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FE-Indicus Policy Series - Government need not play monopoly PDF Print
Written by Payal Malik and Laveesh Bhandari   
Monday, 03 August 2009 09:12
The recently constituted Competition Commission of India (CCI) is expected to advocate competition in the Indian petroleum
 industry, one among many other industries that are public sector dominated. Ironically, most of the competition issues can be ascribed to government policies that do not allow competition to flourish. A recently completed research, “Government Policies and Impact on Competition for the Indian Petroleum industry” by Dr Ashok Desai reveals how these policies have a deleterious impact on competition in all the segments of the market. There are three segments in the industry: upstream (exploration and production), down stream (refining) and distribution. All the three segments are interlinked as competition in one segment has implications for competition in the other.

In 2007-08, India’s five largest companies were oil companies. Four out of five were government owned. The sales of the sixth—Essar Oil—were negligible. Reliance’s share of sales was 17%, but 60% of its output was exported. It does not require much analysis to conclude that the Indian oil industry is an oligopoly, and that it is dominated by government firms. The retail market for petrol and diesel is almost entirely a government monopoly. This monopoly also affects exploration and production as a number of companies that have struck oil or gas cannot find a domestic market because of the government’s monopoly of distribution. How can this situation be changed, and competition be introduced?

All hydrocarbon products are tradeable, although their transport costs vary greatly—the more valuable a refined product, the lower proportionally are transport costs. So the most expeditious way of introducing competition is freeing imports. There cannot be competition in refining unless crude is freely importable.

The next condition is tax parity of imports and domestic production. This means that whatever domestic taxes are levied should be applicable to imports. Import duties may be levied; but unless there is a reason to protect exploration and production beyond the size to which they would grow without protection, crude imports should be duty-free, so that there is maximum incentive to invest in refining. There will inevitably be taxation of refined products, since some of them are considered inputs into luxuries (e g, aviation fuel and petrol), and are in fact sources of prolific revenue. Duties on domestic production must be matched by equal import duties, so that there is no discrimination in favour of exports.

Typically, a refinery’s margin might be 10%, and crude might account for 80-90% of its costs. Since some refinery products are considered luxuries and others necessities, taxes on them will be different; and the average tax on refined product will be high. In the circumstances, the tax system can be simplified and competition in refining intensified by not taxing crude at all, and concentrating all taxation on refined products.

Next, we come to entry restrictions. It should be borne in mind that the attractiveness of exploration is closely dependent on the ease of entry in refining and distribution. It is difficult to conceive of completely free entry into exploration because it involves access to land and governments have a role in allocation. So some form of exploration licensing is unavoidable. The high proportion of concessions granted to ONGC would suggest otherwise, but there is no overt discrimination against foreign companies or exclusion of any companies other than on such self-evident criteria. However, the government’s insistence that discovered oil and gas must be used in India—its implicit export ban—reduces the potential value of finds and probably leads to fewer bids and lower revenue for the government; now that the balance of payments is no longer a policy problem, this domestic use requirement is outdated.

Another area of concern is the inconsistency in government policies as in many instances the government did not stick to contractual agreement and its regulatory framework remained uncertain. For instance, Directorate General of Hydrocarbons’ renegotiation of conditions embodied in the model production sharing contracts issued at the time of announcement of earlier rounds after bidders had invested money and found oil or gas.

Refining and distribution segments cry out more for reforms. In 2002, the government abolished the Administered Price Mechanism (APM) and also the Oil Coordination Committee, which administered the price controls. However, even after dismantling the APM, government continues to regulate prices of petroleum products.

Government gives subsidies but at the time when international crude prices were soaring it did not increase subsidies. All the state-owned companies were selling petrol, diesel, kerosene and cooking gas below the cost.

Government’s discriminatory policy of subsidising petrol and diesel sold out of its companies’ pumps, but not subsidising private competitors put private players at a disadvantage. Therefore, private players like Reliance and Essar could not find retail sales profitable. This lack of a level playing field between private and public players has caused the former to withdraw from the retail market, leaving the entire retail market to public players.

Second, when allowing private entry, the government has insisted that new entrants must set up a minimum proportion of pumps in ‘backward’ or ‘rural’ areas. Ideally, there should be no such condition; if the government wants more petrol pumps in certain areas, it must give them subsidies until they reach a certain minimum turnover. The government has a service tax; it can be applied to petrol pumps, and a cut-off point may be set below which there would be no tax.

It is possible to introduce competition in distribution alone, without any changes in refining. The first condition for this would be to abolish licensing of pumps. Licensing creates rampant corruption, which reaches right up to the minister. Second, there should be free imports of products. There should be no canalisation of product imports, and no quantitative restrictions.

The oil production and distribution chain requires large capital investments with long gestation lags. If the government is serious about competition, it must accept and announce self-restraint on its freedom to make and change policies.

Finally, transportation affects competition in an important way. For all hydrocarbons, pipelines are the cheapest medium of transport. Currently, all pipelines in India are owned by gas or oil companies, thus insulating them from competition. If all the pipelines were common carriers and carried oil, gas or products for all customers without discrimination at pre-announced prices, then refineries and gas-based plants would spread out more evenly across the country, and there would be greater competition amongst them. The best solution now would be to nationalise all existing pipelines and give them to a new company to run as a public utility on a cost-plus basis.

The conclusions we have reached have implications for the CCI. It is for the Competition Commission to decide at what level to frame its interventions. Quite a few of government obstructions to competition that are found in the oil industry are present in other industries as well; the Competition Commission would have to take a view on whether to take an industry-specific approach or to take up more general issues of policy.

—The author is director, Indicus Analytics. This article is coauthored with Payal Malik, advisor, Indicus Analytics