Friday, May 20, 2005

Can Oil Prices motivate Radical Energy Policy Reform?

Oil Prices touched $50 a barrel last year while the International Energy agency confidently forecast that prices could go below $25 a barrel. This year oil prices touched $57 a barrel. Though prices are currently down below $48 don’t be surprised if they again shoot up in the next six months. Will we passively watch these developments or take action to reduce our dependence on oil? If the latter, what can we do? The most important action is to reform our coal, electricity and oil policies. Otherwise we will continue to remain at the mercy of the oil cartel.
India is among the ten largest oil importers in the World. A rise in global oil prices is a tax on the nation paid to the oil cartel. So far we have tried to absorb this tax within the budget, either directly by lowering import duties or by reducing government owned oil company profits and consequently their dividends to the exchequer. This means that these revenues are no longer available to build infrastructure or carry out the social expenditures enumerated in the CMP. Further as the prices paid by consumers of Kerosine, LPG, Diesel and Petrol do not rise there is no incentive to be careful in their use. It is a known economic fact that short term price elasticity of demand for oil products is much lower than the long term elasticity. If oil price increases are not reflected in consumer prices the demand response and the technical change that it induces will be delayed even further. Thus oil dependence will continue to grow and so will the tax that citizen’s pay to the oil cartel.
The solution is to, (a) Allow complete and automatic pass through of international oil prices to domestic users. (b) Set all oil related import tariffs at the peak rate (now 15%) (c) Put a resource rent tax on domestic oil producers that applies above a base oil price (set in the exploration contract) and varies with the international price of oil. The revenues from this tax can be earmarked for development and introduction of energy conservation technology and alternative energy resources. (d) Replace differential pricing of Kerosene, whose adulteration of diesel is destroying Bharat III engines, by a direct subsidy to BPL house holds.
The nationalization of coking (non-coaking) coal mines in 1971 (1973) was justified (among other reasons) by the need to use our abundant coal reserves optimally for the good of future generations (50-100 years). The talk now, thirty years after nationalization, is about how coal imports are needed because the coal is of poor quality and how it will not last very long in any case. What happened? Nationalization created a monopoly, that along with the Ministry of Coal and the regulators appointed by it constituted itself into a monolith that has destroyed this great national resource. Greedy politicians (from coal mine areas or coal ministers), the coal mafia and the public coal monopoly have milked this national resource in the name of the people. A former vigilance head of Coal India confirmed to me that the stories one had heard and read about the ‘Coal Mafia” (which controls the labor force in the mines) are indeed true. Is it any wonder that the Coal Mine Nationalization Amendment Bill had been stuck in parliament since 2000 and was allowed to lapse, without re-introduction, in 2004!
The solution, (a) Amend the Coal Nationalization Act to allow private entry into coal mining. This will end the State monopoly and introduce true competition into the coal mining industry. It will allow specialized companies to come in, reduce demand risk through diversification of buyers, exploit economies of scale, make long gestation investments in mining & processing of high ash coal and in R&D for more effective use of available (quality/type) coal. (b) Sell 49.9% of the shares of public coal mining companies to the public/people. This does not disturb the government’s management control (mafia control?), but will provide an incentive to the people and the financial media to shed light on the worms operating under the stones. Hopefully the performance of the State companies will improve to the point they can compete with imports. (c) Reform and strengthen the coal regulatory system by making it independent and professional.
The electricity Act (2003) is an important step in the direction of electricity reform. But large private investments will not flow unless three critical problems are addressed and policy and regulatory risk is reduced. The most fundamental problem is electricity Theft. With 50% T&D losses Delhi electricity privatization will eventually loose support unless this problem is tackled. The Theft and Dacoity carried out by the electricity mafia is legendry. Several years ago, a central electricity minister, who had himself been a DESU union leader, had no hesitation in confirming this fact. This problem is not unique to Delhi but perhaps Delhi can show the way by taking on and destroying the electricity mafia and thus reducing the cost to honest users by about 40%. Full success would eliminate the need for cross-subsidies and allow a uniform price for all electricity users.
The second issue is that of the cross-tax subsidy to be paid by independent power producers for open access to the existing controlled government distribution system. Unless the methodology is clearly specified and is reasonable and limited by some upper bounds, the risk of arbitrary imposts will remain and deter investment. The third issue is the setting up of an independent and professional regulatory system. This requires regulatory law(s) ensuring sufficient delegation in all matters related to standards, norms, interconnection, pricing and quality of service and clear rules and procedures for financing of regulators, selection of chairman & members and adequate professional staff. State Governments and politicians are loath to loose control of the levers of power and pelf and the setting up of this system in the major states is going to be a long and painful process. Unless all this is done the regulatory and policy risks will remain.
With the best of intentions, these reforms will take about 10 years to fructify. In the meanwhile a radical solution is required. The government should declare a 10 year regulatory holiday for all new private generation, distribution and transmission companies (starting from date of first completed project). Producers/distributors would be free to supply electricity to any buyer at mutually agreed prices, terms and conditions. On completion of the regulatory holiday, normal regulatory systems, which by then will be fully in place across the country, would become applicable. By then the power shortage would be eliminated.

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