OIL FALLING HEAVY ON EXCHEQUER

Rs60 billion worth subsidy given since march 2004

By HARIS ZAMIR
Mar 20 - 26, 2006

The Oil Companies Advisory Committee (OCAC) at par with the international oil prices since July 2001 has been implementing the fortnightly pricing formula. The sky rocketing of oil prices in the recent years has led the frequency of government's intervention difficult to keep pace with. The first adjustment came in the form of Petroleum Development Levy by laying a temporary halt to the price increase to win the consumers hearts.

For the eleventh time the OCAC has shown no change in price though the prices worldwide have shown continuous. The government took the hit and since March 2004 has given a subsidy of more than RS 60 billion while it also paid price differential claim to oil marketing companies to the extent of RS 10 billion against their outstanding amount of as much as RS 20 billion. The sales went down as there was a gradual shift to CNG products and other fuels hence the soaring in the prices observed a makeshift.

The ongoing debate in the government circles is to hand over the domestic POL price setting to Oil and Gas Regulatory Authority (OAGRA) from 6th April instead of the OCAC a cartel of 5 OMC's and 5 refineries who were given a fixed formula to levy the price on fortnightly basis.

Whatever benefit that could be passed on to the consumers has been done so this change from OCAC to OAGRA and the carrying out of the new pricing formula is going to prove as a dent in the profit making of the OMC's. At a time when government plans to privatize state owned entities, would such a move be wise to take is another million-dollar question.

The change of oil companies' margin of 3.5 percent by the government has come, but it is a late decision for if the OMC's were having a hay day then why was the government not quick enough to come up with the plan that it has suddenly put forth. Moreover, the think tank of the government should asked the oil marketing companies to reduce the margin of 3.5 percent for a short-term to make the oil prices cheaper in wake of higher crude oil prices. Following the ease they can raise the margin so that end users gets a cheaper product, which would ultimately raise the volume of companies, as companies would not suddenly switch to cheaper products like gas, CNG and LPG, an observer said.

Following the government's move towards deregulating various industries, the fortnightly oil price revision was handed to OCAC on July 2001.

The fact remains that the pricing formula, which is directly linked with international oil prices, was also passed on and is to date being practiced by OCAC. In light of the soaring oil prices, the government intervened, by adjusting the Petroleum Development Levy (PDL), to restrict prices from increasing further and give some relief to the general public. OCAC follows a set formula to determine oil prices together with a frequent involvement of the government in recent times. Therefore, we feel that it is up to a large extent redundant to make this organizational shift within the oil industry as no additional benefit is anticipated to be passed on to the end-user (except to satisfy the public), because if the government has decided to change the pricing structure, it could very well have been done by OCAC.

Abdul Haleem, research analyst at Atlas Investment Bank said that government has recently announced a change in the pricing structure applicable to the OMC. In this regards, instead of imposing the OMC and Dealer Margins of 3.5% and 4% respectively as a percentage of the retail price, they have been made applicable on Ex-refinery Price + Excise Duty + PDL + Inland Freight (in other words, ex-depot price before levying GST). Then sales tax will be imposed over and above that to arrive at the retail price. As per our calculations, taking into account the period 1H/FY06, average OMC margin on MoGas during the period stood at RS 1.86 per litre (refer to OCAC website), whereas industry sales were 607,000 tons (825 million litres) yielding gross margins of near RS 1.54 billion. According to the change in the formula, OMC margins would fall by 20 percent to RS 1.48 per litre. This would result in a RS 315 million decline in gross margins from MoGas sales alone, translating into an annualized fall of RS 630 million compared to an under RS 1 per litre decline in retail price for the masses.

The loss due to the reduction in effective margins on other products is expected to be many-fold.

The transfer of the price setting to OGRA from OCAC is clearly contradictory to the government's fundamental motivation - help the masses by bringing domestic prices down. Neither of these moves made by the government achieves this. Therefore, the questions that should now be addressed are:

1) On what plausible grounds has the government taken a step to dent profitability of OMC, following the change in the pricing structure because a meagre PRS1/litre reduction in the price of petrol is nowhere near what the public anticipated?

2) Is the government really serious on privatizing state owned entities, as after the pre-bid meeting on the privatization of PSO, the government springs a surprise that will hurt OMC earnings therefore deterring potential bidders to buy the state owned giant entity?

3) If the government objects companies making windfall profits at the expense of consumers, it should pay attention to the banking sector which depicted a profitability growth of over 80% during CY05 at the expense of customers by way of charging them on average a hefty 8.5% on loans and hardly offering them 2% on deposits! OCAC has urged the Prime Minister to put off the change in the pricing formula until an OMC delegation gets the opportunity to meet him.

Whether the change is put off or not, the initial intentions of the government to floating such an idea remains questionable.