Fearful asymmetry

The government has little credibility when it comes to oil prices

It is considered possible that the government is on the verge of lifting its control and moving towards a market price mechanism for petroleum products. Officials and politicians associated with the relevant ministry have also murmured such possibilities. This is not unbelievable: after all,it isnt the first time such a decision has been made. The previous government did lift such controls in April 2002,only for the current regime to re-impose them in 2004. Broadly speaking,when such decisions are being evaluated,there are two aspects to consider: the first is intent and the second is consequence. What is the intent,here,of the government in turning over petroleum products pricing to the market,and what are the likely consequences?

Administrative controls were re-imposed in 2004 when the prices of crude oil had risen steadily and reached 37 a barrel,which were then considered stratospheric levels. The newly-elected government of that time lost its spine and deferred passing on the price increase to the citizenry. Re-imposition of controls implied that folks did not need to pay uncomfortably high market rates. Between 2004 and today,crude shot up to 147 a barrel July 11,2008,retail prices of petroleum related products were increased 2006,decreased 2007,increased 2008 and then decreased 2008 again. Fast-forward to January 2009,and we are on the cusp of a general election while crude prices are hovering at about 40 a barrel. Electoral logic implies that the government should shell out largesse to the citizenry and ride partly on that to victory at the polls. This can be achieved by reverting to a free-market pricing system in order to take advantage of current low market rates of crude oil. It all seems to be a tailor-made situation. Except,like all tailor-made situations,there is a catch: can one fool all the people,all the time or at least,how many times? Does the government honestly intend to follow market prices? Are they willing to make the citizenry pay market rates should crude oil shoot up again? Are they willing to subject the economy to the extreme volatility in energy prices that we have been witnessing and are going to witness?

If the honest answer is that the government is going to stick by market rates,no matter what,at least in the range of prices we have seen in the last six months,namely,high 30s to high 140s,then such a move is to be lauded. This will go a long way in educating the citizenry at large and policy-makers in particular that we have entered a new era of energy prices one of high-amplitude volatility. They will incorporate that into their decision-making frameworks and they will make themselves and thereby through the invisible hand,our economy,less vulnerable to fluctuations in energy prices. This will lead to a more robust economy.

However,if at the back of their minds,the government know that there is no way in heaven that they can continue with market-determined retail prices of petrol,diesel,kerosene and LPG should crude oil for whatever reason touch 147,they are treading on thin ice. Credibility of the government,which isnt very high in any case,will be further lost. Markets are unforgiving: they dont care for the elation or suffering of constituents. They dont have emotion,are impartial and indifferent in the delivery of pain. The vulnerable will suffer more because they have less manoeuvrability.

Thus interference with markets,if present,needs to be symmetric and not asymmetric. Moving to market rates of petrol when prices are low and abandoning the market when prices are high scorns the market; and a scorned market is vicious and dangerous,as the housing bust and global economic crisis it caused in its aftermath will testify. Similar asymmetric intervention after the post dot-com bust made Greenspan spawn a below-market-rate-of-interest in the US in particular and the world in general. That single step left a trail of exuberantly priced realty,which came crashing back to realistic levels when the markets reached their limit of tolerance of the increasing inconsistencies. Falling realty prices led to failing bonds and ignited the current crisis.

Let us be realistic here: the IEA has said that major oil fields are in decline,leading to supply constraints in the future. Crude oil price oscillations are therefore here to stay. Exposing citizens to market prices may seem to be a convenient pre-election decision,but this too could rebound badly on the vulnerable in days to come. One intelligent option is to go with a floor for oil prices,so that the citizenry doesnt have to deal with the gyrations.

The government needs to come clean on their intent in contemplating this decision. Are they willing to stick by it? I am not talking about sticking by it no matter what. All that must be asked is: Are they willing to let market rates prevail as long as crude prices are in the range they have been in the last six months?

The writer is a Hyderabad-based economist and oil watcher

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