Some fuel for sense

A hike in the price of petrol, diesel, kerosene and LPG has been on the cards for some time now. Global oil prices have been rising, but oi...

A hike in the price of petrol, diesel, kerosene and LPG has been on the cards for some time now. Global oil prices have been rising, but oil product prices in India have remained unchanged for some time. The question is how long should the Indian consumer continue to be protected from the rise in world oil prices? Low inflation is a desirable objective, but is it desirable to achieve low inflation by artificially keeping the price of oil products low? As world oil prices rise, and show no particular signs of returning back to the old levels, the consumption of oil needs to adjust itself to higher prices. If not the government will end up bearing the subsidy bill, whether by itself or by imposing it on the oil companies, even while encouraging the consumption of oil.

In the short run, the price elasticity of oil, the amount by which consumption of oil changes when its price changes, is low. Given the technology in use, consumers can reduce the consumption of oil by making some behavioural changes such as travelling by public transport or car pooling. However, the long run price elasticity of oil has been observed to be high. A higher price of oil creates incentives for adoption and development of technology which is not intensive in its use of oil. Either the use of alternative sources of energy becomes more profitable, or companies invest in fuel efficient technologies. This has been seen in the automobile industry in which significant research went into the development of small, fuel efficient cars.

While it may sound attractive to keep oil prices low today and curb inflation or to look for cheap sources of oil, in the longer term interest of the economy there is a case to be made for letting the domestic price of oil move up or down with international prices. It will help producers, consumers as well as the government to rethink and plan energy use. Not only can the government not afford to keep oil prices low for long, if international prices continue on their way up, it is not good policy. Consumers may complain for a while but, as seen in the past, over time they adjust. Since the rich are the biggest consumers of fuel, a subsidy on oil also leads to a disproportionately large subsidy for them. As in the case of power and provident fund interest rates, in this case too there is no reason to subsidise the consumption of the rich.