Underpricing Energy

India has always been heavily concerned about energy prices.

Rightfully so, having the necessity to import 70% of oil and gas requirements is not a good thing. We don’t have much of oil and gas assets in the country, at least not in the traditional formats.

But, what is not good for the country is the underpricing of the imported oil and gas to suit the domestic market – in effect subsidizing the energy for the benefit of the consumers and the oil importing companies.

Is this the right strategy ?

Let us think for a moment. Consumers have to reduce their demand if they cannot afford a certain thing – that is the most logical thing to do. If oil prices climb to astronomical levels, what did the consumers in the Western countries do – they reduced their operating budgets by using other forms of transport or shared transport. Consumers in India cannot expect the government to subsidize their heavy spending ways by asking for petrol at reduced prices – prices which are much cheaper than the imported prices. We have to reduce the consumption of any item when that item becomes unaffordable. If we are a big consumer of that item, then the message goes to the global markets that India would refuse to import the same level of oil if the prices climb unreasonably high. Government should not subsidize oil prices so that the end consumers benefit – that is not economically viable. Ultimately who is going to fund the government’s deficit budget ?

Simultaneously, India should have explored alternate forms of energy like what the U.S. so successfully did in less than a decade – by exploring for shale gas and reducing its dependence on oil imports from the Middle East. India has identified many deposits of shale gas, but it should have moved faster to exploit the same with private participation. Such an aggressive move, with tough timelines, would have benefited the country and reduced our gas imports at least.

The government has no will power to cut the subsidies as that would directly hit its ability to win elections. But again this is a flawed assumption. Let the parties who oppose the oil price hike come and balance the government’s budget. How will they run the government if they are elected ?

The Reserve Bank of India is doing the right thing by refusing to cut interest rates, not yielding to the pressures from the government. Inflation has to be brought down to somewhere below 5% at the CPI level – we are still far away from it. Yes, inflation will go up if oil prices are raised, but that would be for some time, not for ever. Once the demand moderates, inflation will eventually come down.

There is no magic formula – we cannot expect to have 8% GDP growth, less than 5% inflation, and less than 5% government budget deficit and low interest rates of less than 8% (in the Indian context, I mean). Consumer suffering is to be expected in the medium term, but would moderate as the growth picks up with lower interest rates eventually. Difficult pill, but the answer is not in continuing the heavy subsidies and falling seriously short of the budget deficit targets.

Let us not underprice energy, one of the most precious items in all out budgets. We have to pay the price.


Vijay Srinivasan
19th August 2012


2 thoughts on “Underpricing Energy

  1. Oil prices are up more than $8 per barrel this month. Releasing crude from the Strategic Petroleum Reserve would boost the supply of oil, which would drive prices lower. Oil was previously released due to conflict in Libya and after Hurricane Katrina.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s