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India: the price isn't right

Low crude prices could have allowed the Indian government to reform its domestic price-fixing regime, but political factors are likely to prevent such a change, reports James Gavin

India may have missed its chance to take advantage of low oil prices to ease domestic fuel-price subsidies. With elections taking place this month and next, reform of the pricing system is unlikely – politicians are loath to enact policies that would prove unpopular.

Cooking gas (liquefied petroleum gas – LPG) and kerosene, the main fuels used by the hundreds of millions of India's low-income population, are heavily subsidised to ease the burden on the poor; while retail prices for gasoline and diesel are capped to help contain inflation.

India is the world's fifth-largest consumer of energy – oil products demand rose by 7.6% during the 2008-09 fiscal year. But with domestic crude production holding at just under 0.7m barrels a day, imports rose by 9% during the period, with subsidised prices inflating demand. When the average price of Indian crude imports peaked at $142 a barrel on 3 July, state-owned oil companies, unable to pass on the increased cost to the consumer, suffered very large losses.

The government has issued the three main state-owned marketing firms – Indian Oil, Hindustan Petroleum and Bharat Petroleum – with oil bonds covering about half of the losses. These are estimated at $23bn for the 2008-09 fiscal year.

Without state support the private sector has been hit hard. Reliance Industries had closed down its 1,400 retail outlets by mid-2008, unable to compete with the state-owned firms' subsidised prices – in March 2008, it was selling fuel at a Rs4-5 a litre ($0.08/l) premium, but still losing Rs3.4/l on gasoline and Rs5.8/l on diesel. Privately owned Essar also shut down its retail operations and foreign firms suffered too, with Shell closing one-third of its forecourts.

With the fall in oil prices since last summer, the situation has improved. In November, Reliance said it would re-open all of its forecourts, while Essar has re-opened most of its 1,250 outlets. However, as a result of the structure of India's fuel market, companies have cut their downstream expenditure plans. Rather than open more retail outlets, for example, Indian Oil says it will reduce its nationwide network of 15,000 forecourts.

The steep fall in oil prices – with prices averaging just over $40/b so far in 2009 – has taken pressure off the government to remove subsidies. And although fuel suppliers continue to lose money on kerosene and LPG sales, diesel and gasoline sales are profitable again, says an Indian oil-sector analyst, who did not want to be named – the state-run marketing companies are able to make a profit of nearly Rs10/l on gasoline. "It's a net-zero-benefit situation now," he says.

But as soon as crude prices begin to rise again, the same problems will recur and government officials have hinted that subsidies reform is still on the agenda. Suresh Tendulkar, chairman of the Economic Advisory Council and a senior adviser to prime minster Manmoham Singh, told a February conference in New Delhi that India should take advantage of the sharp fall in oil prices to escape the administered price mechanism. With oil prices down, the removal of price caps would be less noticeable to consumers, who would subsequently cope with gradual price increases.

Reliance Industries has called for India to liberalise gasoline and diesel prices, but retain subsidies on kerosene and cooking gas. But there is little appetite among policymakers for this approach – at least until the elections are out of the way. Indeed, on 15 January, a government committee postponed a decision to cut fuel prices – partly in recognition that, because of the recession, now is an inopportune time to raise prices. And even with the elections out of the way, it is unlikely that a new government will want to be seen boosting prices at a time of economic hardship.

As a result, change in India's pricing regime – in the near future at least – seems improbable. And, as international prices rise, reform will become increasingly difficult to implement. But this may be the price that the world's largest democracy has to pay for being a democracy; China enacted fuel-subsidy reforms late last year – measures designed to bring domestic fuel prices into closer alignment with international markets – but its government is unburdened by the fear of not being re-elected. India's oil companies will have to wait a while longer for deregulation.

India's gas pipeline problem

IT IS 20 years since the idea of the Iran-Pakistan-India (IPI) gas pipeline was conceived. But progress with the 2,600 km trunk-line – which would export 22bn cubic metres a year of Iranian gas from the South Pars field to India, through Pakistan – has been limited. And there is no immediate prospect of a deal that could lead to the start of construction, making the pipeline's original start-up date of 2010 an impossibility.

The latest obstacle is Iran's demand for a higher price for its gas. According to Indian newspaper reports, the original, agreed $3.2/m Btu oil-linked, border price was raised to $7.1/m Btu last year, as global crude prices rose above $100 a barrel. Indian consumers would also have to pay a minimum transit fee of $1.1-1.2/m Btu to Pakistan. Even with oil prices now below $50/b, Iranian gas would still cost India around $6/m Btu – higher than the price of Indian domestic gas supply, which fetches a maximum of $5.70/m Btu.

Originally, the IPI gas price was to be calculated as 6.3% of the 10-month average of the Japanese Crude Cocktail – the average price of that country's customs-cleared crude imports – plus a fixed $1.15/m Btu cost. India says that if this formula were to be applied, the price for IPI gas would amount to $3.67/m Btu.

And there are other concerns: with Pakistan's political stability being undermined by a surge in terrorism, India fears gas supplies could by easily disrupted. So far, it has failed to receive cast-iron assurances from Iran that it can ensure the safe export of gas. Iran has, for example, refused to agree to a regime under which it would be held responsible for the non-delivery of gas to the Indian border.

Only Pakistan appears to be fully behind IPI. President Asif Ali Zardari visited Tehran on 11 March and said that, if India does not want to participate, then Pakistan and Iran should proceed without it.



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