Published: The Hindu Business Line, June 21, 2005

By Pradeep S. Mehta & Manish Agarwal

THE Government has raised the prices of petrol and diesel, while kerosene and LPG have been spared. Prices of petrol and diesel had remained frozen since November 2004, despite international crude oil prices going up to $55 per barrel on several occasions. The oil companies have been clamouring for an equitable share of the burden, citing their shrinking bottomlines.

The Minister for Petroleum and Natural Gas, Mr Mani Shankar Aiyar, had suggested that all stakeholders — oil companies, consumers and the government — share the burden.

The Government’s share of the burden is estimated at Rs 3,553 crore , which comprise subsidies on domestic LPG and PDS kerosene. Besides, the oil industry’s share is estimated at Rs 20,310 crore, on account of the under-recoveries on petrol, diesel, LPG and kerosene. The total burden shared by these two stakeholders is about Rs 24,000 crore.

Considering this figure as the benchmark, a part of it is going to be transferred to consumers. But is this the real extent of the burden?

The method of calculating subsides on domestic LPG and PDS kerosene is based on import parity pricing of petroleum products and not unrecovered costs (which is more appropriate). Therefore, the subsidy amount being based on a flawed methodology results in misleading figures.

While the burden of subsidy is itself inflated, the Government mops up a large amount from the oil sector as indirect taxes, most of which is passed on to the public.

Compared to other Asian economies, India’s levies on oil are high. The total tax revenue from the oil sector stood at Rs 1,10,000 crore in 2003-04 (Rs 69,000 crore went to the Centre, and the rest to the States).

Additionally, the Government imposes a `cess’ on indigenously produced crude and collects about Rs 6,000 crore annually from the public. The cess was introduced in the mid-1970s to provide financial assistance to state-owned companies. Over the past three decades, the government has collected about Rs 50,000 crore as cess, and almost all of it has gone into the Consolidated Fund of India.

The rate of cess was doubled in March 2002 on grounds of providing subsidies on LPG and kerosene (but it was never intended to cover subsidies). This cess has become an arrangement to meet the petroleum subsidy burden. Considering the amount of petroleum subsidy vis-à-vis the cess amount collected, there is no net burden of petroleum subsidy on the Government. In fact, the Government is collecting much more than the burden it claims to be sharing.

Even oil companies are reaping profits from the current pricing system. The import parity allows oil companies to factor in the Customs duty to arrive at the import parity prices. Since the country does not import petrol or diesel, the amount collected as notional Customs duty from the public, estimated at Rs 10,000 crore, goes to bolster the financials of oil companies.

There is absolutely no transparency in the pricing of petroleum products. The government and the public-sector companies would seem to be making money from distortionary policies and practices. The claims of a huge subsidy burden and bleeding oil companies are exaggerated, as most of the burden is borne by the consumers.

Additionally, consumer interest is harmed by the government stifling competition in the sector. According to a paper by the Oil Ministry, state-run PSUs make considerable profits due to monopolistic practices.

A significant step towards introducing competition was to allow private parties to import, and market kerosene and LPG at market-determined prices. However, since only state-owned oil companies are permitted to market subsidised petroleum products, the non-targeted subsidies offered to the PSU oil companies (in terms of concessional pricing) distort the market, and restrict the ability of private retailers to compete effectively.

Further , the LPG Control Order specifies that cylinders, regulators and valves to be used by the parallel marketers have to be distinctly different from that used by the public sector oil companies. This reduces the freedom of LPG users in switching from one supplier to the other, restricting competition.

One of the most significant threats to sustained economic growth of the country is the global oil scenario. This requires an effective conservation strategy, which can be feasible only if prices of petroleum products are determined transparently and allowed to reflect in their economic cost.

The Government’s intervention in the sector needs to be rationalised to facilitate the market process with subsidies targeted at the poor and the really needy. The petroleum sector requires a comprehensive competition framework and not stringent regulations.

The prevailing tax structure needs an overhaul. The import-parity pricing regime should be dismantled and oil companies allowed to charge market-determined prices. A price stabilisation fund must be created to take care of spikes in international crude prices. A petroleum and natural gas regulatory board should be established to foster competition and ensure transparency in the determination of prices of petroleum products.

These measures will ensure that prices of petroleum products are determined by market forces — free from distortions. They will also help in determining the real extent of the subsidy burden, which is expected to be much lower.

The subsidy on LPG can be removed as it largely benefits the high-income group in the urban areas. All these measures will ensure lower burden on consumers.

A cautious approach is required in providing kerosene subsidies as nearly half the rural households use this fuel for light and heat. For better targeting, coupons may be issued with entitlement to purchase kerosene from a retailer at the subsidised price. This would discourage diversion of subsidised kerosene to other sectors.

A list of beneficiaries and local level agencies involved in monitoring kerosene distribution could be made public.