The Indian Economy Blog

May 8, 2007

The Oil Distribution Conundrum

Filed under: Energy — Karthik @ 9:03 am

During a guest lecture at IIM Bangalore a couple of years back, Arun Shourie had asked a rhetorical question as to why oil distribution should be termed “strategic” and hence the oil PSUs should be tightly in control of the government. He didn’t pause to answer it, for maybe he knew that a majority already had the answer. Maybe all of us who had seen Mani Ratnam’s Yuva did.

For those who haven’t seen the movie, or don’t recall, the “reward” that Abhishek Bachchan’s character is given for mobilizing crowds for a rally is a gas dealership. In other words, for doing something for his political masters, Abhishek gets exclusive rights to distribute domestic LPG cylinders in a particular area. Quite a reward, I say!

What this has meant, in effect, is that practically the entire distribution network of petroleum products in India has been “allotted”, and not “won” by bidding. This, coupled with the tight control the government exercises over the sector, has resulted in a number of issues.

One of the obvious ones is the pricing anomaly. The retail price of petroleum products is decided by the union cabinet, no less. I’m sure those people could use their expertise in something else, and that there are people who are better qualified to do this job.

The next is that there is no incentive to perform. Demand in this sector is steady, and growing, and the distributor need not worry about volumes. Also, the customers are small (in terms of volume) and many, which implies that the “bargaining power of the buyers” is quite low. An ideal situation for the distributor to under-perform, and there is no way to bring him to book. The odd attempt to do that has usually ended up with negative consequences, as can be seen from the Manjunath Shanmugham murder case in UP last year.

Then there are huge pricing inefficiencies (from the point of view of the oil firm). If the distributors had been through the bidding process, the oil firms could have tried variable distributor margins based on location of petrol bunk. For example, a petrol pump at M G Road in Bangalore gets far more volumes than say one in Ladakh, and hence the former can be sold for a much smaller distribution margin than the latter (as you might have understood by now, bidding would be on distribution margins), thus enabling the oil firm in raking in some extra money. However, the allotment process means all need to be given similar margins; and the M G Road guy makes supernormal profits.

So on one hand you don’t need to ensure quality and on the other being in the right place means you make supernormal profits. Super!

Coming to the bidding process itself, we can loosely say that with a few exceptions (such as war victims), I could argue that dealerships are actually going through a competitive bidding process! The bids are not in terms of margins, but rather in terms of a “down payment” – which need not necessarily be in cash. The saddest part here is that absolutely no part of this bid amount actually reaches the oil firm. Of course, nothing official about it.

There is also a larger issue involved here – one of anti-competitive practices. It is not hard to see that the current government-controlled pricing is anything but competitive, and will not stand the scrutiny of the Competition Commission, once it is fully functional. I begin to wonder whether this could be one of the primary reasons for the inordinate delay shown by successive government in notifying the Competition act of 2002 in its entirety! Knowing the current government, it might be hard to disregard this reason.

There are many more problems with the current setup. While on the topic of competition, private players in oil distribution are being kept out, or being allowed to run under huge losses. Then, the centrally planned allotment process means that the location of petrol bunks is suboptimal. The process has led to cartelization of distributors, and frequent strikes. There is also a petrol mafia – again a result of this setup. The list goes on.

I’m not advocating that the government should completely get out of the sector. Oil distribution is a “utility” and it perhaps makes sense for one government player to be in the market, so as to serve those areas which might not really be commercially viable. Perhaps an access deficit charge (on the lines of the telecom sector) could be levied in the “profitable” areas. And since all oil majors are public companies, won’t face the same problem that we see in telecom – where we don’t know what BSNL is doing with all the ADC it collects.

However, looking ahead, the picture still doesn’t look rosy. Ok, the competition commission will come into force and the government will have to let go of the control of two of the three oil distribution majors. That still doesn’t mean all will be fine. The existing dealerships will continue to exist. The inefficiencies in pricing and quality will continue. The mafia will continue.

Is there a way out of all this? Is there a way we can break the shackles? Is there a way in which we can reform oil distribution to make it more efficient? For the oil firm, the distributor, for the customer. If you have any ideas, please let me know.

3 Comments »

  1. I don’t think oil distribution can be taken in isolation and made more efficient. The entire oil and gas sector, virtually ruled by PSUs, needs reforms. All the oil PSUs share a complex relationship. The upstream companies pay the deficit of the marketing companies. (eg ONGC sells crude to IOC,HPCL,BPCL at $45 or so irrespective of the price in international market.) The marketing companies are not allowed to charge “market” rates. Etc. etc.

    Will Govt bite the bullet? Call me pessimistic, but I don’t see anything happening on this front. There is a simple reason for that. All the oil firms together post sales of close to $100 billion, contribute huge amount of money in terms of taxes, and the Petroleum Minister is bossing around these entities. The power Govt yields is intoxicating. They won’t let it slip away from their hands.

    Comment by Shashikant — May 8, 2007 @ 11:17 am

  2. The ratio of allotted dealershps vz politcal leaders/non politicals, the main culprit in all incorrect policy makings becomes sucessful. Example, the price dfferential in Desel and kerosene is an incentive for adultration -resulting huge but illegal money collecton spoilng the whole system i.e. mother of culprit. If for any reasons includng politcs keepng kero PDS prices low is mandatory; HSD price must be put at par with it and for purpose to raise revenues from transport sector other things like tyres engines roadtaxes and insurance costs can be placed on hgher taxed avenues.

    Comment by surajbhan — May 9, 2007 @ 5:56 am

  3. Govt’s and PSUs/OMC expenses on quality controls is too high; recently a contract to M/s. SGS pvt ltd (A swiss co -a so-called “marker” supliers and exploring the marker at petroleum dealership saleable products; and for this purpose, extreme huge powers have been delegated by the Govt to OMC’s officers ( they do not require to prove any suspected offence before any Law courts for penal actions) to penalze the dealers by themselves – a Consttutional breach -is again is causing sharing of illegal profits, making adultratons an incentives, and ultimate a second culprt. Hands in gloves ?

    Comment by surajbhan — May 9, 2007 @ 6:20 am

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