Diesel Price Deregulation in India

Last Saturday (18 October 2014) as I was watching on TV Maharastra and Harayana assembly election news, the Indian cabinet meeting to discuss deregulation of diesel price topped the agenda. For a fraction of a second I had forgotten that the international oil price had slumped to a four-year low and was getting ready to go and fill my car diesel tank to benefit couple of hundred bucks. I thought the market determining the diesel price meant ending government subsidy on diesel. The subsidy withdrawal normally entails price rise. Wait a minute … diesel price rise in the midst of assembly elections? PM Modi and Bharatiya Janata Party (BJP) could not be so stupid to increase fuel price when they were busy churning Modi’s popularity into electoral votes. The Maharastra and Harayan assembly results were expected next day (Sunday). By Saturday BJP was certain that they had Maharastra and Harayan in their pocket reversing skeptic belief that Lok Sabha results were an aberration and that Modi wave was temporary. There was a game-plan.

Then I remembered brent crude was at mid-eighties for a barrel in dollar terms compared with 115 in June. The international market price must be below the controlled price that the oil retailers were selling diesel in the Indian market. So the Indian government wanted to have a cake and eat it too. The deregulation brought pump price of diesel down immediately (effective midnight of 18 October) which will translate into lower inflation rate with positive impact on the voters, and the government need not foot the huge diesel subsidy bills in future. While the government passed on the volatile oil price risk with diesel price deregulation to the consumers, it also delivered one of the reforms needed for its economic promises -- a feather in the Maharastra and Harayan assembly election victory cap of BJP. The international rating agency, Moody's Investors Service, says the diesel price deregulation is a "credit positive".

On any other day, the political opponents would have made a hue and cry of the subsidy withdrawal as anti-poor policy and announced strike with the help of truckers’ lobby. But this time they were in awe. That’s how BJP plays the game of politics with business advantage, the Gujarati style. A double jeopardy, short-term!

We buy oil from Indian retailers, Indian Oil Corporation and Bharat Petroleum. So, our pump price of diesel will also be based on market (not our market but international) and Indian export tax exemption impacts.  This is perfectly fine as long as the international oil price is on downward slide. We may take advantage of the global oil prices hovering on bear market while the world oil demand forecast is still on down-side and OPEC cartels are not willing to cut production. Also, the oil-guzzling US is busy cutting its oil imports making itself more and more dependent on its own shale gas. The oil supply at the moment exceeds demand, the price is falling. Many analysts are of the view that oil price is heading to $70 a barrel. The short-term outlook is rosy, so let us enjoy!

Will the oil price keep on falling? The oil cartels are in no mood to cut production and let the oil price increase for now. Do not be under illusion that OPEC cartels are not working to create conditions for sudden oil price jump. The low oil price encourages people to buy big cars and make oil fields that are operating at marginal levels not viable. The other OPEC target is shale gas. The extraction of gas from shale rocks involve much deeper drilling than conventional oil. While the cost of extraction of conventional oil is about $25 per barrel, the shale cost $60-80 per barrel. The cartel aims at bringing the international oil price lower enough so that investment in shale does not make commercial sense. If the investment dries up, the US shale will be out of the market pricing. Also the cheap oil price will make investment in renewable energy less attractive. So OPEC members are continuing with maximising production despite oil price fall to liquidate inefficient producers, help increase energy dependency on OPEC and raise oil price later.

When the international oil price takes a reverse upward trend, the diesel price in India will climb faster filling the subsidy void triggering inflation. India deregulated oil price in 2002, but the policy had to be reversed because of international crude oil price increase in 2004. The BJP government is not likely to reverse the policy staking its credibility with international investors, and believes that their financial inclusion programme that enables direct cash transfers to poorer section of the society will shield them from the essential commodity price rise.

That being the case in India, we will be in direct line for oil price rise hit. If the Indian diesel subsidy is not back, our trucks one day in future will need to run paying the petrol pump price or more for diesel like in other countries where diesel is not subsidized. How do you think our policy makers will handle the situation when the diesel price rises in tandem with that of petrol and prices of essential commodities shoot through the roof? Your guess is as good as mine. So I do not need to mention here!