Oil and Beyond: An Analysis of the Petroleum Sector in Nepal

Nepal has one of the lowest energy consumption patterns in the world, a reflection of the slow pace of development within the country. Currently, the fuel requirement of the country is largely met through traditional sources; primarily fuel wood, with petroleum products meeting only 9.9% of the country’s fuel requirements. Dependence on both these sources is worrisome for Nepal since the former is a depleting form of energy while the latter increases the import bill for Nepal as a result of having no natural oil resources of its own. The scope for growth in demand for other alternate sources such as hydroelectricity and other renewable products is therefore extremely high. Additionally, keeping in mind the need for increased conservation and preservation of forests, this switch over is deemed desirable.

Currently, the operational framework of the petroleum sector in Nepal is dominated by monopolistic structures.  Starting with the source, the Memorandum of Understanding (MoU)signed in 1974 between IOC and NOC establishes IOC’s complete monopoly in the Nepali market. NOC has a monopoly in the wholesale market and controls downstream business as the sole distributor. Petroleum transactions in downstream businesses are conducted as per the regulations and internal decisions of NOC. Thereafter, distribution of petroleum products is controlled by a cartel, leveraged by Nepal Petroleum Dealers’ National Association (NPDNA). Although the distributors are appointed dealers who sell the products in the retail market, the dealers association determines profit margins for petroleum products, with some known to adulterate the fuel with cheaper oils to increase profits.

The aforementioned state of the petroleum sector is putting a downward pressure on the economy on account of increase in imports and creation of an anti competitive environment. The consumption of petroleum products has been increasing every year. In fiscal year 2012-13, imports of petroleum products increased by 7.8% to reach 1.08 million KL. Petroleum products account for USD 1.07 billion or 19.14% of total imports made by Nepal. Of the petroleum products, diesel accounts for the highest share at 56% due to load shedding, followed by petrol at 17% and LPG at 16%. This is a major reason behind the increasing import bill over the years. The monopoly in this sector has resulted in the proliferation of an anti competitive environment which creates unnecessary barriers in terms of efficiency and makes the sector difficult to function and operate in. Issues arising out of these developments are discussed below.

Import related

1. Restriction on imports from sources other than IOC hinders liberalization of and competition in the import of petroleum products.
2. IOC currently owes around NPR 1.12 billion (USD 11.2 million) in customs duty refund to NOC, and NOC is estimated to receive around NPR 800 million (USD 8million) in duty refund annually. However, NOC is unable to recover the refund of customs duty due to lack of negotiation power.
3. India has been unwilling to alter the MoU between IOC and NOC, especially NOC’s request to end IOC’s monopoly in import of petroleum products. As a result, policy initiatives regarding privatization would not be successful unless the terms of the MoU are altered.

NOC related

1. Inefficient management owing to management lapse has resulted in NOC not addressing key issues such as overstaffing and cost cutting. Pressure on the management from the Board and political parties has also led to inefficiency.
2. Labor unions often engage in anti competitive practices such as halting supply when officials are arrested, or backing up decisions to distribute bonus while incurring heavy losses. Restricting supply of essential goods is used as a means of bargaining.
3. Lack of internal control systems to take stringent actions against unhealthy practice such as adulteration of fuel.
4. NOC does not make adjustments to price based on international prices, which have led to involuntary subsidization of diesel and LPG, which is sold below market prices. Moreover, the imports and consumption of diesel and LPG are enormous as compared to other fuels; one of the major reasons for the high mounting loss of the NOC. Without price adjustments, NOC’s losses will continue to mount.

Dealers related

1. Supply and distribution of petroleum products are controlled by dealers’ cartel and transportation cartel as they engage in collective price fixing, restrict entry of other players and control supply based on their will rather than the demand.
2. While the decision of the Government to allow dealers to fix their own profits was thought to promote healthy competition, it has resulted in collective price fixing which has increased the cost components of retail pricing.
3. Dealer associations’ protest against many government moves to liberalize primarily to safeguard their investments and commissions, restrict new entry and to avoid privatization since dealers would not be able to bear the subsidy burden thereafter.

GoN related   

1. Any reforms in price adjustments (price hikes) are refuted by politically affiliated student unions in the form of Nepal bandhs or protests on the streets, leaving NOC with little control over price determination. Additionally, the Board being appointed politically also leads to political interference in operations.
2. NOC has to bear the subsidy provided to its customers since the Government does not compensate NOC directly for it. As a result, the losses are mounting.
3. Additionally, the subsidy is inefficient in targeting the right group as it is used by all strata of society.

Overarching issues

1. An inefficient market chain has led to adulteration and theft, resulting in increased financial burden for customers.

Given the aforementioned issues in the petroleum sector in Nepal, various future courses of action have therefore been identified in the report to improve efficiency levels in the petroleum sector. Recommendations are as follows.

• Removal of monopoly at different stages starting from altering the MoU between IOC and NOC in order to start exploring other markets for sourcing of fuel. Also, syndicate system of dealers and transporters should be scrapped and pricing cartels abolished. A clear cut policy of appointing dealers and transporters should be set in place along with strict monitoring and evaluation.

• Development of alternative energy sources such as hydropower, natural gas, solar power, etc. Considering this future switch to alternative sources of energy, it is high time that the private sector also tap into this growth potential by avoiding the present interruptions and disturbances in supply chain, and participate in the business along with the public sector.

• Strengthening of regulatory mechanisms is a must for the petroleum sector. A strong sectoral policy should be formulated, an autonomous and authoritative pricing and regulatory body set up, and inclusion of private players into this sector made. An effective implementation of the competition- and consumer right-related laws is also vital to ensure fair and competitive market environment in the petroleum sector.

In order to absorb the fluctuation in profits as a result of volatile international prices in the market, NOC can adopt a mechanism whereby they can set aside a certain proportion of profits year wise and create a loss equalization fund.

This is an extract from a report commissioned by the Royal Norwegian Embassy in Nepal. This document is solely the work of Nepal Economic Forum. The information documented and the views expressed by this economic periodical do not necessarily reflect the ideas of the Royal Norwegian Embassy.