Politicizing Oil Prices

By KEN OHASHI, World Bank Country Director for Nepal, based in Kathmandu  Published in Kantipur, Nepali National Daily on April 23, 2003 This is the seventh in a series   of opinion pieces on Challenges Facing Nepal's Development.

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The recent decision by His Majesty's Government (HMG) to raise fuel prices has been met with strong protests. Violent demonstrations led to the tragic death of Devi Lal Poudel, a student in Butwal. In this highly charged environment, it seems worthwhile to examine the facts. If my view as an outsider and guest in Nepal can be helpful, I am happy to attempt that at the risk of making statements that might be unpopular with some.

The recent price hikes for diesel and kerosene in particular have drawn intense criticism not just from student groups but from political parties, too. Inherent to this opposition is the belief that kerosene is the "poor person's fuel," used mainly for cooking, and as such the price should be kept low. Let me put it to you this way: by the same logic bicycles are the "poor person's transportation," and as such government should set the price for a decent bicycle at the more affordable price of Rs. 100 each. Why is no one demanding this? The answer is obvious: a decent bicycle in Nepal costs about Rs. 2,000 and cannot be manufactured at a fraction of that. Nor could government afford the massive subsidy to keep the price low. Demanding that HMG should roll back the fuel price hikes is not very different from arguing that bicycle prices be set at Rs. 100 a piece. HMG cannot will the international oil market to reduce prices, and it cannot afford the subsidy to keep the prices in Nepal low. Worse yet, keeping the fuel prices artificially low ends up benefiting those who least deserve the subsidy, as the analysis will show later.

Something unusual happened in 2058 BE (2001/02 AD). Deviating sharply from recent trends, the consumption of kerosene shot up and that of diesel dropped correspondingly (see chart). Did the Nepali poor suddenly start doing a lot more cooking, using kerosene? In doing so, did they become more home-bound and hence reduce the demand for diesel (used largely for transportation)? Not a very plausible explanation. In fact, the 1995/96 Nepal Living Standard Survey showed that only 7% of households used kerosene for cooking (either as a primary fuel, or as a secondary fuel). Of those, 88% were among the richest 40% of households. Thus it is a gross overstatement to claim kerosene is a poor man's fuel. Most poor households, especially in rural areas, hardly use kerosene, except perhaps in small quantities for lighting.

Fuel consumption
(million liters)

Since 1999, the price of crude oil has increased significantly, and the fuel prices in India gradually rose to reflect this. In Nepal, however, the prices were raised only modestly, as successive governments found it convenient to avoid politically unpopular price increases. In fact, in Magh 2057 (January 2001), the kerosene price was lowered by Rs. 5 to Rs. 17 per liter and the diesel price by Rs. 1 per liter. As a result, the price gap between the two fuels became very large. By early 2003, the prices of kerosene and diesel in Nepal had fallen significantly below those in India. These two sets of price differences (between India and Nepal, and between kerosene and diesel) created powerful economic incentives to change the pattern of fuel use in Nepal.

	Before March 25, 2003, Prices		March 25, 2003, Prices
	in India	in Nepal	in Nepal
Kerosene	28.0	17.0	28.0 (23.0 with coupon)
Diesel	33.0	26.5	34.0
Petrol	49.5	52.0	56.0

First, the smuggling of cheaper kerosene and diesel to India boomed (a price difference of Rs. 2 or so per liter is said to be enough to cause smuggling). Second, because kerosene was so much cheaper than diesel, some diesel users (e.g., hotels and factories that use diesel to heat water, etc.) started to use kerosene instead. Third, some even mixed kerosene in diesel to make more money (the so-called "adulteration" of fuel). According to estimates by Nepal Oil Corporation (NOC), 25% of kerosene was being used by industry, 20% used for adulteration, and another 20% smuggled to India. At the 2002 consumption level of 387 million liters, a "subsidy" of about Rs. 10 per liter would mean industries would get windfall profits of some Rs. 970 million, those responsible for fuel adulteration Rs. 770 million, and Indian consumers (and those involved in smuggling) another Rs. 770 million. Large quantifies of diesel were probably smuggled to India as well. This hardly seems like an enlightened public policy.

In the early months of 2003, NOC was losing money at the rate of about Rs. 600-700 million a month. HMG had no choice but to raise fuel prices. In making the politically unpopular decision in March, however, HMG seems to have done its homework. It did not simply raise prices to make them comparable to the prices in India (which is necessary to remove the incentive to smuggle). HMG conducted an analysis of the impact of kerosene price hike on the poor and found that, although the overall impact was modest, the impact on the poor households (mostly in urban areas) who used kerosene for cooking was not negligible. Based on this, HMG decided to introduce a subsidy scheme for poor households that use kerosene in small quantities. Such careful policy formulation should be welcomed as this has not been usual in Nepal.

Of course, one-time price adjustments are not a lasting solution, and recognizing this, HMG decided to free the price setting from politics, by creating an independent price setting committee. It is mandated to adjust fuel prices as the international oil prices move, without political considerations (the first indication of this came last weekend when prices were adjusted downward to reflect trends in international prices). This would avoid huge price shocks of the kind that Nepal recently experienced. Of course, this still does not address the most fundamental problem, which is the lack of competition to force efficiency in the fuel market. The Top Bahadur Singh Committee which recently examined NOC practices has made a number of recommendations to address inefficiencies and corruption. These will need to be implemented. Eventually, private competition must also be brought in. This will bring the lowest prices possible to the consumers within the forces of the international oil market that no country can defy.

All in all, the set of policy decisions taken by HMG recently is sound, at least in addressing the immediate issues. If I were to fault one thing about this, it is the failure of HMG to explain more forcefully to the public why these decisions were appropriate. And, let us not forget that had the successive governments preceding the current one taken more forthright actions and raised fuel prices in smaller increments, such a big price shock could have been avoided. If anything, previous governments are the ones to be blamed, not the one that is trying to deal with the legacy of politically expedient inaction.

It is hard for any rational citizen to disagree with the essence of the March 25 decisions. The political parties all know this perfectly well. Yet, many of them seem to be supporting or even inciting protests against fuel price adjustment. By doing so, are they saying that it is fine for the vast majority of the Nepalese poor, who themselves don't use these fuels in the first place, to be footing the bill for these huge losses? Are they saying that it is fine for big industries, smugglers, and fuel adulterators to make a killing from the subsidies? Or are they saying that it is fine for Nepali taxpayers to be subsidizing fuel prices for consumers across the border?

Before they continue their protests, I hope the students will think through the basic issues as well as the implications of their action. If they are really concerned with the lives of the poor, let us not forget that transport bandhs may hurt many of them, perhaps even more than the fuel price increases. Surely, university students are mature enough to think for themselves and know when to act and how, and when they are being manipulated by others.

Of course there is an unfinished agenda of important reforms, like cleaning up NOC and introducing competition into the fuel market. These changes would benefit everyone, except the unscrupulous individuals who milked the system. Now, this may be something worthwhile demanding.