The Sunday Times Economic Analysis

Petroleum pricing must be viewed on a long-term perspective based on the realities of the global scenario. It is also a very serious issue.
Postponing decision-making would lead to higher costs and burdens in the future and further vulnerability of the Sri Lankan economy.
The pricing policy for petroleum should be within the framework of a broader energy policy that seeks to conserve petroleum use and develop alternate energy sources.

By the Economist
Recent increases in consumer prices of petroleum products, have once again raised controversy and public displeasure.

From the opposition's point of view, this increase is a violation of a promise made at the election. The counter argument of the government is that the massive increase in the price of oil was not envisaged at the time of elections and to cope with international price hikes there is no option but to raise prices.

They also state the fact that even countries such as India that produced about 40 percent of her requirements too, increased petroleum prices. The opposition also claims inefficiencies and corruption in the Ceylon Petroleum Corporation (CPC), as a factor to increase the cost of petroleum.

The government counters that part with privatization of the CPC, which becomes a cause for the lesser viability it.

All these arguments are no doubt valid and to some extent responsible for the increase in the costs of oil to the consumer. There is however little appreciation and awareness of the underlying serious nature of the problem. We focus our discussion on these economic issues here.

The increasing trend in oil prices will continue unabated. The Sri Lankan economy must face up to the problem of continued oil price hikes and adjust to cope with the inevitable economic problems it causes.

With the estimated exhaustion of known oil deposits of international reserves in about thirty years, this trend of increasing oil prices cannot be reversed. Within the next three decades there may be fluctuations in prices and short periods of price declines, but the upward trend can't be reversed.The current increase in prices is no doubt owing to the possibilities of US intervention in Iran. Earlier the US invasion of Iraq increased oil prices. Although the general trend of increasing oil prices can't be reversed, there is however the possibility that the higher prices of oil would make it economical to tap higher cost drilling of oil and thereby increase supplies.

In actual fact the increasing trend is likely to gain momentum in the next few years and especially towards the third decade of the millennium. It will no doubt spur the development and use of other forms of energy.

Are we responding to the emerging scenario of price increases? Our energy policies should not be guided by hopes that oil could soon be discovered offshore or that prices would come down to previous levels.

These are unrealistic expectations. There is a vital need to adopt a realistic price for oil. A realistic price for oil is one that would ensure that consumption of oil would be of a level that the country's finances, particularly its external financial position, could sustain. A low price could result in a sustainable consumption of oil.

Although around 40 percent of India's oil requirements are from her own resources, India has adopted a pricing policy, when international prices rise above US$ 75 per barrel, petroleum product prices are increased automatically. Oil companies have the freedom to change prices of petroleum products when crude oil prices rise above US$ 75 per barrel. For every $ price increased beyond US$ 75, the petrol price would increase by 39 paise a litre, diesel by 30 paise, kerosene by 36 paise and cooking gas by 60 paise per cylinder. In Sri Lankan currency these price increases in paises are about double in terms of Sri Lankan cents. Such a price policy is followed in order to contain the petroleum consumption. In Sri Lanka, political considerations have led the government to a pricing policy of not aligning domestic prices to that of the international price increases. Consequently the reduction in domestic oil consumption in 2005 has been inadequate to cope with the problem of rising costs of petroleum imports.
Last year's price increases were able to decrease demand by 8 percent.

The consumer price increases did not fully cover the additional import price increase of nearly 40 per cent. Despite this reduction in imports, the sharp increase in oil prices have resulted in the oil import bill rising by about 37 percent.

The seriousness of the problem could be gauged by the fact that the expenditure on oil imports alone constitutes 19 percent of the country's import bill. As a proportion of export earnings, it was as much as 26 percent.

More than one fourth of export earnings are spent on petroleum imports, causing a serious dent in the country's balance of payments.

There are indications that this year's position could be much worse, owing to the further escalation of oil prices and the export performance of the country showing signs of sliding. It is in this context that we require a realistic pricing of petroleum prices to contain demand effectively.

The pricing policy for petroleum should be within the framework of a broader energy policy that seeks to conserve petroleum use and develop alternate energy sources.

There is a pressing need for both conservation of energy use and alternative sources of energy, however, there has been little success in finding alternate power supplies to a significant extent.

Hydro-electricity is virtually at its peak production and the increases in electricity consumption are outpacing increases in hydro-electricity generation.

In 2005 hydroelectricity contributed to only about one half of our energy while thermal power accounted for most of the other electricity generation. If we are to depend on thermal power generation then the escalating costs of oil will have a serious impact on the economy. In such a context, there is a need for a well thought out short-term and long-term energy policy.

The issue of the government subsidising electricity, especially to middle class consumers must be reviewed, as it is not helpful in conserving energy.

Despite the high prices for petroleum products, they are subsidised and consequently the demand is not aligned to international pricing and does not lead to the conservation of energy.

Conservation of energy could be looked at as a short-term respite but a permanent cure must be found through the exploration of alternate sources of energy.