You got the float, now take the cost

Diesel & petrol prices to go up! Catchy headlines. Sure to register in the already weary eyes of the common man on the street. The mind struggles to find answers to the inevitable flurry of related questions that pop up with lightening speed ? how much will the local sabziwala hike his wares by? Would the bus/auto fares go up? Will another hike follow? Let?s ditch that plan to buy the new scooter altogether. Welcome to the free market! The Indian oil industry has been deregulated, the oil prices decontrolled (supposedly). The government pats it back for pushing through the reform agenda set out in 1997. The critics cry foul ? deregulation with government dictating price lines? The poor common man wonders what?s in store for him next. Let?s look at the facts for starters. First, with 80% import dependence, we cannot afford to divorce domestic retail prices from international oil prices. Buying crude at high prices and selling products processed from that very crude at artificially low retail prices is just not sustainable. Prices have to reflect costs. Second, price volatility in international oil markets is today a norm, rather than the exception. There are just too many factors influencing oil prices ? Organisation of Petroleum Exporting Countries (Opec) decisions; conflicts in the Middle East; US crude stock levels; the harshness of the European winters; and so on and so forth. The erstwhile administered pricing me-chanism (APM) protected the Indian consumer from the ups and downs in the global markets through the oil pool. The pool absorbed the volatility and kept retail prices stagnant. In April 2002, however, the APM for the oil industry was dismantled. The oil pool is now defunct. Save the government directive to oil companies to hold price lines for some time, the common man would have already been fully exposed to the vagaries of the global oil markets. Lastly, it must be borne in mind that the said directive, is at best, temporary. Distilling the facts, it follows, that eventually domestic retail prices will start reflecting international oil prices. So how does that system work? The best way to analyse it is to consider it in two distinct segments ? refining and marketing, even while considering prices offered by one single company. The refining division would procure crude from international markets; process it; and transfer products to the marketing division at the refinery gate. Margins in the refining industry are embedded in the inherent crude and product price differentials in international oil markets. The transfer price for products at the refinery gate thus reflects international product prices, what is typically referred to as the import parity price of that product. Deregulation to this effect, i.e., affecting refinery purchases and receivables at import parity prices, actually took place way back in April 1998 itself. This refinery gate price, essentially, becomes the base price for the final consumer. Added to this are distribution costs; excise duties; sales tax and other local levies; and finally the marketing margin. The only variable element in this entire list of mark ups is the marketing margin, and hence, it becomes one of the most crucial elements in price fixation in a deregulated environment. Under the APM, marketing margins were decided by the government in relation to the net worth of the companies, and reimbursed through the oil pool. An important point to note is that the margin was fixed and was not adjusted from a month-to-mon-th basis as done for the refinery gate product prices. (Actually there are daily variations in prices in international oil markets, but in India these were averaged out over a month for simplification and administrative ease). For instance, just prior to deregulation the marketing margin on diesel was fixed at Rs 195 per kilolitre. It is this system which changes with the now announced full deregulation of the industry. In a deregulated environment, market prices would be driven by competition. In mature markets in the West for instance, pump prices of one company differ from that of another. Oil companies vie for market share through aggressive stands on marketing margins. In addition, there are weekly/fortnightly price revisions. In times of high oil prices, oil companies moderate the impact of high international prices by taking a squeeze on their margins. As expected, they follow the reverse in times of low prices, by padding up the marketing margins. An analysis of fully deregulated Thai petroleum industry, for instance, shows that when diesel prices shot up to over $37 per barrel in September 2000, the oil companies actually operated at negative marketing margins,- $0.31 per barrel (-Rs 93 per kilolitre)! As soon as the oil markets crashed (December 2000), the marketing margin was shored up to a peak of $4.82 per barrel (Rs 1,455 per kilolitre) to recoup losses. The consumers went through a roller coaster ride with price variations in excess of 30 per cent, from a low of $32.83 per barrel (Rs 9.90/litre) to a peak $43.10 per barrel (Rs 13.10/litre). The long and short of it ? the Indian consumer should reconcile himself to frequent price adjustments (either way, upwards and downwards). As international oil markets become tight, global prices would rise, and so would domestic retail prices. The common man may be on the short-end of it on account of market sentiments alone. Ask an auto driver in Biharigarh in UP today if he is really bothered by the tension between Israel and Palestine, the answer most likely would be a resounding no. Tell him that the same conflict shakes market sentiments in the global oil industry, pushing up oil prices, which would inevitably cause a hike in petrol prices in the remote town of Biharigarh in UP and you have got his undivided attention. The oil companies would play their role in moderating the price fluctuations to some degree by contracting/expanding their marketing margins. Under the APM, they enjoyed guaranteed returns. Now, the common man on the street is their bread maker and they will go all out to appease him. Of course, the name of the game is still profits. The Thai experience shows that the standard deviation (a measure of variability of a set of data about its mean value) of marketing margin for the period under consideration was 1.39 as against 3.24 for retail prices, implying a greater strain on the pocket of the consumer as against that on the revenues of the oil marketing companies.