India boldly scraps oil subsidies

India boldly scraps oil subsidies

By Simon Cameron-Moore

BOMBAY (Reuter): India's opposition parties will be silently thanking Prime Minister Inder Kumar Gujral for chopping back an oil price subsidy regime the country could increasingly ill afford, analysts said on Tuesday.

The United Front minority coalition government had kept putting off a desperately needed oil price hike while the opposition crowed over its hesitancy -- until Monday.

The decision to remove diesel from the subsidy scheme, involving a price increase of more than 20 percent for India's main fuel, and take out liquefied petroleum gas in two years time, was bolder than most analysts had expected.

Diesel consumption, at 35 million tons annually, accounts for around 45 percent of the country's total current petroleum consumption.

"They have done very well with diesel prices and the plan to dismantle the administered pricing mechanism (APM) within two years," said R.K. Pachouri, head of the independent Tata Energy Research Institute.

The main opposition Hindu nationalist Bharatiya Janata Party (BJP) and Congress party know putting up prices is no way to get re-elected, especially in a country used to consumer subsidies.

"Whether it is the BJP or Congress, they'll be making token noises (criticizing the price increase), but inwardly they will be relieved," said Subra Subramaniam, director at H.G. Asia. India is fast becoming one of the world's heaviest oil consumers as it fuels an economy growing at seven percent a year.

Consumption, put at 77 million tons in 1996/97, is expected to increase almost 50 percent in the next five years and by 90 percent over 10 years.

Caught by a surge in world oil prices last year, the United Front delayed putting up domestic prices and endured the resulting headache for almost all of its 15-month tenure.

It ended up with a $5 billion bill to oil companies, waiting to be repaid for selling their products below market prices.

The government has wiped out this "oil pool deficit" by issuing bonds to the companies, and put up prices enough to ensure that next fiscal year the incremental deficit will disappear.

The bonds will be unsellable for five to seven years, but can be used by the companies as collateral to raise loans needed for the heavy capital investment they need to make to keep pace with growing market needs.

"If you look at the companies' balance sheets they have a debt/equity ratio of less than 15 percent, so they have sufficient room to keep on borrowing even if the bonds have not solved their cash flow problems," commented Sanjeev Prasad, oil analyst at Kotak Securities, the Indian affiliate of U.S. investment house Goldman Sachs.

"There is no problem in terms of financing capital expenditure," he said.

Most of that investment will be concentrated on the refining side. Official projections show India expects to import just 11 million tons of refined products a year by the end of 2001, compared to current levels of 24 million.

The crude import requirement is a wildly different story, with imports set to grow from 31 million tons to 72 million.

The growing market and deregulation of the sector means oil firms will see cash tills ring loudly in the coming years.

What the refiners need next is for the government to rationalize to widen the differential between crude oil and refined product import duties. Crude duties are currently just five percent less than the main products, and to create adequate margins a gap of 10 to 15 percent was needed, analysts said.

Analysts expect the integrated oil companies like Indian Oil Corp, Bharat Petroleum Corp Ltd and Hindustan Petroleum Corp Ltd to clock 100 percent increases in profits in a deregulated market.

And exclusively refining companies like Cochin Refineries and Madras Refineries stand to see profits shoot up by 150 to 200 percent once deregulation finally happens.

Politics allowing, that day could come in around three years. The bureaucrats have plotted the industry's soft landing into a free market world, the oil companies want it, and it is just down to the politicians to follow through on reforms.

Central government revenues from the oil sector amounted to 168 billion rupees in the 1996/97 fiscal year, around nine percent of total receipts.

That dependence on oil for revenue streams may slow any decision to rationalize import duties, although some analysts hope Finance Minister P. Chidambaram will take the plunge in next year's budget.