135) Bubble in Oil

Oil was at $26 a barrel when the US vowed to go into Iraq and secure oil supplies. It is now trading at over $130 a barrel. And while the price of oil is soaring, the Indian government continues to fool around with what the price of oil should be to the end consumers. What is formula How much of the "oil subsidy burden" must be shared between the government, the oil producing companies, the oil refinery companies, and the oil marketing companies. And they change the formula when they want - for any reason.

The petroleum ministry has been pushing for a combination of duty cuts and price hike (Rs 10 per litre in petrol, Rs 5 a litre in diesel and Rs 50 per LPG cylinder) to bail out PSUs IOC, HPCL and BPCL that are on the verge of running out of cash in the next 2-3 months to import crude. At inflation rising over 7.5%, the price hike will definitely give it a push.

Reason for the rise in Global Oil Price
The price of oil is rising due to a combination of rise in demand from Developing countries, a weakening dollar, the reduction in supply from the Persian Gulf nations and the unprecedented spurt in crude price is speculation. The speculated oil bubble will burst if the US & UK goes into recession, thus the demand for oil will fall making oil cheaper in the international market. In this case, hedge funds & the companies which are bullish about the future oil price will incur huge losses.

Oil Pricing in India

If we go by the 2002 and 2008 prices changes, the application of the price relative for crude would imply a present Indian retail price of Rs 175, which is way above the current Rs 50.51.

The Committee on Pricing and Taxation of Petroleum Products under the Chairmanship of Dr C. Rangarajan, submitted its report to the Government.

The following principles were adopted by the Committee:

Pricing and taxation of petroleum products should be rationalised to transmit the right price signals so as to minimise, if not eliminate, distortions and inefficiencies that result in misallocation of resources;

Prices of petroleum products should, as far as possible, be aligned with international prices;

Across-the -board subsidies result in inefficiencies and place an undue burden on an already strained fiscal situation;

Subsidies should be minimal, targeted and restrained by a monetary ceiling;

To the extent the Government decides to extend subsidies, the burden should be borne entirely and transparently in the Budget;

Oil marketing companies should be freed from the burden of subsidy;

Customs tariff on crude and products should be rationalised so as to moderate the effective rate of protection to a level that will offset the disadvantages suffered by the domestic producers without, at the same time, allowing them any undue cushion.

Excise tariffs should be restructured to protect the consumers from excessive volatility in prices.

Beginning of the Burst
As oil prices continue their seemingly endless trek skyward, the whispers about peak oil have turned into a roar. Peak oil is the hypothetical date when the combined daily output of global oil producers has reached its maximum and then begins to decline. Essentially, this is the point where supply starts to move downward, while demand continues to climb. You don't need to be an economics major to figure out what the effect on prices will be.

Sasmit Kumar Sahu