By Manish Sharma

The government of India has finally de-controlled petrol prices from its shackles. In a significant move, the Empowered Group of Ministers appointed to look into the Kirit Parekh recommendations eventually took the politically sensitive decision on June 25, 2010. As per media reports, diesel prices, which have so far seen a marginal hike, shall also be decontrolled eventually along the lines of petrol; whereas, subsidy burden on cooking fuels is going to be borne by the government. Yet, the prices on LPG fuel has been hiked by Rs 35/cylinder and kerosene oil saw its first increase in 8 years at Rs 3/litre.

While the decision would help oil-marketing companies (OMCs) reeling under financial crunch, inflationary fire will be stoked further due to this reform endeavor. Chief Economic Advisor Kaushik Basu estimated that the fuel price hike would add around 1 per cent to the headline inflation rate from July onwards due to the cascading effect. At a time when overall inflation is hovering in double digits and food inflation is at an all-time high of 17 per cent, the common man would find himself at the receiving end of the proposed policy directive.

However, for the OMCs, it is time to rejoice or, perhaps, heave a sigh of relief. With the revised pricing norms, the gross under-recoveries, which result from selling petroleum products below the required selling price, will be compensated adequately. Under-recoveries of OMCs were at Rs 460 billion (US$ 9.5 billion) in 2009-10. As per CRISIL, by adjusting the retail prices according to the prevailing market price of crude, public sector marketing firms would be able to reduce their under-recoveries by about Rs 260 billion (US$ 5.5 billion) in 2010-11. Upstream oil companies, namely, ONGC, OIL and GAIL, which share the burden of under-recoveries, would also benefit as this would reduce their share of subsidy burden of auto fuels by about Rs 200 billion (US$ 4 billion).

Share prices of oil refiners and marketers have shot up this week, perhaps, buoyed by this windfall. The shares of public OMCs HPCL and BPCL have zoomed 32 per cent and 18 per cent, respectively, during this week, although benchmark index or Sensex declined by 1.5 per cent for the period. The oil index of the Bombay Stock Exchange (BSE), too, surged by 4 per cent amidst overall selling. However, the price hike may embolden private players such as Reliance, Essar and Shell, etc., to expand their footprints, again putting pressure on the market share of public sector OMCs in the long run. Also, gas companies too will reap the advantage of the level-playing field being laid under the new price mechanism.

India imports 80 per cent of its petroleum consumption. Although crude prices have sobered in international markets currently, at around US$ 80/barrel, the market determined price will affect the motor fuel users the most. Any spike in crude oil prices would be negative for the industry. Though, as of now, the government is playing down the impact, when it comes to diesel de-regulation, the impact will be severe for commercial vehicle segment and SUVs (sports utility vehicles), a growing segment among the passenger car sector.

Prime Minister Manmohan Singh knows well that this is the most opportune time to take the toughest political decision. With four years still to go for the next general election and the Opposition in a state of disarray, the UPA government has made a tactical move. However, present level of under-recoveries for OMCs stood at around Rs 530 billion (US$ 11.5 billion) based on an average crude price of US$ 75/barrel. It would shoot up if the global price increases sharply. The government has to intervene if the price level breaches the US$ 100/barrel mark. Despite showing firm resolve, team UPA is still on a slippery ground.