Oil Below $60: Time to Wean India off Petroleum Subsidies

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As oil fell below $60/barrel last week from its peak of $145 in July 2008, Indian government has come under increasing political and public pressure to decrease fuel prices. So far Dr. Manmohan Singh has held firm citing the need for India’s oil companies to make up some of the massive losses they incurred over the past couple of years. After all, as oil climbed to record highs, Indian government increased prices just twice in two years.

The move is in line with what most economists argue vehemently: if consumers and industry are protected with artificially low prices when oil prices in free markets soar, they should also be prepared to pay higher than free market prices when prices fall. Sure this is simple economic sustainability, but only in a rather narrow sense. In my mind, all this talk about what the price of petrol or kerosene should be misses a bigger and more opportune question to consider: Shouldn’t the government stop meddling in fuel prices?

Not exactly a new idea, I admit, but in the Indian context it would be radical. Not the least because it would take a significant shift in energy policy, and that too at a politically inconvenient time not far from general elections. Despite the seemingly insurmountable odds of getting this done, I strongly feel it’s an idea whose time has come.

For decades the Indian government has indulged in bizarre practices of price-setting and cross-subsidization of petroleum commodities in the name of protecting the poor. These tactics have proved downright counter productive. For example, the artificially low price of diesel have inflated demand so much that losses from diesel account for 50% of all petroleum losses. Why? Turns out the government has inadvertently made diesel cheaper than fuel oil, a commodity used in industrial power generation. This growth in demand, now at 18-20% per year, will force India’s public sector oil companies to import diesel as they are prepared to meet only 12-15% growth with domestic refining. This in turn will magnify the losses incurred.

Kerosene subsidies are another case in the point. Cheap kerosene is used to adulterate as much as 40% of petroleum products sold nationwide according to a study by CONCERT (Centre for Consumer Education, Research, Teaching, Training and Testing).

Add current energy price volatility to government’s inability to effectively limit subsidies only to those who truly need them, the result is that even the most well-intentioned price intervention is bound to result in perverse negative consequences that will hurt us for decades to come. Energy efficiency improvements and renewable energy resources, both critical for future economic and social health, are victims of petroleum subsidies.

If there ever was an opportune time to say goodbye to petroleum subsidies, it is NOW. Why? Because low oil prices allow such a move while inflicting least short-term pain on Indian consumers and industry. Global energy demand is expected to stay low over the next year, but as the economy recovers, so will oil prices as IEA predicted in its latest World Energy Outlook. So instead of incurring record petroleum losses (Rs. 1,30,000 Crores in this fiscal year), we would be much better served to find ways to divert that money to energy efficiency efforts, hybrid or electric vehicles, smarter electricity grid and local renewable energy resources instead.

Author and Copyright:  Raghu Dharmaraju