The turmoil in Pakistan following the assassination of former prime minister Benazir Bhutto had an unexpected fallout on the world economy. The fears of political repercussions in the Islamic world made oil markets react nervously and pushed the already high crude prices to a record peak of 100 dollars per barrel on Jan 2. While this may have been a one-day wonder, the very fact that oil prices reached these dizzying heights is worrying governments in both developed and developing economies.

In India, the government which had been trying to avoid taking any hard decisions on the oil crisis was finally forced to concede that prices of retail products like petrol and diesel may have to be raised soon. The prospect of raising prices by about Rs.1-2 per litre is now being talked about, along with some reduction in taxes, to ensure that the consumer does not have to take much of a hit. With a series of state assembly elections scheduled this year, the ruling United Progressive Alliance (UPA) coalition is not keen to take any unpopular decision right now.

But it has also little option with crude oil prices continuing to rule at around $98-99 per barrel - levels that could never have been envisaged even a year ago. India's dependence on imported crude supplies has grown over the last two decades from 50 percent to over 70 percent. It has now emerged as one of the largest buyers of crude along with China. In fact, the surge in economic growth in China and India leading to a steep rise in their oil buying globally has been widely considered a major factor for the rising graph of world oil prices in recent years.

The latest surge in global market prices appears to have been mainly sparked by the assassination of Benazir Bhutto in Pakistan, as it is felt the repercussions of instability in this nation could be felt in neighbouring oil producers like Iran. At the same time, other international developments are also said to be partly responsible for the spike in global prices. These include tension in Nigeria, the world's eighth-largest oil producer. Similarly, there have been fears US crude inventories may not have been as high as earlier anticipated. Finally, of course, fuel prices always show a seasonal hardening in the winter as demand rises exponentially in Europe and the US during this period.

The net result for India is that the domestic oil companies are not recovering their cost of production for products like petrol, diesel and cooking gas. The losses are much higher in the case of subsidised kerosene supplied through the public distribution system, as public policy demands that it be priced far lower than the actual costs. So far, the piecemeal solution to this problem has been issuing bonds to the oil companies to partly cover their under-recoveries.

The balance of under-recoveries of the oil marketing companies is spread over the upstream firms like the Oil and Natural Gas Corporation, GAIL India and Oil India Limited. Clearly, with oil prices hitting $100 a barrel, it is no longer possible to continue putting band-aid on the recurring losses of public sector companies like the Indian Oil Corp, Bharat Petroleum Corp and Hindustan Petroleum Corp. These are now estimated to reach nearly Rs.700 billion ($17.5 billion) in the current fiscal. Private companies like Reliance Industries are free to raise prices, but have to be circumspect as hiking rates means they become less competitive vis-a-vis public sector oil firms.

In the past, several options have been considered to put some mechanism in place that would insulate domestic consumers from the volatility of world oil prices. Initially, of course, there was the complex system of oil pool accounts, which aimed at using the profits obtained during a period of low world prices to subsidise periods of high oil prices. This system did not work too well since the resources in the oil pool accounts were gradually drawn out by the government to bridge the budgetary deficit. Then it was felt that transparency needed to be introduced by dismantling the administered pricing mechanism so that domestic oil prices are linked to world markets.

This again proved difficult to implement since global oil prices have been steadily rising and it has not been possible to pass on this level of price increase to the Indian consumers for all petroleum products. For instance, kerosene meant for the PDS has necessarily to be priced low as it is meant to meet the needs of those living below the poverty line. Even for diesel, passing on global prices means fuelling inflationary pressures on the economy.

Finally, therefore, the country has been left with knee jerk measures to deal with the problem of soaring international oil prices. The petroleum ministry is trying to urge the finance ministry to cut taxes on imports and production of crude oil and products. But the finance ministry, in turn, relies on the huge inflow of taxes from the oil sector and is certainly not in a mood to allow these to be reduced. Some cuts have already been made in both excise and customs duties, but the petroleum ministry is pressing for more to be carried out to avoid having to effect a big hike petrol and diesel prices.

The decision on the extent of price increases will ultimately be a political one, taken in consultations with UPA chairperson Sonia Gandhi and the Left parties rather than solely by Prime Minister Manmohan Singh and his cabinet colleagues. With the general election due next year and a spate of states going to the polls this year, Gandhi is not likely to favour any significant increase in prices of commodities that could hit the common man.

But even to help the "aam aadmi" (the common man), it is high time that a long-term petroleum and energy policy is put in place. Otherwise, the country will continue to lurch from crisis to crisis every time the world markets move in a volatile manner.

(Sushma Ramachandran is an economic and corporate analyst. She can be reached at sushma.ramachandran@gmail.com)