measure.

Those were the years when the sun was shining on India’s petroleum economy. The turning point came in January 2016, when crude oil prices began rising from $28 a barrel. The Indian basket crude oil price rose to about $64 a barrel by March 2018. And by June, it spurted to almost $74 a barrel. This raised retail prices of petroleum products to levels higher than those prevailing in 2014, triggering demands for a cut in taxes and a lowering of retail prices. In October 2017, the excise duty was even cut by ~2 a litre on petrol and diesel.

Fortunately, the Modi government has not announced any more cuts in excise duty. Nor has it succumbed to the pressure to roll back retail prices by offering higher subsidies or requiring oil companies to bear once again the under-recovery burden on petrol and diesel. Cabinet Minister Arun Jaitley has ruled out a cut in taxes on oil products and so far oil companies are able to pass on the impact of higher crude oil prices to the consumers. The government’s excise revenues from oil have continued to rise — to ~2,427 billion in 2016-17 and ~2,290 billion in 2017-18, the lower collection being on account of a ~2 per litre cut in excise on petrol and diesel in October 2017. The government’s fiscal deficit saw a slippage but was reined in at 3.5 per cent of GDP last year with the promise that it would be cut to 3.3 per cent in 2018-19. And Mr Jaitley has indicated that the government planned to raise its tax-to-GDP ratio by 1.5 percentage points in the next few years, without of course tinkering with taxes on oil.

This should come as a relief. But there is no denying that the government lost a big opportunity to do a lot more when oil prices were low and the sun was shining on India’s petroleum sector. For instance, the government could have introduced a stable and sustainable petroleum product pricing policy regime to remove distortion and encourage efficiency and competition in oil marketing. Continuing to stick to a trade parity based system of pricing (assuming 80 per cent import price and 20 per cent export price) for petroleum products is an idea that should have been given up and replaced with a cost-plus pricing regime.

Trade parity based pricing makes public sector oil refiners lazy, uncompetitive and inefficient, as there is no incentive for them to reduce costs in refining, transportation and marketing. Worse, private-sector oil refiners can take full advantage of the trade parity based pricing system as they can secure an even better margin for themselves. A switch-over to a cost-plus pricing regime can even reduce retail prices, encourage refineries to fix prices reflecting their respective efficiencies and, therefore promote competition. It would also help sustain the other marketing reforms the government has introduced by asking oil companies to announce daily prices of petrol and diesel.

More importantly, the opportunity of low crude oil prices was not used by the oil exploration and production companies to invest more in new discoveries and boost domestic production to reduce the country’s dependence on imports of crude oil. India’s domestic crude oil production fell for the sixth consecutive year in 2017-18, when it was estimated at 35.68 million tonnes, down from 37.78 million tonnes in 2013-14, raising the country’s import dependence on crude oil to 82.8 per cent. Prospects of reducing dependence on crude oil imports by 10 per cent by 2022 now look quite dim. And when the US enforces sanctions on crude oil supplies from Iran (at present around 11 per cent of India’s imports), alarm bells start ringing for those who have to manage India’s energy security and crude oil imports.

The irony is that ONGC, India’s largest oil producer, may have announced many new discoveries or launched new drilling activities, but its production has plateaued and its capital expenditure in the last four years has been estimated at just ~1,239 billion. Its capital expenditure on exploration and production would have been a little more respectable, if it were not persuaded to acquire HPCL a state-owned refinery and marketing company at a cost of ~370 billion. The Central government may have boosted its finances as a result, but without the acquisition, ONGC’s capital expenditure programme would have got the muchneed leg-up, brightening prospects of reducing India’s dependence on crude oil imports.