Deregulating oil or price ceiling?

July 04, 2020

The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy Issues: Success and Challenges’.New and higher oil prices have been announced after...

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The writer is a former member of the Energy Planning Commission and author of ‘Pakistan’s Energy Issues: Success and Challenges’.

New and higher oil prices have been announced after the government fixed very low prices in June. The June prices were extraordinarily low, in the company of 15 lowest price oil producing countries like Saudi Arabia, Qatar and Turkmenistan (and less than half the prices in India).

In hindsight, it was perhaps not an optimum decision which caused price shock and created most of the problems faced by the market, government and the public. A better option could have been to pass on the surplus to the Ehsaas programme and to victims of Covid-19. Admittedly, one is wiser in hindsight. Everyone was confused as to how to manage the economic shocks of the coronavirus pandemic. Is deregulation a solution or some other variant of it like price ceiling and not fixing? We will examine this difficult issue in the following paragraphs.

The month of June passed in controversy, oil shortages and black marketing in the wake of the drastic cut in petroleum prices announced by the government. International oil prices plunged due to lack of demand as a result of the Covid-19 pandemic. Oil prices even became negative, although for a short while. The government of Pakistan passed on most of the surplus it could to consumers. The political and welfare impact was marred by the subsequent market problems which would annoy any reigning government.

Oil Marketing Companies (OMCs) blamed the shortage on the petroleum division, claiming that it did not adequately project and manage the demand and supply through timely interventions. The petroleum division argued that there was an abrupt increase in demand in the wake of lifting of the Corona restrictions. Government circles blamed the shortages on OMCs which did not maintain the required inventory of 21 days and hoarded (did not release supplies to the market) the petroleum products. OMCs argued that they were suffering a loss of Rs17.00 per litre due to the inventory bought by them at higher prices. Similar arguments were proffered by the dealers as well.

The SAPM acknowledged that the current pricing system does not work well in large price changes, up or down. Sometimes OMCs and dealers make a killing when prices increase, and suffer when prices decrease. For consumers, it is the other way round. It is a zero-sum game; OMCs’ loss is consumers' benefit and vice versa. A need is being felt to bring about changes in the current system. While that is easier said than done, something has to be done. There has to be a fair and efficient system which promotes supplies and investments and at the same time through reduction of process inefficiencies awards fair market prices to the consumers.

Gasoline price has increased from Rs74.52 per litre to Rs100.10. The price increase is as sharp as the decrease was. International oil prices have increased and thus prices had to be increased. Petroleum levy has been maintained in the new price at Rs30 per litre. Previously, international prices were low and thus a higher PLD of Rs30 was acceptable by the market. The government had the option to reduce PLD, say, to Rs20 and thus the price increase could have been reduced to Rs90 and the increase could have been only Rs15 instead of Rs25.

Additionally, there is confusion because transparency is lacking. In earlier days, a complete breakdown used to be made known. Experts and other people somehow find out the complete price break-up. The government would do well if it reverts to the earlier system. Also, 40 percent of petrol is consumed by the low-income group of motorcyclists which forms a highly price sensitive market segment, although there are additional options to reduce prices in this segment, other than pricing reforms. (These are of blending a low RON -87 fuel out of Naphtha and marketed through a separate low-overhead petrol pump system). Another issue is of reducing diesel prices with respect to gasoline as is the situation in most countries.

It may be noted that basic oil price (imported or ex-refinery) is already linked to international prices (there is a 7.5 percent custom duty levied on HSD which requires some rationalization). It is related to Platts Oil-Gram but the final price is dependent on PSO actuals, which may be a double edged sword; besides, it is a time consuming process. A better approach could be simple interlinking with an appropriate index such as Platts Oil-Gram. Import expenses such as Ocean Transport, insurance, L/C costs etc can be based on estimated averages of the past months on the line of Ogra LNG calculations.

OMCs have been demanding a 15-day pricing cycle as opposed to the current monthly pricing cycle to reduce the price risk exposure. This can be reduced, in our view, to even one-week, ala the Malaysian pricing system which is similar to that of Pakistan. The difference is that the Pakistan system is based on a time consuming calculation of actuals, while in most other places, there is an automatic formula. The regulator can announce a six-monthly charge of the three items; IFEM, OMC and Dealers Margin which adds up to under Rs10.00. Ex-refinery price can be announced on a weekly basis by Ogra. Taxation changes may be kept on a monthly cycle. Under such a system, an automatic price calculation system can be established without waiting for Ogra/ECC deliberations and approval.

A lot of criticism has been leveled on IFEM such as transparency and transport inefficiencies. Many demand that it should be eliminated. The main advantage or merit is uniform petroleum pricing throughout the country. For pure economists, location advantage should be reflected in costs and prices to boost optimal resource allocation. However, there are other issues of regional inequalities and poverty which argue in the opposite direction. To be acceptable, it can be considered a location tax; after all it is only Rs3.19 for gasoline and Rs1.46 for HSD. Under a deregulated system, however, such costs are subsumed in marketing costs and are not charged separately. Nevertheless, it is an implicit or explicit cost. In India, there is no IFEM; and there is a wide difference in regional prices. However, the difference is not only due to varying transport costs. In India GST is charged by provinces and the rates are different in every province/state. In Malaysia, there is a regional transport cost element.

Deregulation means no control on price. Sellers compete for market share and in the process minimize prices and maximize quality. However, it requires real competition and institutional system controls that restrict price conspiracy and collusion and other anti-competitive practices. Markets have not worked efficiently in Pakistan. One would be scared to leave the price of such an essential item free and subject to manipulation. However, an alternative would be to announce price ceilings under which efficient companies may be able to acquire market share under a competitive price-quality supply system.

A competition boosting option could be to allow independent dealers. There are three dealer systems; COCO (company owned-company operated), CODO (company owned-dealer operated) and DODO (dealers owned-dealers operated). In most countries, DODO is allowed as well. Pumps under DODO are independent and are not tied to a particular OMC, which often results in lower prices as competition is boosted, while in the other two systems, OMCs have a large handle on prices. And OMCs are not many, while dealers are in the thousands. In Germany, market share of independent DODO pumps is 15 percent and in Australia 30 percent.


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