Some day, the earth is going to run out of oil. It's already getting harder to tap. That is why BP was doing risky drilling deep in the Gulf of Mexico. As oil gets scarcer, its price will go up. As China and India demand more oil, the price will go up further. Throw in political turmoil in high-risk oil producing areas and market prices can skyrocket.
Two years ago, Arjun Murti, an Indian analyst at Goldman Sachs, earned fame for his "super spike" prophecy that oil prices will hit $200 per barrel. Nowadays it’s around $70 but the spectre of $200 is enough to make governments, corporations and the rest of us worry.
Historically, we did not need to worry. Governments shielded us from the true market price of petroleum through price controls and subsidies. The logic was impeccable: Kerosene was the poor person's fuel and must be affordable. Diesel powered freight transportation. Allowing its price to increase would trigger all-round inflation.
As global oil prices went up, governments spent thousands of crores on subsidies. Budget deficits shot up, with inflationary impacts. This money could have been better spent on development or infrastructure or education. Other perverse impacts arose: The middle and upper classes started buying diesel cars. Thus, instead of just keeping goods transportation cheap, the subsidy went to private, personal transport. Studies have showed that the richest 20% of Indians received almost half of all fuel subsidies and the poorest fifth only 10%.
Obviously, then, it is a good idea to phase out oil subsidies. The perverse subsidisation of the rich would end. Market prices would send signals that would get people to use petroleum products carefully. Governments would have smaller deficits and state-owned oil companies (who partly bear the cost of the subsidies) would regain health.
In India, though, what is obviously worthwhile is not always politically viable. Decontrol of oil prices would mean that petrol, diesel and kerosene would likely see their prices increase. This would affect everyone, rich and poor, directly. The inflationary impact through higher transportation costs would affect everyone indirectly. Theoretically, prices could go down if global oil prices drop, but that is less likely over the longer term.
So, while decontrolling oil prices and ending subsidies makes good economics, it is scary politics. Any government that wants to end the populist petroleum subsidy would need to have adroit timing, skillful media management, and a booming economy that ensures that people are getting richer across the board so they do not feel the pinch.
In spite of various commissions recommending oil price decontrol, and India supposedly shining, the previous National Democratic Alliance government balked at implementing this revolutionary policy change. Coalition pressures and impending elections came in the way.
Today's United Progressive Alliance government, though, seems ready to bite the bullet. It has learned from the nuclear deal that it can get away with bold changes in strategy. Elections are technically far away. All parties seem unprepared for early polls. Beyond a bundh or two, the government figures, the people and the country will adjust. As historically we have.
So, even though inflation (especially of food prices) is still high, the government is pushing forward with decontrol. Kerosene will likely remain subsidised and accessible to the poor through the Public Distribution System. Rural Employment Guarantee and other mega pro-poor initiatives may have convinced the poor that the government’s heart beats firmly for them. Prime Minister Manmohan Singh has the upper and middle classes firmly on his side, given his track record of liberalisation and economic growth. If ever oil prices skyrocket, the government can always intervene again, and possibly gain political payoffs in the process. All these factors explain the boldness and timing of oil price decontrol.
Strategically, higher oil prices will make other sources of energy more attractive. As we focus on a fossil fuel free future, research and development will inevitably make renewables, fuel cells, etc., more competitive. Cleaner, greener fuels will become viable. India's abundant sunlight, wind and fuel crop capacity will lead to energy independence. Thus the government’s politically bold step makes for excellent longer-term economics. It is good for us and good for our planet.
(The writer is Chairperson, Centre for Public Policy, Indian Institute of Management, Bangalore.)