Sunday, June 27, 2010

Oil Price De-regulation: Is it really de-regulated?

The government finally bit the bullet on Friday and not only hiked LPG, Kerosene, Petrol and Diesel prices but also deregulated Petrol prices. Leaving the jargon aside what does this mean to the common man and is it the big deal which is being made about? I do not think so and here is why?

1. The Petrol prices are deregulated means they will move in line with the International Crude prices. If crude goes to 100 dollars then our prices will move up. Now, what is the mechanism to do this? It is not very clear yet but the prices will be fixed once a fortnight. Each Oil Marketing company like Indian Oil, HPCL and BPCL is free to sell petrol at whatever prices they deem fit. This may mean one may get some small discount offers too. The Private retailers like Essar Oil and RIL can open their closed pumps too. Essar has announced that they would do so but RIL has very cautiously not made any comments.
2. The government saves a subsidy burden of Rs 24000 crores at current prices out of a total subsidy burden of 77000 crores. Now what is this subsidy? The subsidy means the government ensures that petrol was being sold at Rs 3.72 less than what it actually cost to import and sell. They were making good the losses suffered by the OMCs. There in lies the catch. Have a look at the below article from Hindu Business line. I was searching for updated material on this for quite sometime. For every 1 rupee the consumer pays oil, 45 paisa goes to the State and Central government as taxes. Now a tax of about almost 81 percent is way too high.

3. So where is the subsidy? First you charge abnormal high taxes and then pay back the consumer a fraction of the amount. Like Petrol which was retailing at Rs 52 in Mumbai, about Rs 24 were taxes out of which government was paying you back Rs 3.72.

4. The government has not made it very clear what will happen if crude goes to 100-125 dollars a barrel? Also Diesel has been left out of deregulation for the time being. There are elections in Kerala, Tamil Nadu, W Bengal in May 2011. These 3 States account for about 100 Members of Parliament. The window for reforms will end in October-December time frame.

5. Now, Diesel there is a subsidy. What about Diesel cars whose market share is about 15 pc of the total car segment. Why should they get a subsidy? One way of targeting this is higher taxes when a brand new Diesel Car is sold making it less lucrative to opt for a Diesel car.

6. The positive side is that Oil marketing Companies losses will decrease, and the Retail Fuel segment would be much more competitive. Immediate downside is increase in the Inflation. The Rate Hike is almost a forgone conclusion. I expect a minimum 50 basis points hike i Repo and Reverse Repo Rates. The CRR may not be hiked immediately as the 3G Auctions and Advance Tax payments have taken out the liquidity from the markets.
7. After the price hike announced on Friday, the Banks were weak factoring in a Rate Hike. Fiis sold on Friday after a long time and so did the DIIs.

The Monsoons are here and are already priced in the markets on the positive side. The markets appear to be in a Range waiting for the next set of cues from the Global Markets. Inflation is in Double digits and that would put the brakes on the market for the time being. I would be long only after 5366-5400, the previous tops are taken out.

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