October 6, 2005

The hike in oil prices announced last week means that compared to January 2005, the price of petrol is almost 39 per cent higher, while that of diesel (a key input in business and commerce because of its impact on transport costs) is 42 per cent higher.

Even for CNG users, the price hike is bad news because it will fuel demand and eventually increase CNG prices as well. A recent report says that the price of a CNG kit (required to convert a car’s engine so that it can use CNG as fuel) has risen from between Rs 27-29,000 to over Rs 40,000.

Considerable criticism has already begun to come in and more will probably come as the days go on. The government will probably defend the price hike citing the high prices in the world market. The oil marketing companies (OMCs), of course, will do the same, since they after all, along with the refining companies, control the oil companies advisory committee (OCAC) which calculates and sets prices every 15 days. However, the point is not that the price should not be increased but questions need to be asked regarding the degree of the increase –– and hence reference to the way the price is set.

Of late, the whole mechanism of oil prices being set by the OCAC has come under increasing scrutiny and criticism. Some members of the Senate have also raised it on the floor of the upper house, and a couple of weeks ago a report by a news agency quoted Prime Minister Shaukat Aziz as expressing concern over the OCAC’s pricing and its composition and representation.

This all raises many questions, especially since the issue is of the paramount public interest and because oil prices affect just about everyone in the country. In fact, the government should be concerned as well since unchecked they could fuel inflation beyond its current nine to ten per cent levels and that could have a serious impact on the country’s economic growth.

For now, though, the finance ministry must have hedged its bets believing that the economy is currently sound enough to absorb such increases in the oil prices. Hopefully, it will be clear to the prime minister and his advisor, Dr Salman Shah, that the ordinary Pakistani is not (financially sound, that is, to withstand these increases).

Firstly, why did the government hand over the pricing of oil and petroleum products to the very companies that market oil? Was this to done to avoid public criticism, when prices would be raised? This violates a very basic principle of economics, something that surely those sitting in the finance ministry would have been aware of — that given a chance a company or companies will set prices in a manner that maximize their revenue and consequently their profits. The OCAC may wish to clarify this but the public perception (and this is something that Aziz wanted to look into as well, according to the agency report) is that the committee has no government representation and no independent economic expert sits on it.

Secondly, it has been alleged in some reports that the OCAC uses US crude as its benchmark for making any price calculation. If that is the case, then it needs to be explained since Pakistan mostly imports its oil from the Gulf and the Middle East. In fact, the biggest oil company in Pakistan, gets its supplies from Kuwait Petroleum whose prices are relatively cheaper than that of US crude. Should not the OCAC use a different benchmark for its pricing calculations?

Thirdly, why is the government’s regulatory duty, levied since June 2002 at the rate of 11 per cent on import of diesel and six per cent on other products, being charged on non-imported oil products as well?

Fourthly, what are the reasons for the profit margins per litre of the OMCs rising by 380 per cent between 1999-2005 and for retailers by almost 740 per cent over the same period? The earnings per share of some refineries (according to publicly available data) have increased over seven times the past five or six years and profits of all OMCs have risen sharply as well, but is that only because of the high price of oil in the world market or also partly a result of the OCAC’s ‘innovative’ pricing formula?

And fifthly, why is the government regulator for the oil and gas sector, the Oil and Gas Development Authority, kept out of the pricing system? Given its mandate, isn’t it only logical that the regulator be given a key role in the determination of petrol prices?

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