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 that can ramp up living and business costs. This is because economies run on fuel.

From business and production outfits to the daily lives of households, they all are heavily fuel-dependents. Factory operations, distribution processes, logistics, construction, our everyday commutes and meals run 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 many critical factors - firstly to the global price fluctuations to which it adjusts its domestic price with. Being a net importer of fuel, Nepal is potentially exposed to erratic oil prices in global energy markets and its damaging effects at any given time.

Other influences stem from the fact that Nepal’s fuel supply is rooted on an inefficient supply mechanism driven by monopolistic forces.

First, it exclusively sources fuel from IOC based on a Memorandum of Understanding signed between the two countries in 1974 that specified the IOC as its sole supplier. Although the land-locked country has signed a framework agreement on fuel import with its only other neighbour China in 2015, there’s little progress on that front.

Second, Nepal Oil Corporation (NOC) who buys petroleum products from the IOC holds monopoly power in the domestic market and has total control on prices. 

Third, the cost is then exacerbated by NOC’s institutional inefficiency. Poor workforce competency, deeply seated corruption, excess political interference and institutional resistance to reforms such as system automation and supply pipelines have long impeded the corporation from capturing efficiency gains. As a result, it is compelled to run on poor infrastructures and costly operations.

For instance, in absence of a cross-border fuel pipeline to fulfill Nepal’s petroleum demand, around 300 fuel tankers transport fuels from India on a daily basis. 

This fleet size may have only slightly fallen after the much awaited Motihari - Amlekhgunj pipeline became operational at the end of 2019, which presently transmits diesel only.

Fourth, the distribution is then controlled by individual cartels of transporters, dealers and gas companies, who influence supply and prices through collusion and even resort to creating artificial crises to maximise their bargaining power. Only a few days back, NOC agreed to hike dealers’ commission rates after the colluders continuously pressed for it who even used veiled threats of ceasing distribution. Dealers are also found to have engaged in fuel adulteration with NOC staff as complicit. 

Fifth, fuel import prices are subject to different taxes, accumulating into almost 100 percent of the procurement price. These taxes - custom, road maintenance, pollution, infrastructure development and VAT - make up a good chunk of government revenue.

Among these taxes, the government began imposing a 5-rupee infrastructure development tax from May 2016 on every litre of petrol and diesel, which was later adjusted to 10 rupees in the early 2020 without hiking the existing retail price. 

The accumulated infrastructure tax revenue is planned to finance the Budhigandaki Hydropower Project. If the project really materialises, it is likely to contribute to offsetting the future inflation through economic gains.

Taxing fossil fuels is also an effective approach to curbing emissions. Similarly, NOC charges higher prices on aviation fuel and uses the surplus to provide subsidies on kerosene for low-income segments of the society.

Dependency has many costs
As Nepal lacks its own natural oil reserves, has no influence on fuel production, and entirely relies on Indian monopolistic supply - the IOC, it is not only a net importer and a price taker, but exposed to many vulnerabilities such as external supply and price shocks and economic and political difficulties.

According to the Foreign Trade Statistics, Nepal’s fuel import bill (petrol + diesel + LPG) was NRs 146.48 billion in the fiscal year 2019/20, which declined by 44.51 billion (23.3%) compared to the previous year. This is a relief to Nepal’s overall skyrocketing import graph where fuel imports alone amount to around 15% of the total imports, but the decline is most likely temporary. 

There are geopolitical implications as well. Nepal faced external supply shock when India imposed an ‘unofficial’ blockade on Nepal in September 2015 over its concerns on Nepal’s recently promulgated constitution. The blockade caused an economic and humanitarian crisis in Nepal at a time when it was struggling to recover from the devastating earthquake in the same year. 

Previously, Nepal regularly faced external supply shocks owing to financial reasons but these were NOC’s doings. NOC’s poor financial position and mounting losses meant that it often failed to settle IOC dues on a timely basis; as a result, IOC was compelled to cut down the supply. 

These supply shocks have led to several long spells of fuel shortages and high prices. All periods with supply shocks were marked by overall high inflation and a traumatic business environment.

In recent times, fuel supply is relatively well managed. Domestic prices are adjusted with global prices. There is a pipeline in operation now. Nevertheless, present domestic fuel prices don’t do justice to Nepal’s overall economic landscape, and at the end of the day, there is a cruel impact on the overall cost of living. 

The international Oil Crisis in seventies and the scenes in the ground during the 2015 blockade, both are good references to broadly understand the cost-push inflation arising from fuel crises. They also provide insight into the oil geopolitics and how geopolitical equations shape between the oil exchanging countries.

For Nepal, there’s no shred of doubt its sole supplier will continue to leverage the power relation equating from the fuel dependency when negotiating its matter of interests.

If these crises are prescriptions to anything, it is the fact that Nepal must structurally reform its institution and supply management, and curb its dependency. Unless tackled, the dependency will continue to be a great source of economic fragility.

In sum, considering international experiences and Nepal’s economic aspirations, it is imperative Nepal quickly transforms into an alternative energy-powered economy - run by sustainable, clean and green forms of energy - mainly hydroelectricity, which is a perfect substitute of oil and where Nepal has natural comparative advantage. There is also a moral and environmental imperative in view of escalating climate change effects.

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

the_farsight :)

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