India's tough choice

Sept. 17, 2012
An important center of oil-demand growth has turned wobbly, largely but not wholly because of structural flaws in its market for petroleum.

An important center of oil-demand growth has turned wobbly, largely but not wholly because of structural flaws in its market for petroleum. In most projections of expansion in oil consumption, India comes in second behind China. Economic growth in each country far outruns the global average. But it's slowing. The International Monetary Fund last month trimmed its expectation for the 2012 increase in China's gross domestic product to 8% from 8.2% projected in April. For India, the forecast GDP growth rate dropped to 6.1% from 6.9%. At a press conference, an IMF official noted that in India, more than in China or another rapidly growing country, Brazil, "some of the slowdown in investment is due to political problems, uncertainty about policy, [and] some freezing of permits for infrastructure and other investment."

Indeed, the Indian political climate is edgier than usual, in part because of contention over the prices of oil products. Nowhere in the world has the brittleness of price controls been more clearly demonstrated than it is now in India. The inevitable fractures couldn't come at a worse time—for the country and, possibly, the global oil market.

Price controls

India keeps prices below market levels for diesel, publicly distributed LPG, and kerosene sold by three state-owned oil marketing companies (OMCs), the main operation of which is refining. The OMCs—Indian Oil Corp. Ltd., Hindustan Petroleum Corp. Ltd., and Bharat Petroleum Corp. Ltd.—must buy crude oil at market prices. They're supposed to be compensated for the so-called under-recovery of crude costs from product sales through payments from upstream operations of other state-owned oil companies and, mainly, the government. Lately, with under-recoveries stretched by elevated crude prices and a weak rupee, the government hasn't been able to keep its side of a bargain that costs it more than $20 billion/year.

The OMCs are suffering. During the April-June fiscal quarter, when under-recoveries totaled $8.7 billion, the OMCs lost a total of $7.4 billion: IOCL $4.1 billion, BPCL $1.6 billion, and HPCL $1.7 billion. The petroleum ministry in August projected total under-recovery for the financial year ending next March at $28 billion under price relationships then in effect. A ministry official on Sept. 4 said the OMCs were borrowing at high interest rates to meet working capital requirements and to fund capital expenditures. He said their debt on June 30 totaled $28.5 billion.

The pressure on OMCs might worsen. Diesel demand surged this summer after a massive power outage increased the use of independent generators and a late monsoon raised pumping needs for agricultural irrigation. For the OMCs, higher volumetric sales widen the under-recovery wound.

Price hikes for the controlled products are essential but difficult. A government meeting that was supposed to have addressed the issue on Sept. 11 was delayed. According to news reports, the Cabinet Committee on Political Affairs, which is led by Prime Minister Manmohan Singh, was to have met Sept. 13 to discuss price hikes.

Political resistance

But price increases would incite fierce political resistance at the shakiest moment of Singh's 8 years as prime minister. His administration, once thought to be an antidote to corruption, has been shaken by scandals involving telecommunications licensing and, more recently, coal leasing. With economic growth slowing, the government having trouble funding services and subsidies expected by 1.2 billion Indians, and the view growing inside and outside the country that India is sliding back toward state-centered malaise, Singh must tread carefully.

It's easier to draw lessons from India's experience than it is to identify painless solutions to these problems. For economic reasons, the status quo can't continue. For political reasons, changing the status quo bristles with hazard. The wrong action, which includes inaction, can reverse the fortunes of a country that until recently has radiated promise and represented an important growth market for oil. The dilemma proceeds inevitably from overreaching governance. The lesson for other countries is to let markets set oil prices.