Petroleum Pricing Mechanism

PETROLEUM PRICING MECHANISM

OBJECTIVE OF PRICING

The main objectives for the pricing of a mass commodity like petroleum are extremely crucial in Indian context as it is very much related with the following variants.

1. Economic efficiency
2. Social equity
3. Financial viability

It relates to the welfare & income distribution considerations and it would ensure continuity & quality of service & help to achieve future investment requirements.

FUNDAMENTALS

If there are no trading constraints in the International markets, the efficient price for fully traded goods should be International or border price (import or export parity)

This fundamental rule applies to all traded goods; petroleum products included, thus Import parity pricing (IPP) is applicable if the country is a net importer of the products and Export parity (EPP) for countries which are net exporters.

But India being a special democracy where a huge population has consistently lived below the poverty line, the government assistance or the social costing for a mass commodity like the petroleum products is invariable.  

FLASH BACK: THE EVOLUTION

The Pricing before reforms has been a knee-jerk approach.

• Regulation of oil prices was first attempted in India when the Valued Stock Account (VSA) procedure was agreed between the Government & Burmah Shell in 1948

• In the 1960’s, various committees namely the Damle Committee, 1961, Talukdar Committee, 1965 and the Shantilal Shah Committee, 1969 were appointed by the Government to recommend the pricing modalities for petroleum products in India.

• These committees recommended prices to be determined on principles of import parity
• Ceiling selling prices were recommended for various petroleum products

• Subsequently, in 1974, the Government appointed an Oil Prices Committee (OPC) headed by K. S. Krishnaswamy

• This committee recommended discontinuation of the import parity basis  
• It made a case for “cost plus basis” which came to be commonly known as the Administered Pricing Mechanism (APM)

• The regime recommended by OPC was amended by Oil Cost Review Committee (OCRC), 1984 headed by J. S. Iyer

• Compensating return was amended from a flat rate on the capital employed to 12% post tax return on net-worth & weighted cost of borrowings

APM methodology was definitely not the best one adopted by the government as it was denting the profits and was triggering the adulteration of petroleum products as well. So, dismantling of APM was a rather obvious consequence, but the question was, which the best alternative was?

• Post APM

The Oil companies, powerful as they were, made the government adopts import parity pricing. The import parity was adopted so as to give our domestic industry some kind of protection

• The Era of Import Parity Pricing

Industry post 2002 entered another era of complete deregulation with a shift to market determined pricing mechanism