India's Decision to Deregulate Domestic Diesel Prices Positive for Economy, Oil Industry

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Researched by Industrial Info Resources (Sugar Land, Texas)--After announcing the deregulation of domestic petrol prices, the Indian government has indicated that the deregulation of diesel rates is next on the agenda. Making this announcement on the sidelines of the G-20 summit at Toronto in Canada, Indian Prime Minister Dr. Manmohan Singh called the price hikes and eventual fuel price deregulation "much-needed reforms."

Last week, the government increased the prices of cooking gas, petrol, kerosene and diesel by $0.75 per cylinder, $0.075 per liter, $0.064 per liter and $0.043 per liter, respectively. Subsequently, the government freed prices of petrol from state control, allowing the oil-marketing companies (OMC) to charge as per market rates. The OMCs, including Hindustan Petroleum Corporation Limited (BSE:500104) (Mumbai), Indian Oil Corporation Limited (BSE:530965) (IOC) (Mumbai) and Bharat Petroleum Corporation Limited (BSE:500547) (Mumbai), have been incurring huge losses, as they were forced to sell fuels at government-fixed subsidized rates. Singh also indicated that the subsidies had become unsustainable and were adversely impacting the financial health of the country.

Reacting to allegations by opposition parties that the fuel price hike will burden the poor, Petroleum Minister Murali Deora said that despite the increase in rates of kerosene and cooking gas, the prices of these fuels were respectively $0.32 per liter and $4.89 per cylinder lower than actual cost. He also said that the price hike would create an additional burden of only $0.0056 per day for kerosene and $0.021 per day for cooking gas usage. Market analysts have observed that the increase in fuel prices is aimed at cutting the budget deficit to 5.5% of the gross domestic product by March 2011 from 6.9% reported last year. Several industry bodies, financial institutions and economic research agencies have welcomed this move.

Earlier, India's leading industrial body, Associated Chambers of Commerce and Industry of India (ASSOCHAM) (New Delhi), had recommended that the federal government free prices of diesel and petrol and bring it at par with market rates. ASSOCHAM also appealed for immediate withdrawal of subsidies on petrol and phased elimination of diesel subsidies. The recommendation was considered imperative to reduce the huge losses incurred by state-owned oil companies due to government subsidies on fuel.

Under the government's subsidy scheme, kerosene and liquefied petroleum gas (LPG) is sold at $0.64 per liter and $6.37 per cylinder, respectively, below prevailing prices. Diesel and petrol is sold at $0.15 per liter and $0.13 per liter, respectively, below market rates. In 2010-11, the subsidies were expected to burden oil companies by about $6.37 billion. By March 2011, the total amount of subsidies on kerosene and LPG for this fiscal year was forecast to increase by more than $12.74 billion. Early this month, BM Bansal, the chairman of IOC, indicated that on account of the subsidies, the company was posting losses of $21.2 million every day.

S. Sudarshan, India's Oil Secretary, said that with the price hike and proposed deregulation of diesel prices, revenue losses (or "under recoveries") will be reduced to $11.5 billion, from an earlier estimate of $16.3 billion this financial year. According to Deepak Pareek, an analyst with Angel Broking (Mumbai), the government's decision to share subsidy burden with upstream companies could translate into higher earnings for downstream companies. Varun Goel, fund manager at K.C. Securities (Mumbai), has observed that the price hike and fuel price deregulation is critical for India's economic growth. Continued subsidies will increase borrowing that would impact inflation. Hailing the decision to deregulate prices, Goel hoped that the increase in prices would force people to use fuels economically.

Namrata Padhye, chief economist at IDBI Gilts (Mumbai), has indicated that fuel price deregulation will have a strong impact on inflation. However, Prakash Diwan, the head of Institutional Equities at Networth Stock Broking (Mumbai), believes that in the long term, the impact of fuel price hike will be negligible. Padhye also said that the Reserve Bank of India (Mumbai) could increase interest rates in the next two weeks. Seconding this view, D.K. Joshi, the principal economist at CRISIL Research (Mumbai), has forecast that the Reserve Bank of India may increase policy rates by 50 basis points.

Kevin Grice, senior economist at Capital Economics (London, England), said that despite the risk of short-term inflation, the Indian government is committed to implement reforms, reduce subsidies and reduce the fiscal deficit. Sharing a similar opinion, Anubhuti Sahay, an economist with Standard Chartered plc (LSE:STAN) (London), has indicated that with inflation soaring, a deregulation and a price hike were tough, albeit much-needed, decisions.

Sujan Hajra, the chief economist at Anand Rathi Associates (Mumbai), has observed that the government is likely to wait until there are no under recoveries before implementing its decision regarding deregulation of diesel prices. Hajra has indicated that the deregulation is not expected to go into effect before October this year. Alok B. Agrawal, the head of research at Mata Securities (Mumbai), has indicated that while the government's decision will help OMCs increase revenues, it will have an adverse impact on transportation and automotive sectors. Industries relying on petroleum inputs, including pharmaceuticals, manmade fibers and chemicals, also will bear the brunt.

The government's decision to free the price of petrol and diesel is expected to help private players, including Essar Oil Limited (BSE:500134) (Jamnagar, Gujarat) and Reliance Industries Limited (BSE:500325) (Mumbai), restart their retailing stations. Earlier, RIL and Essar, which have 1,700 and 1,200 petrol stations, respectively, decided to close this business due to pricing subsidies offered to public sector OMCs. However, analysts have observed that with stiff competition and little scope for price undercutting, refining margins could be as low as 2%.

In a related development, India's crude oil output in the month of May increased 5.8% from the same period last year to 2.94 million tons. However, the output was only 95% of the targeted 3.1 million tons for this period. During the months of April and May, combined crude oil production grew 5.5% from the same period in 2009 to 5.816 million tons. In May, natural gas production increased 34.4% from the same period last year to 4.586 billion cubic meters. During the April to May period, combined natural gas output grew 43.5%. In April this year, India's oil imports increased to $8.08 billion in comparison to $4.74 million last year.

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