Mr. Ankit Sigtia, Mr. Vineet Jain

MBA 1 st year

IIT Kanpur

The rising prices of crude oil have put Indian oil PSU's in an unenviable situation, turning them from money churners to money guzzlers. With international crude oil prices touching $70 per barrel and the government refusing to hike the oil prices significantly, the question staring at the face of our Navratna's is that how long can they sustain in this environment.

Recently, the government increased the prices of diesel and petrol by Rs 2/litre and Rs 3/litre respectively without any corresponding increase in the prices of kerosene and LPG. Before the price hike, petrol was being under-priced by Rs 7.45 per litre and diesel by Rs 5.15 per litre. Further, LPG was being sold at a loss of Rs 96 per cylinder and kerosene price was being discounted by Rs 12.85 a litre to the cost. A fter the recent hike in oil prices, the retail prices of petro fuel stands linked to a crude price of $47/barrel. However, the current price of a barrel of crude (Indian basket) is around $61, amounting to a gap of $14/ barrel. With our annual consumption estimated at 950 million barrels of crude, this leads to an estimated deficit of $13.3 billion (assuming the average gap between actual and assumed costs stays at $14/barrel) on the front of oil consumption alone.

The rising crude prices have now started taking their toll on the financial health of the oil companies. Having already lost upwards of Rs. 10,000 crores in the first half of this fiscal alone, the estimated annual losses of the oil companies are being pegged at Rs 40,000 crores for the current fiscal. If the current trend continues, then many of our oil PSU's can go bankrupt in the near future. As per some estimates with the continuation of the current trend (i.e. of under pricing of petro-products), IBP can go bankrupt in the coming months, with BPCL (13 months), HPCL (20 months) and IOC (35 months) following suit respectively.

Current oil crisis has hit the oil PSU's hard and they are finding it difficult to fund their project commitments and other activities through internal funding (which was the norm till last fiscal). Thus, oil PSU's have now been forced to resort to heavy short–term lending from banks to meet their financing requirements. In the first half of current fiscal alone , oil PSU's have raised Rs. 15000 crores from banks , which is approximately 15% of the total bank lending of Rs. 1,10,000 crores for the first half of this fiscal. In contrast to this, last year total share of oil PSU's in bank lending was 1.16% only.

In India , crude imports are more than 70% of our total oil consumption. Consequently, what ever changes occur in the international market are directly reflected on the input cost of our oil PSU's. However, even after the dismantling of the administered price mechanism (APM), the output cost is still effectively regulated by the union government. Thus, even in the current situation where the input costs are rising, the oil PSU's are being compelled to sustain losses (as they are unable to hike the output prices independently).

When we look at other Asian economies, the retail price movements for oil products have been in the favor of oil companies. For the period between, the December 2004-August 2005 period petrol and diesel prices in India have gone up only 7% and 8%, respectively. In the same period, Pakistani prices have risen 24% and 22%, respectively. In the case of diesel, the rise is much sharper in Thailand and Malaysia at 54% and 58%, respectively. For petrol, Thailand has jacked up prices by 37% and China 17%. Similarly in Philippines , diesel prices have risen 30%, while petrol has appreciated by 16%. In Malaysia too, diesel has shot up by 54% but petrol has gone up only 14%.

In subsidized products like kerosene and cooking gas too, Indian consumers had a fairly joyful ride than their SAARC counterparts. After adjusting the rupee exchange rate, each cylinder of cooking gas sells for Rs 333.65 in Islamabad , Rs 342.05 in Dhaka , Rs 388.16 in Colombo and Rs 563.64 in Kathmandu . In contrast the same cylinder sells for Rs. 294.75 in New Delhi (at a subsidy of approximately Rs. 100 per cylinder).

Thus, it can be seen that the oil companies have no other option than to raise the prices (to control the losses).But as mentioned earlier their hands are tied due to various political reasons. In this era of coalition politics, government always finds it difficult to increases the prices of petro-products. Doing so proves difficult in the wake of resistance government's faces from their coalition partners (given their penchant for populist policies).

This situation has lead oil companies to think out of box solutions to minimize their risks and losses. Many domestic oil companies, for instance, are exploring the options to participate in domestic MCX (multi commodity exchanges) crude futures market to hedge their price risks. Further, government is also trying to help the PSU's maintain their liquidity by issuing bonds (worth Rs. 11,000 crores) to oil companies to help them raise money and tackle their liquidity crunch.

On the part of government, it has three options left with it. Firstly, it can increase the prices of petro products to the levels desired by the oil companies and help them reduce their losses. Secondly, it can provide direct subsidies to PSU's to cover the indirect subsidies they are providing to the customers in the form of under pricing of products. Finally, it can reduce the various taxes, cesses (road cess on petrol and diesel) and duties (excise and customs) levied on petro products and then increase the prices. This will result in the net increase being on the lower side, while insuring the PSU's margins are maintained.

The increasing crude oil prices have posed a serious problem before the government, which if unattended can have disastrous consequences on the overall health of the economy. Thus, the ball is in government's court and its actions will have a significant bearing on the fate of these PSU's.