fs-i | Prices | Inflation | Monopoly | Hydropower | Sustainable Development | Economic Independence

Dissecting fuel price and why Nepal should disrupt its fuel dependency?

What drives fuel price in Nepal, and why Nepal should disrupt its reliance on fossil fuels and expedite its alternative energy ambition?

- By the_farsight |

Transporting cooking fuel cylinder to the destination | Photo by: Adli Wahid on Unsplash
Transporting cooking fuel cylinder to the destination | Photo by: Adli Wahid on Unsplash

Fuel price is one of the principal drivers of inflation, taking its effect by pushing up living and business costs. As anyone can see, economies run on fuel while fuel price is one of the major input costs. Thus, overall inflation rises when fuel price rises because business and production outfits to the daily lives of households are all heavily fuel-dependents. Factory operations, distribution processes, logistics, construction, households’ everyday commutes and meals are all reliant on fuel. Business and production overheads are, thus, vulnerable to fuel price instability.  

In Nepal’s context, the price of fuel and its supply is subject to several critical factors, including the global price fluctuations to which it adjusts its domestic price with, potentially exposing the country to erratic price rise and its potential effects at any given time. 

The vulnerability stem from the fact that fuel import in Nepal has always relied on an inefficient supply mechanism driven by monopolistic forces. First, it exclusively sources fuel from IOC (earlier based on a Memorandum of Understanding signed between the two countries in 1974 that specified the IOC as its sole supplier). The land-locked country Nepal signed a framework agreement with its another neighbour China on fuel import in 2015, but there’s only little progress on that front. Second, Nepal Oil Corporation (NOC) who buys petroleum products from IOC holds monopoly power in the domestic market and has total control on prices. 

The cost is then exacerbated by high operation costs arising from transportation and manpower costs (compared to effective staff and labor management, automation and pipelines), institutional inefficiency, and theft and leakage that are rampant in the institution that is under no obligation to reform itself due to its monopoly power and excess political interference.

Around 300 fuel tankers entered the country from India on a daily basis in absence of cross-border fuel pipeline to fulfil Nepal’s petroleum demand. The number may have reduced only slightly after Motihari - Amlekhgunj pipeline became operational during the end of 2019 as it only transmits diesel at the moment. The prevalent corruption in the institution further intensifies the deadweight loss as it impedes efficiency gains.  

The distribution is then controlled by respective cartels of transporters, dealers and gas companies, who influence supply and prices through collusion and even resort to creating artificial crisis to seize bargaining power. Only few days back, NOC finally agreed to hike dealers’ commission rates that the association had been continuously pressing for with veiled threats of ceasing supplies. On the other hand, dealers are also found to have engaged in fuel adulteration with NOC staff as complicits. 

Fuels are also subject to different taxations (in total almost 100 percent of the price at which NOC procures the fuel) generating a good chunk of revenue for the government. The levied taxes are custom tax, road maintenance tax, pollution tax, infrastructure development tax and VAT. The infrastructure tax of NRs five was imposed from May 2016 for every litre of petrol and diesel, adjusted to NRs 10 in the early 2020 at the existing retail price. 

Since those accumulated tax revenue (infrastructure) are planned as financing source for infrastructure development – the Buddhi Gandaki Hydropower Project, it can be assumed it will do its fair bit in offsetting the future inflation. Besides, taxing fossil fuels is an effective approach to curbing emissions. NOC also charges higher prices on different fuels (for instance, aviation fuel) so that it can provide subsidies on kerosene for low-income segment of the society.

As Nepal lacks its own natural oil reserves, has no influence on fuel production, and entirely relies on Indian monopolistic supply - the IOC, Nepal is basically a total fuel importer and a price taker, which makes it completely vulnerable to external supply and price shocks. It is plausible that these shocks will recur even if the country improves its inefficient institution and supply mechanisms.  

Nepal’s fuel import bill (petrol + diesel + LPG) was NRs 146.48 billion in the fiscal year 2019/20, according to the Foreign Trade Statistics, a deviation (fall) by 44.51 billion (23.3%) from the previous fiscal year and from the overall peaking import graph, thanks to the ongoing pandemic. 

In the last two decades, external supply shock owing to geopolitical reasons, supply cuts by the IOC for NOC’s inability to settle dues on timely basis (due to NOC’s poor financial position leading to its mounting losses) and ineffective internal supply management have led to several long spells of fuel shortages resulting in price rises. All periods with supply shocks were marked by high inflation and traumatic business environment, for instance, the 2015 economic blockade imposed by the Indian government.

In recent times, fuel supply is relatively well managed while the Motihari-Amlekhgunj pipeline is also operational now although it has its limitations for now. Nevertheless, fuel prices remain relatively higher compared to Nepal’s overall economic landscape. 

At the end of the day, there is significant direct effect on the cost of living with price rises in transport and production fuel (petrol and diesel) and cooking fuel (kerosene and LPG gas). The fuel inflation increases the cost components of businesses, producers and even everyday life, putting end consumers (households) on the receiving end. 

The international Oil Crisis in seventies and the domestic scenes of the 2015 blockade, both are good sources to broadly understand the cost-push inflation arising from fuel crises. They also provide insight into geopolitics of oil and how geopolitical equations shape between the oil exchanging countries. In Nepal’s context, there’s no shred of doubt that its sole supplier will continue having the upper hand over its energy-dependent partner in other host of issues due to the power relation equating from the fuel dependency. 

Deeper analysis of Nepal’s fuel crises clearly indicates the need to structurally reform its institutional and supply management, and curb its excess reliance on fuel and dependence on India for the supplies – as the excess reliance has become a source of insecurity and its Achilles heel. 

In sum, based on international experiences and Nepal’s economic aspirations, it is imperative for Nepal to rapidly transform into an alternative energy powered economy - run by sustainable, clean and green forms of energy - mainly hydroelectricity where it has natural comparative advantage and is a perfect substitute of oil. There is also moral and environmental imperative to switch to the alternatives in view of escalating climate change effects and risks of more pronounced environmental outcomes.

In the long haul, investments in alternative energy will prove sustainable and environment-friendly, a source of reliable energy, geopolitical balance and economic independence, and anti-inflationary.

the_farsight :)

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