Tuesday, July 8, 2008

Price differentiation in the oil market

There appears to be no let up in the rising oil prices. Even if prices stops rising, there is little possibility of it falling back to anywhere close to the levels of early part of this decade. Therefore the best that can be hoped for is that prices stabilize, atleast at the present levels, for the short to medium term.

With elections around the corner, it is highly unlikely that the Government of India will raise prices over the coming year. Even after the elections, any price rise, however large, may not be enough to cover the difference between the cost of production and the subsidised sales price. The Government policy of giving oil bonds may soon run into fiscal problems and is in any case not sustainable. Given this reality, it is important that the public sector oil companies adapt their sales strategies to reduce their losses.

One way of doing this is by aggressively promoting price differentiation. Already the state owned oil companies sell their own branded petrol and diesel. The sales of this branded oil should be increased by opening exclusive branded oil dispensing outlets. In fact, the existing outlets located in the downtown areas of major cities can be converted to selling only branded petrol. Customer service can be improved to atleast marginally offset the higher prices and attract consumers to such outlets.

There may even be a self-fulfilling logic about such outlets. As some of the existing stations get converted to exclusive branded oil outlets, the customer pressure on the remaining stations increases. This translates into longer waiting times and even ques in these stations. This in turn incentivizes atleast certain categories of consumers to prefer the less crowded branded oil outlets.

This strategy is not new to India. Many states, at some time or other, have sold petrol and diesel through their civil supplies stores at lower than the market rates. The aforementioned price differentiation by branding is only a variant of this old strategy.

Oil companies can also, in consultation with the car makers, explore the possibility of selling higher quality petrol or diesel to specific categories of cars and SUVs. Besides capturing atleast some of the price differential and reducing the subsidy burden, such price differentiation strategies will also go along way in making the market more mature and economically efficient.

By capturing the uncovered willingness to pay of certain categories of consumers and recovering a greater share of the cost of oil, this will increase the total economic surplus. Further, it will also ensure better targetting of the oil subsidy.

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