De-regularization of Fuel Prices in India

In India fuel prices are controlled by government. Although government announced the dismantling of Administered Price Mechanism (APM) effective 1st- Apr-2002 in order to move towards market determined prices for petroleum products, it has not taken off its hands from determining fuel prices. This intervention even after dismantling APM was due to unprecedented rise in crude prices since late 2003. Oil marketing companies (OMCs) such as Indian Oil, Bharat Petroleum & Hindustan Petroleum, which deal in refining & marketing activities of petroleum products, sell auto fuels & cooking fuels below prevailing international market prices. Estimates say OMCs will have under-recoveries of around Rs.45,000 Cr in this financial year assuming crude oil at $70 per barrel. Out of this Rs.15000 Cr will be on account of Auto Fuels (Petrol-Diesel), Another Rs.17000 Cr will be due to Kerosene & remaining Rs. 13000 Cr will be shaved off on account of LPG. Indian Oil (IOC), Hindustan Petroleum (HPCL) and Bharat Petroleum (BPCL) lose Rs 4.69 per liter on petrol and Rs 3.09 a liter on diesel. They sell LPG at a loss of Rs 158.55 per 14.2-kg cylinder and kerosene at Rs 17.15 per lit loss. These under-recoveries will be reimbursed in part by government in the form of oil bonds which would cover losses incurred due to Kerosene & LPG. So government has to issue oil bonds worth Rs. 30,000 Cr to OMCs. Some part of losses will be shared by upstream (e.g. ONGC) & downstream (IOC, BPCL, HPCL) companies. Government will try to offset losses of OMCs on Auto Fuels by asking companies like ONGC to sell crude oil & LPG to retailers (OMCs) at discounted rates. Still part of losses has to be taken care of by OMCs. Some help will come from Rs.3109 Cr which is provided under the head of Petroleum Subsidy in union budget 2009-10. Now let’s look at the other side of the saga. Government earns huge tax revenues from petroleum products in the form of customs as well as excise duties. In FY2008-09 total tax revenues earned from petroleum products was Rs.78373 Cr. If we assume those to be more or less on similar lines for the year 2009-10 as well then government seems to be in green. Tax rates in India on Petroleum Products are irrational. Petrol is highly taxed. Around 50% of the petrol price is made up of taxes if central sales tax & state sales tax are taken into consideration. Diesel taxes are relatively lower in comparison with Petrol. Around 30% of its price will be on account of various taxes. This is the prime reason for diesel consumption to have leapfrogged in India. Diesel forms 85% of the total consumption of auto fuels. Taxes on Kerosene & LPG form a tiny part of their prices. It has been so due to the government’s perception of kerosene & LPG as household’s cooking fuel – more precisely a fuel of poor people. So can Government of India continue with such kind of pricing in future? Is it sustainable? Let’s look at it -
Pricing of these products has always been a political issue than an economic one in India. Those having reins of the country always find it difficult to increase the prices as it has been considered as an unpopular measure. Some feel it will lead to an increase in prices of primary articles leading to a spiraling inflation. Many governments have reduced the prices when elections were just around the corner in order to cash in votes. Governments have set up many committees to formulate a strategy for pricing of petroleum prices, recommendations of which have been hardly implemented. With fiscal deficit looming large at 6.8% of GDP, is India in a position to continue such kind of Fuel subsidies? Government is set to borrow around Rs. 4,00,000 Cr from market to power its various initiatives. Such kind of mammoth borrowing will definitely lead to increase in interest rates. This will in turn affect capital expenditure plans of corporate sector as they will not get capital at lower rates. It will impede employment generation to some extent. De-regularization of fuel prices will help in reducing the ballooning fiscal deficit. Issuing oil bonds to OMCs was thought to be a financial innovation as it facilitates OMCs to cover up their losses & government is not required to pay upfront money as well. But it is anybody’s guess that government has to pay interests on the bonds issued plus at maturity principle amount also has to be returned back. Consider this as your children paying taxes for the petrol or LPG you have used. Does this sound rational by any means? The answer is big NO. Why Indian citizens should pay back, for fuels which we are using now, after 10 years? Is it because we should get fuels are discounted rates? Do people who really require subsidies getting any help by all this? Why people driving Mercedes & BMWs should get subsidies? Going forward - Why Indian middle class should get LPG at a discount of 158 Rs? Let’s churn this aspect out -
Let’s consider a household of 4 members with earnings of 15,000 Rs. per month. How much burden it will be on such households if LPG cylinder is made available at market prices? Is 158 /- Rs. such an enormous amount? Just imagine how much government can save through this. The way people having higher incomes do not get anything through Public Distribution Systems, they will not get LPG at subsidized rate if they fall in high income group. Government just needs to check pan cards of the gas applicants. I really don’t see any major hurdle in implementing this. Pyramid like subsidy structure can be followed for LPG if required. High the income lower will be the subsidy burden. Now let’s focus on petrol & diesel. Petrol & diesel prices are pretty much nearer to market prices. So those can be made fully in line with prevailing rates. But government has to shun its control from dictating prices to OMCs. OMCs should be given a total freedom to increase & decrease the prices at par with international prices. For e.g. when crude oil was boiling at 140 $ per barrel, government intervention to increase fuel prices came too late. At that time OMCs were losing around Rs.500 Cr a day. Such kind of losses affects health of the OMCs. They cannot go ahead with their expansion plans because of uncertainty of under-recoveries. If government de-regularizes these products even private players will come to the fore in retailing business. Then eventually we may get fuels at little lower rates due to competition. Refining companies like Reliance will try to sell products in India because they don’t have to export the same to get free market prices since selling in domestic markets will reduce their freight charges. De-regularization will automatically impact the demand of these products. It is said that people in India are poor so they are entitled to get subsidies. Simple statistics shows that fuel consumption increases with rise the per capita income. Subsidies are not targeted at people who are really poor because they are not using fuels in large quantities. Rich people use more fuels & more subsidies they get. This is not what government intends, Right?
No one likes hike in commodity prices. Human tendency is to use resources available in nature as tools to achieve economic progress. But the way we look at commodities needs to change a lot. These commodities are not available in unlimited quantities. There are going to be supply constraints in future. With current consumption rate we will consume all fossil fuels by 2040. We have not found fuels which can replace them. India imports 80% of its fuel needs. There is a need to maintain austerity. For e.g. If prices are made market driven then people who just manage to maintain cars may shift to public transport. It will modulate the demand of fuels. Government has to break its shackles & de-regularize the prices. It is time to think beyond politics for this issue at least.
Terms Used:
1) Administered Price Mechanism (APM): In an administered price mechanism Price of a good is specified by a governmental or some other nonmarket agency. Sellers are not allowed to sell goods as per supply-demand scenario.

2) Oil bonds: Bonds issued by Government of India to Oil Marketing Companies in order to compensate for losses which they have made by selling petroleum products at government dictated prices. OMCs sell these bonds to mutual funds, insurance companies and other such financial institutions in secondary market so as to get hard cash. Government of India has to pay annual interest rates & principle at maturity to the entity holding these bonds.

3) Upstream & Downstream Companies:
Upstream companies deal in searching of underground or underwater oil & gas fields, drilling of exploratory wells, and subsequently operating the wells that recover & bring the crude oil and/or raw natural gas to the surface.
Oil & Natural Gas Corporation (ONGC), Oil India Limited.

Downstream companies deal in refining of crude oil, and selling and distribution of natural gas and products derived from crude oil.
Indian Oil Corporation (IOC), Bharat Petroleum Corporation limited (BPCL), Hindustan Petroleum Corporation Limited (HPCL).

4) Petroleum Subsidy: Freight subsidy for far flung areas & other related compensation of Rs. 3109 Cr has been provided under the head of Petroleum subsidy in Union Budget 2009-10.

5) Custom & excise Duties: Custom duty is a tax which government imposes for any import into the country from outside. Excise duty is sales tax which government charges on sale of any good.

6) Inflation: It is a rise in the general level of prices of goods and services in an economy over a period of time. When the price level rises, each unit of currency buys fewer goods and services; consequently, inflation is also erosion in the purchasing power of money – a loss of real value in the internal medium of exchange and unit of account in the economy. A chief measure of price inflation is the inflation rate, the annualized percentage change in a general price index (normally the Consumer Price Index) over time.


7) Fiscal Deficit: When a government's total expenditures exceed the revenue that it generates (excluding money from borrowings) it is called Fiscal Deficit.
References:
1) Official website of Ministry of Oil & Gas, India :
http://www.petroleum.nic.in
2) News report in Economic Times : http://economictimes.indiatimes.com/articleshow/4998275.cms
3) C. Rangarajan Report of the committee on pricing & taxation of Petroleum Products : http://www.petroleum.nic.in/Report1.pdf
4) Union Budget 2009-10, Government of India :
http://indiabudget.nic.in/ub2009-10/eb/npe.pdf




Prasanna P. Vaidya
Prasanna.vaidya@gmail.com