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Energy Sources: Deregulation dilemma - Views on News from Equitymaster
 
 
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  • May 25, 2002

    Energy Sources: Deregulation dilemma

    Those invested in energy stocks at the start of the year must be smiling all the way to the bank. Oil stocks on an average have gained 95% during this period. The rise in stock prices -- result of a spurt in market sentiment towards the sector -- was triggered by industry deregulation and Government disinvestments.

    The United Front government with Mr. Chidambaram as Finance Minister (FM) laid down the schedule for phased oil sector deregulation in September '97. The plan envisaged complete deregulation and price dismantling by April '02. Prices of transportation fuels viz. diesel and petrol were to be de-controlled by moving to a market determined pricing mechanism. On the other hand, subsidy on domestic fuels viz. kerosene and liquefied petroleum gas (LPG) was to be brought down to 33% and 15% of market prices respectively.

    Further, marketing of transportation fuels, which till FY02 was the sole franchise of four public sector companies, was to be liberalized permitting private sector participation. Indigenously produced crude oil prices were to be progressively linked to import parity rates over a four year period between FY99 and FY02. However, volatility in oil markets led to the Government introducing floor and ceiling prices for the natural resource during this period. Post FY02, with subsidy on certain fuels continuing, the plan was silent on crude oil prices. This could be to offer some elbowroom to the Government in the deregulated environment.

    That said, with volatility in oil markets over the past twenty-four months and a large deficit in the oil pool account, not many expected the Government to adhere to the original schedule. Despite the schedule for all to see and the FM re-iterating the Government's resolve to adhere to the schedule in the budget before last, oil stocks continued to remain depressed till the early part of 2002. In budget '03, the finance minister announced last phase of APM dismantling. Also, what not many expected was the linkage of indigenously produced crude oil prices to international rates, which led to the sharp spurt in Oil & Natural Gas Corporation (ONGC) stock price.

    While these developments augur well for the industry; the Government, and rightly so, is concerned about ensuring a smooth transition to market determined pricing mechanism. An estimated 65% of petroleum consumption is by the retail sector. Also, with applications across all industries, higher prices could reflect in cost-push inflation. Consequently, pricing is going to be a sensitive issue -- add to that a political one. Several sections are expressing discontentment, as marketing companies still do not enjoy freedom to determine petroleum prices.

    Since the beginning of the 2002, oil prices have put on 30% with much of the increase in the first quarter itself. Also, with revival in global economic activity, international petroleum prices have firmed up. However, contrary to the new pricing mechanism, domestic petroleum prices (4 controlled products) have not been adjusted. The oil budget is reported to have been based on crude oil prices of $20/ barrel. Failure to adjust prices has led to marketing companies incurring losses. At the same time, with dismantling of the APM, marketing companies may not be compensated on retention pricing mechanism.

    Although the ONGC stock has rocketed, there is lack of clarity on pricing of crude oil by public sector companies. ONGC is reportedly in negotiations to hike prices to $22/ barrel from the current ceiling of $16/ barrel. But even this increase is below current international crude oil prices of $26/ barrel. The higher stock price could indicate that markets believe the Government will eventually decontrol crude oil prices. If decontrol in upstream holds true there is no reason to believe that decontrol of transportation fuels will not go through.

    We believe loosening of shackles on the industry and eventual decontrol is likely to be related to the establishment of an industry regulator to ensure fair and equitable pricing across the country and improvement in the country's oil economy, which is linked to crude oil prices. The regulatory bill has been introduced in parliament and is likely to be passed in the Monsoon session.

     

     

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