Barring a swift resolution of the turmoil in West Asia or the release of strategic stocks by the International Energy Agency or IEA, crude oil prices will remain high in the coming months. It can be argued that the Libyan situation is temporary, and there is enough global supply to eventually tamp down prices. That would be a mistake. India itself needs to confront a structural problem - it now imports 80 per cent of its crude oil requirements.
Oil production is growing modestly, thanks to new discoveries, but domestic refinery runs still outpaced oil production by 3 million barrels per day, or bpd, last year. Domestic oil demand has been growing at an average of 4.9 per cent (140,000 bpd) in the past five years - strongest demand growth last year in Asia outside China whose coffers are deeper and energy mix more diverse. While India's rising crude oil needs are indicative of a growing economy, part of this is also due to huge subsidies to keep domestic oil product prices low. These price distortions encourage inefficient use of fuels and incentivise adulteration.
Deregulation of diesel prices will allow state oil marketing firms to retail the fuel freely and reduce under-recoveries. The step will also encourage private refiners to more effectively participate in the retail market
If India is serious about moderating its oil demand (and reducing the crude import bill), it has to deregulate diesel prices. This will allow our oil marketing companies to retail diesel freely and reduce under-recoveries.
It will also encourage private refiners to more effectively participate in the retail oil market. We have already taken steps towards fuel deregulation. Freeing of petrol prices last year shaved almost 3 percentage points off petrol demand growth in just one year to around 12 per cent. However, petrol deregulation alone cannot make a dent in the total oil demand as it is only 10 per cent of the total consumption. Diesel takes the lion's share - about 40 per cent or just over a million bpd. So if we need to curb oil demand, we need to curb consumption.
One could argue that this will create inflationary pressures. But not raising oil prices will not check inflation either. If we do not increase oil prices, we continue to bleed the oil sector because the subsidy burden is borne by the oil marketing companies, upstream companies and the government - directly, or indirectly. That means there is less money for investment in oil exploration and other research and development efforts - a surefire way of undermining India's future supply capability.
This also creates a long-term energy security problem. If you continue to subsidise the sector, and let the fiscal deficit rise, inflationary pressures will build in the long run. However, if we allow diesel prices (and petrol) to rise, there will be a short-term upward movement of prices, but not in the long run. This will actually encourage endusers to use transport fuels more efficiently.
Certainly, there are other ways to curb oil demand. Developing domestic natural gas resources is critical to increase in supplies, lowering naphtha and oil demand by industry. Non-conventional fuels can help replace oil demand, but our blended petrol and diesel industry is only a tiny fraction of the overall pie, and will take time to develop.
The biofuel policy mandates a 20 per cent blending target by 2017. Meanwhile, supply concerns continue to dog the planned 10 per cent ethanol blending target. These, along with a focus on renewable sources of energy can, and should be, India's strategy to meet the growing energy demand over the long term. In the short term, however, the need of the hour is to quicken the pace of domestic fuel price reform. And that starts with deregulating diesel.The author is Associate, Energy Security Analysis, Boston