AN OVERVIEW OF
PETROLEUM PRICING: IMPLICATIONS OF IMPORT PARITY PRICING FOR INDIAN ECONOMY
Dr. Mahammad
Rafee.B1 &
Dr.A.Hidhayathulla2
1Assistant
Professor in Economics, School of Legal Studies, Reva University, Bangalore
2Associate
Professor of Economics, Jamal Mohamed College, Tiruchirappalli, India
ABSTRACT
This paper
studies the implications for implementation of Import parity pricing for
Petroleum products in India. The study analysed the impact of hike in crude oil
price and its impact on inflation and exchange rate of Indian rupee in two
analytical periods 1970-77 and 2002-06 respectively, where import parity
pricing regime was in implementation. The study also analysed the inelastic
nature of demand for crude oil and the hysteria of exogenous factors and
volatility. The findings of the study will certainly contribute to the oil
importing countries in their petroleum pricing policy and to reduce the impact
of hike in petrol price on common man with a decisive pricing policy.
Keywords: Import
parity pricing, oil price shocks, exchange rate, CPI inflation, elasticity in
oil prices, natural gas pricing
1.
INTRODUCTION
Energy is the key driver of Economic development.
85* percent of the energy used in the world today is produced using
non-renewable sources. This percentage is forecast to remain the same through
2030, unless something changes drastically such as the widespread enactment of
legislation, breakthroughs in energy technology or the development of abundant,
inexpensive new energy sources. Non-renewable fuels are also known as fossil
fuels because they are the fossilized remains of plants and animals[1]
which died up to 300 million years ago and became buried beneath the surface of
the earth and the ocean floors. Time, pressure and heat transformed this
material into hydrocarbons which we burn to extract energy. Ever since the
discovery of crude oil, it has started to fulfill the need in energy sector of
energy use. This made the demand for oil inelastic. The situation of inelastic
demand generates ample scope for huge profit, as consumers are ready to pay any
price. Thus, pricing policy become a toll to maximize the profit .Cartelization
in 1960s and 1970s and speculative trading that began in early 1980s are the
probable events that might have caused the dynamic changes in international oil
market.
1.2.
Phases of Cartelization of International Crude Oil Market between 1928 and 1972
There is a
tendency of oligopoly in oil sector. First cartelization had happened in
nineteenth century when the crude oil reserves were found. The seven giant oil
companies called seven sisters attempted the cartelization. Later other
new discoveries of oil fields in the Middle East and other parts of the world
led to formation of Organization of the
Petroleum Exporting Countries (OPEC) in 1960’s.
Setback to the US political hegemony consequent to military failures in Vietnam
and Yomkippur war added to monopoly power of OPEC members.
The OPEC was actually formed to counter the oil company’s cartel,
which had been controlling prices since the so-called 1927 Agreement. The Red Line Agreement is the name given to an agreement signed by partners
in the Turkish Petroleum Company (TPC) on July 31, 1928. The aim of the agreement was to
formalize the corporate structure of TPC and bind all partners to a
"self-denial clause" that prohibited any of its shareholders from
independently seeking oil interests in the ex-Ottoman territory. It marked the creation of an oil monopoly, or cartel, of immense influence, spanning a vast territory. The cartel
preceded easily by three decades the birth of another cartel, the Organization
of Petroleum Exporting Countries (OPEC), which was formed in 1960 and 1928 Achnacarry Agreement (Achnacarry served as the meeting place for global
petroleum producers in an effort to set production quotas. A document known as
the Achnacarry Agreement or "As-Is" Agreement was signed on 17
September 1928) and had achieved a high level of price stability until
1972.
1.3.
Speculation in Crude Oil Market and Price Fixation from 1983 onwards
Crude-oil futures began trading in New York on March
30, 1983. After the collapse of the
OPEC-administered pricing system in 1985, and after a short lived experiment
with netback pricing (costs associated
with bringing one unit of oil to the marketplace, and all of the revenues from
the sale of all the products generated from that same unit), oil-exporting
countries adopted a market-linked pricing mechanism first by PEMEX(Mexican state-owned oil monopoly Petroleos Mexicanos) in 1986, it received wide acceptance
and by 1988 it became and still is the main method for pricing crude oil in
international trade. The current reference, or pricing markers, is Brent, WTI, and Oman.
The price of petroleum as quoted in news
generally refers to the spot price per barrel (159 liters) of
either WTI/light crude as traded on
the New York Mercantile Exchange (NYMEX)
for delivery at Cushing, Oklahoma, or of Brent as traded on the Intercontinental Exchange for
delivery at Sullom Voe.
The
price of a barrel of oil is highly dependent on
both its grade, determined by factors such as its specific gravity or API (American Petroleum Institute) its sulphur content,
and its location. Other important benchmarks include Dubai,
Tapis, and the OPEC basket. The Energy Information
Administration uses the imported refiner
acquisition cost, the weighted average cost of all oil
imported into the US, as its "world oil price”. The price of oil underwent
a significant decrease after the record peak of US$145 it reached in July 2008.
On December 23, 2008, WTI crude oil spot price fell to US$30.28 a barrel, the
lowest since the financial crisis of 2007–2010 began,
and traded at between US$35 a barrel and US$82 a barrel in 2009 . On 31 January
2011, the Brent price hit $100 a
barrel for the first time since October 2008, on concerns about the political unrest in Egypt.
The paper is further divided into five sections. The
second section comprises of review of literature on (Import parity pricing)
IPP. The third section devoted to petroleum pricing policy in India .The fourth
section comprise of data analysis. The fifth section is offers concluding
comments.
2.
Literature review
Geoff
perr (2005) assessed an applicability of Import
parity pricing which depends on so many variables; its affects are uneven
across sectors and it so is difficult to condemn out right or to address via a
policy measure in terms of SA competition Act. The study concludes that many
factors contribute to the determination of a price charge at import parity, and
then factors in turn variables that can and do change overtime For Ex: SA
experience since 2000 has seen wide fluctuations in exchange rate that have
caused similar variations in import parity price. It has different effects on
different sectors. It is difficult to condemn the practice of IPP outright,
because it is moving target, it would be difficult to devise a sensible policy
instrument to tackle some of the negative effects that have been attributed to
IPP. (1)
Robert
E. Marks (1981) observed that crude oil levy in 1975 and
the subsequent introduction of import parity pricing for all Australian
produced crude oil in August 1978 together with rises in the world price of oil
had the consequence of raising the price paid by the refineries for domestic
crude oil over a short period of time from below $3 per barrel to $20 per
barrel. Australia had been largely protected from the post- 1973 increases in
the world price of oil. The study concludes imposition of IPP has resulted in a
sharp increase in the relative price of crude oil in Australia since 1978, both
because of the rise of previously controlled price of oil to world parity, and
because of subsequent increase in the world price of oil. However, the
government has allowed crude oil levy on the average price received by
Australian oil producers to rise only slowly, with the result that the levy is
equivalent to about two- thirds of the total cost to refineries of domestically
produced crude oil. In successive-National Wage Cases the government has had
some success in convincing the full bench of the arbitration commission that
indexation of wages should not always include the direct and indirect effects
of the price rise on the CPI, and this discounting, while reducing the real
wages level, has perhaps contained the inflation and unemployment which might
otherwise have resulted as domestic factors of production competed for shares
of the lower national income. The government avowed aims in imposing import
parity pricing has been to encourage oil exploration, to encourage conservation
of oil, and to encourage development of alternative energy sources. The
government has not used the very large revenues generated by the crude oil levy
and IPP policy to offset inflationary impact of higher oil prices on the CPI by
reducing other taxes or changes while maintains the aggregate position. (2)
Richard
Murgatoyd and Simon Baker (2010) analysed an economic
theory and relevant jurisprudence in an attempt to provide clarity as to the
circumstances under which IPP might conceivably reflect excessive pricing. Here
it is an attempt where an abuse is found, it may be effectively remedied. The
study concluded that although in theory import parity pricing may result from
excessive pricing; it is in isolation likely to be a poor indicator of
excessive pricing. It is necessary to understand why IPP has resulted or
occurred purely as a result of competitive market conditions. In order to advance
a theory of harm that a firm is engaged in excessive pricing, it is essential
to explain as part of the theory why the firm is not subject competitive
pressures and is thus able to charge excessive prices, and indeed demonstrate
empirically that price are indeed likely to be excessive .When prices are found
to be excessive, substantial hurdles are then likely to be encountered when
seeking to remedy such behavior. In certain situations it may simply not be
possible to affect the firm’s behavior in a way that is not ultimately self
defeating and actually enhances customer welfare. (3)
Shahauddin
M. Hossain (2003) drawn a theoretical and empirical
literature which provides a operational frame work in case of Nigeria, the
relevance of taxes/subsidies to correct the externalities and to address
equities and revenue considerations can be measured with a view to setting
prices of petroleum products. Domestic taxes on petroleum products provide a
major source of revenue in developing countries, with their share of total
revenue ranging from 7% to 30%. In countries suffering from revenue shortfall,
increasing the taxes and prices of petroleum products is often recommended as a
quick measure to boost. The exchange rate used to convert the dollar value of
imports in to domestic currency is the interbank exchange market rate, which is
market determined. The author concludes through empirical analysis indicates
the prices of gasoline (petrol) and diesel should reflect their opportunity
costs as measured by the import parity price as well as road user charge to
recoup the road damage congestion externality imposed by automobiles. Demand is
relatively inelastic; the tax authorities may impose taxes on petrol based on
equity and revenue considerations. (4)
F.H.Meyer
(2002-12) examined the efficiency of variable import levy
scheme of the wheat market in South Africa and its economic effects. The South
African agricultural sector has experienced long history of state intervention.
The study analysed main historical events and deregulatory activities impacting
on the wheat to bread value chain. The study with empirical analysis found that
between specific ranges of prices ($167-$147) the variable import levy did not
succeed in disconnecting the domestic prices of affected imports from
international prices. For some phases it will be lower than the reference
price, the world price will reach an average of approximately $157/ton. (5)
Kaushik
Rajan Bandyopadhyay (2009) briefed in his study, pricing of
refined petroleum products have gone through various phases beginning from
value stock accounting system and import parity pricing and then to retention
pricing under Administrated price mechanism (APM) and presently trade parity
pricing. Up to1939, there was no control on the pricing of petroleum products.
Between, 1939 to 1948 the oil companies themselves used to pool accounts for
major products without intervention of the government. After independence there
was a change in pricing of petroleum products. In 1948 a cost plus based formula(
import parity) in which additions like ocean freight up to Indian ports,
insurance, ocean loss, remuneration, import duty and other levies and changes.
The realization of oil companies under this procedure was restricted to import
parity price of finished goods plus excise duties/local taxes/dealer margins
and agreed marketing margins of each of the refineries. The petroleum industry
was deregulated with the intention of shifting to market determined pricing
mechanism. Where in practice the deregulation process has been only implemented
partially due to restriction on prices imposed by the Government to shield the
Indian consumer from oil price volatility especially since 2004.The process of
deregulation of petroleum product prices begun in 1998, five sensitive products
namely petrol, diesel, domestic LPG, PDS kerosene, ATF (Aviation Turbine Fuel)
continued as controlled commodities. Presently trade parity pricing has been in
practice for petroleum products for refinery gate as well as retail pricing (recommended
by Rangarajan committee) and proposed to review and update the trade parity
price every year depending on the relative weights of exports and imports. (6)
3.
Pricing of petroleum in India
Crude oil, both indigenous and imported are refined
in to various petroleum products viz., petrol (motor spirit), napthol, light
diesel, aviation fuel, kerosene, high speed diesel, furnace oil, bitumen, waxes
etc. The pricing of refined petroleum products have gone through various phases
beginning from value stock accounting system and import parity pricing and then
to retention pricing under Administrated price mechanism (APM) and presently
trade parity pricing. Among the above petroleum pricing systems import parity
pricing is said to be one which meets the international product pricing. India
had followed the same at two different time periods from 1970-77 and 2002-06
respectively.
Why
did India adopt Import parity pricing? (IPP)
Import parity
price or IPP is defined as, “The price that a purchaser pays or can expect to
pay for imported goods; thus the c.i.f. import price plus tariff plus transport
cost to the purchaser's location.
Crude oil price is said to be a highly volatile and
whose price is influenced by exogenous factors and inelastic in nature. Goods
that are elastic tend to have a high correlation between price and demand,
which is usually inversely proportional: When prices of a good increase, demand
tend to decrease. This relationship makes sense because you’re not going to pay
for a good that you don’t need if it becomes too expensive. Inelastic goods,
however, are goods that are so essential to consumers that changes in price
tend to have a limited effect on supply and demand. Most commodities fall in
the inelastic goods category because they’re essential to human existence.
Formula
to Calculate Import parity pricing
IPP = (P fob + Tr) * XR (1+T)
IPP= Import parity price (LC/mt)
P fob =world (or cheapest city import)
market price of the commodity
XR= Exchange rate local currency Vs US$ (LC/US$)
LC= Local Currency unit
Mt= Metric ton
Fob= Free on board i.e. price of the good in the
country of origin
CIF= Cost, insurance and freight i.e. price of the
good in the country of destination (at the border)
T= Advolerum tariff (in %)
Tr= Transportation costs, port handling etc. (US
$/Mt)
Robert J. Stonebraker, Winthrop University had
observed the demand and supply of oil are relatively inelastic
in the short run: changes in price have little impact on either the quantity
demanded or the quantity supplied. When oil prices rise we spend
considerable time and energy complaining but, at least in the short run, spend
almost no effort in trying to adjust our habits to consume less.
Similarly changes in price do little to spur new supplies in the short
run. Exploring for, drilling, and bringing new sources on-line can take
many years. Since the quantities demanded and supplied change very little as prices
rise and fall, both curves are relatively vertical as shown below:
Figure No: 1.5
Figure No 1.5 - Short run
demand and supply of oil
Because
quantities are relatively fixed in the short run, any shifts in demand or
supply will cause large changes in prices. For example, suppose that
supply falls. The decreased supply creates a temporary shortage that will
begin to drive up price. If demand is elastic, only a small increase in
price will be needed to get consumers to cut purchases enough to meet the new
reduced output. However, if demand is inelastic, it will take a much larger
price increase to generate the needed cut in quantity demanded. The
graph on the left below illustrates the elastic demand case. The demand
curve is relatively flat and the drop in supply (from S to S') causes only a
small increase in price (from P0 to P1). However,
if the demand curve is less elastic or more vertical (as in the graph on the
right), the same cut in supply causes a much larger increase in price.
Figure
No 1.6
Figure
No 1.6. Elastic and Inelastic demand for oil
We can understand from the graphs
that when curves are elastic, shifts in demand and supply because only small
changes in price, but when curves are inelastic, those same shifts cause much
larger price changes. Apply this to oil markets. For many years members
of the Organization of Petroleum Exporting Countries (OPEC) have controlled
most of the world's oil market. In the early 1970's, partly reacting to
political turmoil in the Mideast, OPEC oil ministers voted to deliberately cut
production. As illustrated above, this shifted the supply curve for oil
to the left and drove up prices. Because demand was inelastic, the price
increase was significant. The higher prices OPEC countries received more
than offset the lower sales and their oil revenues rose rapidly. In 1979
a bitter war between long-time enemies Iran and Iraq shut down more oil fields
and caused additional price increases. Demand and supply are far more
elastic in the long run than in the short run. After oil prices rose, firms
began shifting to less energy-intensive ways of manufacturing goods and
services. Similarly, consumers started to conserve as well.
Stonebraker reiterates that suppose if the
government decides to lower gasoline prices by decree and forbids firms from
charging any price higher than P1 in the graph below. In
economic jargon, P1 becomes a ceiling price. Consumers
immediately react to the lower price by increasing their quantity demanded from
Q0 to Q2. However firms react in the opposite
way. Stuck with a lower price they reduce their quantity supplied from Q0
to Q1 and a shortage results. The quantity demanded (Q2)
now exceeds the quantity supplied (Q1).
Figure No 1.7
Figure No 1.7 -Oil price determination and
Government Intervention
Some consumers do get gasoline for a lower price,
but others get no gasoline at all. Since output has been cut from Q0
to Q1 there is less gasoline to go around. It simply is not
profitable to produce as much at the lower price. In a free market consumers
would compete for the scarce gasoline by offering higher prices; those willing
to pay the most would get the gasoline. However, with a price ceiling in
effect, paying higher prices is illegal. Firms and consumers must find a
different way to decide who gets the gas and who does not.
With regard to literature available for the
volatility in crude oil prices, it is oil derivative market which is
responsible for fluctuations in price where the demand for energy is inelastic
in the short run and the consumer is ready to pay any price by taking this
advantage the oil marketing companies (OMC’s) fix the higher prices to maximize
the profit at domestic level. At the international arena the oil speculative
market traders will speculate the price to take advantage of inelastic nature
of energy demand. Sometimes exogenous factors (geo-political events) will
create speculation in the oil price or either the speculative investors create
artificial disturbances which make oil price volatile. It is the nature of oil
derivative traders who takes the advantage of inelastic nature of crude oil
prices, speculate the price and transfer the money from the pockets of petro
users to speculative gains to the investors. Millions of dollars goes to the
pockets of speculative traders and add up as inflation in the respective
countries.
Based on the recommendations of
the Kirit Parikh Committee, the Government of India (GOI) on 25 June, 2010
announced the full deregulation of the prices of two crucial petroleum
products: petrol and diesel. Henceforth, prices of these two products will be
determined by the unfettered play of market forces and government “subsidies”
on these products, which worsen the fiscal situation, will be completely
removed. Government control over the determination of the prices of these key
commodities was willingly ceded to the magic of the market, presumably to
“rationalize” prices and to wipe away losses of state-run Oil Market Companies
(OMCs) to the tune of ₹ 22,000 crores. There were strident complaints that this
policy change was not enough: prices of kerosene and liquefied petroleum gas
(LPG) were still minimally under government control and therefore even after
the deregulation move, the losses of the OMCs on account of these two petroleum
products would stand at ₹53,000 crores for fiscal 2011.The first crucial
victory of this struggle came in 2002 when the government dismantled the
administrative pricing mechanism (APM). This move reduced the “subsidies” on
petrol and diesel but the government decided to continue to “subsidize”
kerosene and LPG. Accordingly, in 2009 the next committee was constituted to
examine the same set of issues, i.e., the Kirit Parikh Committee. In its report
submitted in February 2010, the Kirit Parikh Committee finally recommended what
the capitalist sector had been telling GOI all these years. It recommended full
liberalization of petrol and diesel prices. (7)
In case of India nearly 39% of the subsidies given
by the government go to oil and gas payments. Oil price fluctuation affect automobiles
and transportations, Agro based industries, oil industry, Household and Fast
Moving Consumer Goods etc. so, almost all the sectors of Indian economy is
likely to feel the impact as inflation will rise and rupee value against dollar
will fall. In the physical terms the quantum of crude oil imports of India rose
up by just 3%, where as in rupee terms it rose up by 49% during 2010-11 to
2011-12. It implies that even if we keep the demand for oil constant, the price
which we have to pay phenomenally increases. The rate of increase in the oil
import bill is far greater than the rate of increase in physical quantity of
oil import. This drains away the precious financial resource of India which can
otherwise be utilized for raising the welfare of the people.
The economic times mentioned in its column that India
could seek diversification for its crude oil imports and build up on its
reserves to tackle risk associated with geo-political instability: The unrest in Iraq threatens to
aggravate oil supply shocks in a market already faced with disruptions owing to
domestic turmoil in other petro countries viz. Libya and Nigeria. Concerns of
potential lower oil supplies from key producer Iraq has pushed up global crude
oil prices to 9 month highs in a short span of a week since the crisis erupted.
As the unrest in Iraq rages, the risk of a spillover of the turmoil into
neighboring petro states has emerged, deepening fears of potential oil supply
losses and concerns of long-term supplies from these regions. Given India’s
vulnerability to a rise in global crude oil prices, considering that almost
75-80% of our consumption is met through imports, the sudden and rather steep
rise in the same has the potential to dislodge the envisaged economic recovery
of the country in the current fiscal. It has the potential to: - Widen the CAD
and put pressure on exchange rate - Hamper the fiscal consolidation intent of
the government - Increase inflation at a time when the news of a sub-normal
monsoon has put pressure on food prices - Delay any action on interest rates by
the RBI All these possibilities could come in the way of the revival of
economic growth in the country which is expected given the early moves made by
the government to reinvigorate the economy and put investment on a fast track.
In the context of the escalating violence in key oil producer Iraq, the
prevailing fundamentals of the oil markets and implications for oil import
dependant India has been looked into here. The times of India mentioned in its
column that India's crude oil basket
is now worth $111.25 a barrel, translating into an import cost of Rs 6,688 a
barrel. This could go to Rs 7,200 a barrel if crude touches $120. It is
difficult to forecast the extent of the diesel price hike, but keep in mind
that the losses on diesel will raise to Rs 5 in a $120 scenario. Hindustan
times observed, Oil marketing companies like Indian Oil, BPCL and HPCL and
upstream majors such as ONGC will
be affected due to unrest in Iraq. The former will not be able to pass on the
higher crude cost while the latter's share of the subsidy burden will increase.
ONGC's subsidy burden in FY14 was Rs 56,384 crore, or one-third, of its
revenues. Stand alone refiners such as RIL or
MRPL may not be affected so much as they sell petrol or diesel at international
rates to Indian OMCs which will bear the burden.
Profit through price increase in pricing is
difficult, considering increase in input pricing the firms justify pricing. In
trade parity pricing without any justification a firm can hike the price, by
simply quoting the international price increase. The domestic economy may
remain static but the price increase, because of trade parity pricing. There
must be justification while taxing on sensitive products like oil. Normative
economics says that the essential commodities and services should not be used
as a source of public revenue. The basis behind Import parity pricing is
Opportunity cost, if domestic supply is not there we must import. Therefore,
international price is charged. Oil is brought to India as a raw material in
the refineries it is converted into final product. About 109 by products been
generated in the refining process. The price of the final product in some other
country cannot be used in computing the oil price like Import Parity Pricing
(IPP).In the case of oil pricing in India the refining cost is around ₹20/- the
retail price is around ₹75/-. The tax and profit margin works out to 350%.As a
positive aspect of trade parity pricing, higher profit may attract investors. For every dollar dip in crude oil prices, petrol
prices come down by 33 paisa a litre. Similarly, for every depreciating Indian
rupee against the US dollar, petrol prices go up by 77 paisa a litre**.[2]
The government can follow Singapore
model of importing crude, refining it to generate surplus final petroleum
products and export it to other countries. This would generate demand for
Indian rupee and Indian currency value can appreciate. If rupee is used as a
payment medium in oil trading by India she can reduce trade deficit. Instead of
buying oil futures and contracts in speculative market if India goes for the
country where oil originates and purchases, can reduce the import cost. Even
though the OMC’s are charging international price for oil (IPP) is still claims
they are under recoveries and the Government of India given subsidies too. The
pricing mechanism itself is a flaw, which affect the interest of common man.
Since 24% of the crude oil demand met with the domestic sources, it is
injustice to impose International price or Import parity price. India herself
exporting few of petroleum products and it’s by products, if it is diverted to
domestic use, it can serve the interest of common man. The ongoing debate on KG
basin LNG exploration, where Indian government leased it to Reliance Company,
the resource found in Indian soil the Government should stop pricing LNG on the
basis of IPP by Reliance.
With regard to gas pricing Delhi
Chief Minister had ordered registration of FIRs against Reliance Industries Ltd
(RIL) chairman Mukesh Ambani, Petroleum Minister Veerappa Moily and former
Petroleum Minister Murali Deora for conspiring benefits RIL leading to higher
prices of Natural gas. Where the cost of production of one unit of gas was less
than $1, but the RIL got the contract of 17 years for gas production, it forced
govt to revise the rate $2.3 per unit in 2010. It was revised to $4 and they
have planned to re-revise the rate to $8 on April 1, 2014. He also opined
revised price of natural gas will lead to further inflation. When the gas price
goes up, this will lead to costly transportation and hike in prices of every
commodity. Power tariff will go up; fertilizers will become costlier which lead
to steep hike in prices of food items. In a complaint he cited where reliance
supposed to supply 80 million units of gas, but only 18 percent of it being
supplied. They have created fake crisis of natural gas in the country so that
they could black mail the government to revise the rates. A company named NIKO
which is partner of Reliance in gas basins is selling natural gas to the
neighboring country of Bangladesh at $2.32 per unit. How it is possible that
Reliance’s rates are much higher than its partners? (Source: Deccan Herald,
Bangalore Feb 12, 2014). (8)
Why
did the government and oil marketing companies adopt Import parity pricing
model for petrol, diesel and Natural gas pricing?
It is observed that in the short run the demand for
energy products are inelastic, taxes from energy usage by the consumers is the
one of the main source of revenue. Even though there are many pricing methods
like marginal pricing, cost-plus pricing, skimming pricing etc. because IPP is
beneficial for the Government, oil companies and speculative traders i.e. the
demand for energy in the short run not going to change, neither supply
disruptions nor rigidity in supply or change in demand. The infrastructure for
oil drilling and refining is the same it does not bring a change in price, only
the price is influenced by exogenous factors or any of the events across the
globe will be treated as a cause for the price change. As the supply of crude
oil comes or it is in the hands of few companies that are oligopolistic in
nature where companies cite an international event (geo-political) is a cause
for price hike. Sometimes domestic events will attribute for price hike like
exchange rate volatility and domestic crisis. In case of India’s petroleum
pricing policy trade parity pricing is in implementation at present (according
to Rangarajan committee recommendations) trade parity pricing consist of
(80:20) format IPP and export pricing respectively.
India is solely crude import country 80% of energy
needs fulfilled by imports only which eats up the majority of export earning of
the country. The pricing mechanism is allowing an import linked price at the
refinery gate on the sale of petro products. The IPP pricing mechanism consists
of expenses like custom duty, insurance, ocean freight etc which are not
incurred but are reimbursed to the refineries. So, it is beneficial for government
in form of tax revenue, beneficial to the OMC’s as subsidy and huge dividend to
oil speculators. The CAG (Comptroller and Auditor General of India) have found,
the present pricing mechanism benefited Oil marketing companies by Rs 50,513
crore during the five year period of 2007-12.The pricing mechanism allowing an
import-linked price at the refinery gate on the sale of regulated products —
LPG, kerosene, diesel and petrol — is beneficial to the oil-marketing companies
(OMCs), the federal auditor said and pointed out how the faulty pricing
mechanism has acted as a source benefit to private refiners (Reliance
Industries Limited and Essar Oil Limited), which was estimated at Rs 667 crore
on high speed diesel alone in one year(2011-12).The pricing mechanism,
including notional import related expenses like customs duty, insurance, ocean
freight etc, which are not incurred but are reimbursed to the refineries works
out to Rs 50,513 crore for the period 2007-12. Even allowing for import-related
expenses incurred by the refineries on import of crude, the oil marketing
companies ought to have benefited at least by Rs.26,626 crore through the
pricing methodology of products. (Source: Times of India, Bangalore July 19,
2014).
4.
Data Analysis:
The data on oil prices were downloaded from
knomea.com. Data related to exchange rate was downloaded from RBI Publication
(Hand book of Indian statistics 2012-13), CPI inflation from inflation.eu. The
variables that we use are the world crude oil prices in Us Dollars, CPI inflation
in India and exchange rate of rupee per
$1 Us Dollar. Time series data from 1970 to 2012 are used for all the
variables. The time series data has drawn in the form of diagrams to interpret
the impact of IPP in the two analytical periods and to observe the volatility
of three selected variables.
Relationship
between Historic crude oil prices, Inflation (CPI) and Exchange rate or Rupee
Vs US dollar
There is non-linear
relationship between the crude prices, inflation and exchange rate. The
fluctuations in crude price have found to be commendable influence on consumer
price inflation and exchange rate. Price for energy is found to be in elastic
in nature where consumer is ready to pay any price. Even the government bears
the burden in the form of subsidy, as energy is a basic infrastructure for
economic development. Fluctuations in the price of crude prices have cascading
effects on the performance of an overall economy.
Figure No 1.8
Figure No 1.8.Crude oil price per
barrel in US dollars (Futures price WTI), CPI inflation and Exchange rate
From the above diagram it is clear that there is a
non liner relationship between Crude oil prices, Inflation (CPI) and Exchange
rate. The study period can be divided in to two different analytical
periods1970-77 and 2002 to 2006 where Import parity pricing had in practice in
pricing petroleum products.
Analytical
period I (1970-77): The decade witnessed a severe political
and geopolitical uncertainties and wars like yomkippur war in 1973, Iran oil
embargo and emergency situation in India. To counter the situation may be the
popular governments would have gone for import parity pricing to guard the
state run oil companies.
Figure No 1.9
Figure No 1.9 .Crude oil price per
barrel in US dollars (Futures price WTI), CPI inflation and Exchange rate
The above diagram shows time period where Import
parity pricing was in practice in India i.e. from 1970-77. Where the value of
crude was rising at a marginal rate till 1973 and there was a sudden spike due
to oil embargo the rise in price was continued till 1977 with moderate
fluctuations. Since there was an oil embargo the Indian government adopted IPP
to put more burden on the users of petroleum products like adding fuel to fire.
So for that might be the price in 1973 was $1.21 per barrel and it plummeted to
$12.57 in 1977.The Consumer price index (CPI) inflation was also had the
implications of both Oil embargo and application of IPP, in 1973 and 1974 it reached to a peak of
23.81% and 25.4 % respectively. In 1975 CPI index went in negative -6.18% and
further in 1976 became ‘0’. In 1977 it reached to 7.86%. As the Exchange rate
of rupee for dollar is concerned it raised marginally in the decade from
1970-77.
Analytical
period II (2002-06): From 2002-06 was also witnessed
conflicts and geo political events which made the crude prices to fluctuate
like invasion of Iraq by US in 2003, Hurricane Katrina devasted North America
causing huge economic loss at the international level and change of governments
in India with populist policy.
Figure No 1.10
Figure No1.10 .Crude oil price per
barrel in US dollars (Futures price WTI), CPI inflation and Exchange rate
In the above diagram crude oil price
shows increasing trend in 2002 it was $ 23 per barrel there was a consistent
rise in prices till 2004 and in 2005 and 2006 oil price spiked to $49 and $61
dollars respectively. Whereas CPI inflation is concerned there was a marginal
rise over the period 2002-06, not much to note. To support petroleum pricing
policy that is IPP, when the new government came to power in 2004 it given the
statement and as its policy to shield the burden of high crude prices on aam
aadmi i.e. populist policy. As exchange rate of rupee Vs dollar is concerned it
was very high about ₹48.59 a dollar in 2002 in the consequent years it reduced
marginally till 2005 and it was₹ 44.1 per dollar in 2005. In the next year it
spiked further to ₹45.30 per dollar in 2006. From the past few quarters it is
trading around ₹ 66-68 per dollar. It is clear from the analysis that the
successive governments imposing IPP to raise more revenue on the inelastic
commodity and giving the reasons as (oil marketing companies) OMC’s under
recoveries which is not exists in reality.
5.
Conclusion
The
objective of this paper is to study the implications of implementation of
Import parity pricing in Petroleum products. The study analysed the impact of
hike in crude oil price on inflation and exchange rate of Indian rupee in two
analytical periods 1970-77 and 2002-06 respectively, where import parity
pricing regime was in implementation. The study finds in the above two
analytical periods there was a sudden spike in the prices of crude oil where in
1973 Iran oil embargo was another international political event which led to
increase in crude prices. In the second analytical period (2002-06) too it is
observed there was a huge rise in crude prices. In response to the same the CPI
inflation and Exchange rate of rupee against dollar had a commendable impact.
From above two analytical periods of Import parity pricing implementation, it
is observed that first analytical period ended with ruling party losing power
in 1977. This time around the same for the General elections 2014 for the
congress government it repeated again. It is lesson to be learned by politician
of the national parties who lost ruling power because of petroleum pricing
policy and those who form the government should take it as a caution note. With
regard to the elasticity in oil prices, the demand and supply of oil are
relatively inelastic
in the short run: changes in price have little impact on either the quantity
demanded or the quantity supplied. When oil prices rise we spend
considerable time and energy complaining but, at least in the short run, spend
almost no effort in trying to adjust our habits to consume less.
Similarly changes in price do little to spur new supplies in the short
run. Exploring for, drilling, and bringing new sources on-line can take
many years. Since the quantities demanded and supplied change very little as
prices rise and fall, the exogenous factors responsible for oil price
volatility. The recent militant crisis in Iraq has widened the CAD as India’s
vulnerability to hike in crude prices which imports 75 to 80 percent of oil for
consumption will have cascading effect on the economy in the form of inflation.
The CAG report on Petroleum product pricing which is tabled in the parliament
recently asserts the present pricing mechanism benefited the OMC’s by Rs 50,513
crores during the five year period of 2007-12.
The pricing mechanism allowing an import-linked
price at the refinery gate on the sale of regulated products — LPG, kerosene,
diesel and petrol — is beneficial to the oil-marketing companies (OMCs) not to
the petro consumer. It is observed that oil derivative market which is
responsible for fluctuations in price where the demand for energy is inelastic
in the short run and the consumer is ready to pay any price by taking this
advantage the oil marketing companies (OMC’s) fix the higher prices to maximize
the profit at domestic level. At the international arena the oil speculative
market traders will speculate the price to take advantage of inelastic nature
of energy demand. Sometimes exogenous factors (geo-political events) will
create speculation in the oil price or either the speculative investors create
artificial disturbances which make oil price volatile. It is the nature of oil
derivative traders who takes the advantage of inelastic nature of crude oil
prices, speculate the price and transfer the money from the pockets of petro
users to speculative gains to the investors. Millions of dollars goes to the
pockets of speculative traders and add up as inflation in the respective
countries.
It is also observed that whenever there is a fall in
International crude oil prices the Ministry of petroleum and Natural gas and an
Oil marketing company does not regulate the diesel and Kerosene, LPG prices
expect petrol partially. Here too there is a exploitation of petro user by the
concerned Ministry and Oil marketing companies crores of rupees goes to the
pockets of (OMCs) and the Government by not regulating the price according to
the fall in prices of crude oil, and whenever there is a increase in
international crude oil price there will be a sudden hike is prices of petrol
and diesel expected without any delay.
References
1.
Geoff
Parr (2005). “Import Parity pricing: A competitive constraint or a source of
market power?” Trade and uneven development, opportunities and challenges,
United Nations University, Annual Forum, 2005.
2.
Robert
E. Marks (1981). “Macro Economic effects of import parity pricing of oil”,
Australian Graduate school of Management, University of New South Wales, 1981.
3.
Richard
Murgatroyd and Simon Baker (2010). “When does Import parity pricing constitute
an abuse, and where it does how can the abuse be remedied”, 2010.
4.
Shahabuddin
M.Hossain (2003). “Taxation and pricing of petroleum products in developing
countries: A frame work analysis with application to Nigeria”, IMF/WP/03/42,
2003.
5.
F.H.Meyer(2012).
“Evaluating the efficiency of wheat tariff regime in South Africa”,Department
of Agricultural Economics, University of Pretoria, (Working Paper- 2002-12).
6.
Kaushik
Rajan Bandyopadhyay (2009). “Petroleum Pricing in India: Transition from APM to
MDPM”, Asian Institute of transport development-MPRA Paper No: 25905/2009.
7.
Surya Sethi (2010) The political Economy of oil prices in India:
EPW article: “Analysing
the Parikh Committee Report on Pricing of Petroleum Products,” Economic and Political Weekly, March 27, 2010.
8.
Natural
gas pricing policy: Implications in power tariff and fertilizers prices, DH
News service, Bangalore Feb 12, 2014.
Webilography
http://faculty.winthrop.edu/stonebrakerr/book/oilprices.htm
http://www.hindustantimes.com/business-news/sensex-stocks-nifty-bse-trade-markets/article1-1228948.aspx
http://timesofindia.indiatimes.com/india/Fault-in-fixing-price-gave-oil-companies-Rs-50000-crore-gain-CAG-says/articleshow/38635830.cms
