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Deregulation:A losing proposition for Public Oil Marketing Companies - Views on News from Equitymaster
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  • Mar 2, 2011

    Deregulation:A losing proposition for Public Oil Marketing Companies

    With a plethora of issues weighing heavy, one that can be the biggest threat to Indian economic growth story is mounting fiscal deficit. A high share of blame for this deficit goes to fuel subsidies. While the Government freed petrol prices last June, a similar move for diesel is still waiting for the 'right' time and conditions. We believe that it will be a little long before it sees the light of the day (at least till state elections get over and inflation rate normalizes).

    So far, the Government had a 'reason' for maintaining inertia as its income from the sector exceeded the subsidies that it grants by decent margins.

    However, it has put itself in a very tight spot with tough fiscal deficit targets set in the current budget. While Budget is a place to announce ambitious targets and overstretch them later, any serious intention to implement these under a rising crude price scenario will need fuel prices to be freed. The move will help country's finances, but will it serve Public oil marketing companies (OMCs) better than earlier system of payment via cash subsidies? We have our doubts. And it seems Public OMCs share them too. While they are lobbying hard for cut in duties and for full payment for losses under current pricing system, their efforts for price decontrol seem muted.

    The reasons will be clear if we dig deeper into logic. A complete deregulation of fuels will bring Private sector back into action. This will imply loss of market share and pressure on margins due to price wars. In the short term, the infrastructure of private sector will surpass that of public OMCs. Also, the private sector has a natural tendency to work at lower costs and offer better service standards versus the relaxed standards of public sector. While freeing diesel prices will attract a lot of foreign investment, it will be mainly skewed in favour of Private players. The Private sector has mostly outperformed Public sector in terms of technology and performance in the past as well. The success story of liberalization holds a testimony to that. No points for guessing that the biggest losers will be Public sector OMCs .

    To conclude, we believe that between full compensation of under recoveries and deregulation of diesel prices, it is the former which makes perfect business sense for Public OMCs. After all, they have managed pretty well so far this way. This is evident from the ample cash reserves in their balance sheets and rich dividends they offer every year. With this system, they have smoothly carried out ambitious capex plans as a result of which the country faces refining over capacity (ironically along with a crude supply shortage). Hence, the real gain in freeing prices lies not for Public OMCs, but for the Government to improve their fiscal balances. It is sad that the charm to remain in power takes over economic logic and the mess in the oil economy and country's fiscal balance continue.



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