Fuelling a diesel crisis

It is a scene reminiscent of war times. Vehicles queuing up at petrol bunks and people lugging all kinds of containers, from plastic water pots to jerry-cans and even empty mineral water bottles, to buy that precious litre of diesel or petrol. From Chennai and Salem in Tamil Nadu, to Belgaum and Mangalore in Karnataka and Anantapur in Andhra Pradesh and other parts of the country, reports have been coming in of a shortage of fuel, especially diesel, over the last two days .

No, India is not at war and there is no clampdown on fuel sales. Nor is there a scarcity of oil supplies worldwide, as it last happened during the first Gulf War in 1990. So, why are petrol bunks pulling down shutters? The reason, at least in Chennai, is attributed to logistical failure. A public sector oil company apparently failed to move a parcel of diesel from Kochi to Chennai in time, leading to a shortage at its outlets and causing a run on the outlets of other oil companies.

Plausible as the reason seems, the truth lies elsewhere. The events of the last two days are but a manifestation of the bad governance of the petroleum economy that is now snowballing into a crisis. How is a shortage of diesel in some parts of the country bad governance? Read on.

Truth about diesel

Diesel accounts for a little more than one out of every three litres of petroleum products sold in the country. At 47.63 million tonnes (of a total of 129.24 million tonnes of petroleum products sold in the country) diesel sales grew by a big 11 per cent in 2007-08; in contrast, sales of all petroleum products put together grew by 7 per cent in the same period.

Diesel sales growth has been galloping away over the last couple of years, and at rates higher than the overall economy. This has confounded experts, who are unable to justify the apparent lack of correlation between diesel sales growth and that of the economy itself.

Some say that the spike is because of the increasing number of utility vehicles and cars on the roads that run on diesel but a number of others point to a quiet shift by captive power plants and other small users to diesel from expensive fuels such as naphtha, furnace oil and low sulphur heavy stock (LSHS), driven by price economics.

Diesel sells for Rs 35,000-38,000 a kilolitre (KL), compared to Rs 40,000/KL for fuel oil and Rs 43,000/KL for LSHS. Whatever the cause, the bottomline is that diesel sales are growing at an unnatural, rapid pace. And this is exerting direct pressure on oil companies’ finances because of the artificially low price for diesel fixed by the government. They are being called upon to subsidise higher volumes than planned for.

What compounded the problem of the oil companies — Indian Oil, Hindustan Petroleum and Bharat Petroleum — was the EOU (export oriented unit) status granted to the 33-million-tonne refinery of Reliance Industries in Jamnagar by the government in April 2007. What this seemingly harmless development did was to take away more than 11 million tonnes of diesel from the domestic market for supplies abroad.

This forced the public sector oil companies to import diesel to compensate for the loss of volumes from Reliance. In 2007-08, the oil companies imported 2.93 million tonnes of diesel at international market prices, while Reliance exported 11.46 million tonnes at the same international prices. This has led to heartburn for the oil companies — while they were making losses buying diesel abroad at market prices and selling below that, Reliance was able to export its own production at premium prices.

No imports

In order to protect their finances, the oil companies cut down on diesel imports from April this year. They appear to have resorted to an unspoken strategy of “managing” supplies, that is, control sales in order to cut down on losses. And they are doing it cleverly — their production, at full tilt, is enough to meet the projected demand growth of 12 per cent but not the incremental growth. And that seems to be the reason behind the shortage that we are witnessing in select pockets of the country now.

There have been reports that dealers have been informally told that their monthly supply is being linked to their average sales in the same month last year. Thus, a dealer who sold 10,000 litres of diesel in June 2007 will be supplied the same quantity this year. In effect, the incremental demand will be left unserviced. To be sure, there is nothing on record, nor are oil company executives willing to confirm this, even off the record. But the experience in the market over the last two days only seems to confirm this theory, especially because the shortage coincided with the end of the month. Dealers ran out of their quotas and hence had to down shutters till the start of the following month.

Bad governance

It is easy to blame the oil companies now but that would be missing the wood for the trees. Which producer of a product can continue to sell at unremunerative prices for a sustained period of time and also hope to stay afloat?

The oil companies cannot be blamed for their attempt to cut down on losses by resorting to ‘supply management’, if indeed that is what they are up to. If anything, it is a smart strategy that will not only help them stay in business but also control the exploding rate of fuel consumption in the country!

The blame rests squarely at the doorstep of the government for allowing things to come to such a pass. The administered price regime and artificial subsidies have created a cancer that has now grown deep to the bone, threatening the economy itself.

The so-called hefty hike in prices of petrol, diesel and cooking gas last month was too little and too late. The government ought to have passed on price increases over the last year at regular intervals, in tune with the international price trends. It could have avoided this unseemly crisis had it done so. Unfortunately for the government, oil prices have advanced further since June 5 and very soon it will be confronted with yet another price hike decision.

Link prices to market

Ideally, the government should now move away from the subsidy regime and link at least petrol and diesel prices fully to the market. Subsidies on kerosene, the so-called poor man’s fuel, can continue while cooking gas prices can be gradually linked to the market. There is no reason why petrol and diesel prices ought to be subsidised. The long queues in front of petrol bunks in the last two days confirm that people, even if they are grumbling, are willing to pay what it costs to buy their fuel.

They are not willing to sacrifice the comfort of personal transportation even if it means waiting for hours in a queue, sometimes even paying a premium for the scarce fuel. This is not behaviour expected from consumers pinched by supposedly high fuel prices. Why should the government protect this class of consumers and risk damage to the economy in the process?

While the arguments in support of market-linked prices are weighty it is impossible to see the government moving in that direction for now. The hullabaloo over prevailing double-digit inflation is enough deterrent for the government to even think in terms of freeing prices. So, does that mean we should be resigned to live with shortages?

Probably yes, unless the government is miraculously able to find resources to fund the yawning subsidy gap. In the specific case of diesel, it could consider directing Reliance Industries to sell a part of its diesel output in the domestic market.

EOUs can be permitted to sell in the domestic tariff area but they have to suffer numerous duties and taxes while doing so. The government could consider waiving duties and taxes for diesel supplied by Reliance and treat it as deemed exports by the latter. There is already a working example of such an arrangement in the case of cooking gas. Extending this to diesel will help ease the burden on the oil companies and prevent shortages of the kind we are now seeing.