The seeds of the recent price hike, which does not envisage equitable sharing of the burden among consumers, oil companies and the government, were sowed in P. Chidambaram's last Budget, which realigned excise duties on petrol and diesel.
AFTER considerable dithering, largely because of pressure from its Left allies, the United Progressive Alliance government increased the prices of petroleum products, notably petrol and diesel, on June 20. Retail petrol prices in Delhi were increased by Rs.2.50 a litre, and diesel prices by Rs.2 a litre. Although the cooking fuels - liquefied petroleum gas (LPG) and kerosene - were spared, the higher-than-expected magnitude of the hike in the prices of the basic automotive fuels led to sharp reactions from the Left parties.
Parties from across the political spectrum condemned the move and organised protests across the country. Although these have now died down, the issues relating to the pricing of petroleum products remain alive as ever. In particular, the question whether the hike was justified remains open. Also, given that petroleum products constitute a basic input for the economy at large, did the government explore other options so that consumers could be spared the burden of the price increase? With global crude oil prices having increased sharply since the hike, the fears about further hikes are not without basis.
Over the last several months, the spectre of a fuel price hike had been looming. Reports in the business press had been clamouring for a price hike to protect the profits of the oil companies, private as well as public. More curiously, industry lobbies also advocated an increase despite the fact that a hike in prices would adversely affect many industries. Those urging a price hike based their case on two sets of premises. First, they pointed out that the continuing buoyancy in international crude oil prices required a realignment of retail prices. Secondly, it was said that the public sector oil companies, which were required to sell cooking fuels at below-market prices to consumers, had to be compensated for their mounting losses. Emerging out of the hour-long meeting of the Union Cabinet which debated the price hike on June 20, Union Minister for Petroleum and Natural Gas Mani Shankar Aiyer said that the hike was based on the principle that there ought to be an "equitable sharing of the burden" among the three main sections involved - the government, the oil companies and the consumers.
The Left parties, which issued an immediate rebuttal to the government, rejected the government's contention. In fact, they alleged that it had not done enough to protect the interests of consumers at large. Their case rested on three sets of arguments. First, in their perception, the Finance Ministry, rather than the Petroleum Ministry, was the motive force behind the move to hike prices. Dipankar Mukherjee, Rajya Sabha member belonging to the Communist Party of India (Marxist), told Frontline that the Finance Ministry regarded the petroleum sector as a "milch cow" (see interview). The second set of issues pertains to the manner in which prices are determined in the petroleum sector since the dismantling of the Administered Pricing Mechanism (APM) in 2002, when the Bharatiya Janata Party-led National Democratic Alliance was in power. The liberal notion that the APM was an anomaly led to its replacement by a system based on what is referred to as the "import parity" principle. To sceptics, the increasing margins of the oil refining companies in the last few years - precisely at a time when global oil prices have soared - represents a serious anomaly in the existing pricing structure.
The third set of issues raised by the Left parties relates to the perception that the government has not explored other options before placing a disproportionate burden on consumers. In short, in their perception, there is no "equitable sharing" of the burden among consumers, oil companies and the government. The increase in consumer spending on fuel will allow the government to enjoy increased revenues and enable the oil companies to have greater headroom for profits.
Looking back, it appears that P. Chidambaram, Union Finance Minister, sowed the seeds for the present hike when he presented the last Union Budget. The Budget pared import duties on crude oil from 10 per cent to 5 per cent, while reducing rates applicable on petrol and diesel from 15 per cent to 10 per cent. It also reduced to nil the customs duties applicable on imports of LPG and kerosene. However, the excise duty on the two major automotive fuels, a combination of flat rates plus a specific duty in terms of rupees a litre, were realigned. The excise duty on petrol was realigned from the existing 23 per cent plus Rs.7.50 a litre to 8 per cent plus Rs.13 a litre. Similarly the rates for diesel were recalibrated from 8 per cent plus Rs.1.50 per litre to 8 per cent plus Rs.3.25 per cent per litre. In his Budget speech Chidambaram assured Parliament that "there will be no increase in the retail prices on account of the proposed excise duty rates." In other words, he claimed that the move would be revenue neutral.
When the price hike actually took effect, it did not take into account the supposed pressures emanating from international oil markets. In fact, Rs.2.20 of the Rs.2.50 hike in petrol prices, constituting 88 per cent of the increase, reflected the enhanced excise duties effected by Chidambaram in the last Budget. In the case of diesel only 70 paise of the hike amounting to Rs.2, was on account of higher global oil prices; this accounted for 35 per cent, while enhanced excise duties accounted for more than half the price increase effected.
Deposing before the Standing Committee of Parliament attached to the Union Ministry for Petroleum and Natural Gas, the Secretary in the Ministry said that the Finance Ministry had taken more than what it gave (through the reduction in import duties). In fact, he termed the alignment of excise rates as "revenue positive". The Ministry also informed the Standing Committee that the new rates would result in petrol being dearer by Rs.2.52 a litre and diesel by Rs.1.65 a litre. Interestingly, the magnitudes of the recent price hikes are fairly close to what the Petroleum Ministry expected as a result of Chidambaram's Budget proposals for 2005-06. This also bolsters the case of those who allege that the Finance Ministry tends to treat the petroleum sector as a cash cow.
Taxes of all kinds account for 57 per cent of the selling price of petrol; in the case of diesel more than one-third of the price paid by the consumer goes to the government in the form of taxes (Tables 1 and 2). Economists would generally regard a proportionate increase in the tax arising out of a corresponding rise in prices to be regressive. In other words, as prices rise, the government would literally make money out of the misery of consumers. The fact that the tax relates to a product whose demand is fairly inelastic to price changes in the short term because it is a basic input implies a mounting burden on consumers. The Union government's revenues from excise duties on petroleum, oil and lubricants (POL) amounted to Rs.40,151 crores in 2003-04. Collections from levies on POL accounted for almost 44 per cent of all revenues that accrued to the government from excise duties (Table 3).
In its Fifth Report submitted to Parliament in April 2005, the Standing Committee expressed "serious concern" about the Finance Ministry's proposal to mobilise additional revenues amounting to Rs.3,000 as a result of the changes in excise duties. It noted that the changes were being proposed at a time when international oil prices had reached an all-time high. It pointed out that this would not protect consumers from the "cascading effect" of rising global oil prices. It recommended that the additional resource generation planned by the Finance Ministry should be "neutralised" so that the promise of the Budget regarding "revenue neutrality is adhered to in letter and spirit".
THE other major argument cited by those campaigning for a "freeing" of prices is that the `partial' dismantling of the APM has resulted in losses to the public sector oil companies, which supply cooking fuel to consumers at below-market prices. There is a kernel of truth in this contention, and there is more to it. The fact of the matter is that the explicit subsidies from the Union Budget for LPG and kerosene have declined sharply. The fiscal subsidy on kerosene declined from Rs.2.45 a litre in 2002-03 to Rs.0.82 in April-December 2004. During the same period the subsidy on LPG fell from Rs.67.75 a cylinder to Rs.22.58. Obviously, this burden has been increasingly placed on the public sector oil companies. The Left parties have pointed out that although the oil companies' contribution to the exchequer increased from Rs.46,603 crores in 2001-02 to Rs.69,195 crores in 2003-04 - an increase of almost 50 per cent - the government has failed to bear the burden of these subsidies instead of transferring them to the PSU oil companies.
The main reason for the pressure on the oil companies has been the dismantling of the APM. The APM, a creature of the environment that prevailed after nationalisation, essentially guaranteed profits of 12 per cent to the oil companies after applying normative criteria for costs. However, the problems associated with the pricing system that has replaced the APM are even more problematic. Fundamentally, the new pricing system has significantly skewed the balance against the publicly owned oil companies. It is an open secret in the markets that the new rules of the game have offered tremendous advantage for the biggest private refinery in India, operated by the Reliance Industries Ltd. (RIL).
The oil refining companies, particularly those with standalone refineries, have benefited the most from the new pricing regime. Dipankar Mukherjee regards the "import parity" principle that is at the heart of the current pricing structure as being not only being irrational but one which defeats the very purpose of achieving self-reliance in the petroleum sector. Although India is entirely self-reliant in petroleum refining, the application of the import parity principle results in refined products being treated as if they are imported when, in fact, they are produced within the country. This results in the padding up of prices, which oil refining companies are allowed to charge.
This explains the sharp increase in refining margins in the last couple of years. RIL's refining margins have been especially buoyant. They increased from $5 a barrel in the second quarter of 2002-03 to $8 a barrel in the second quarter of 2003-04; a recent report by a Mumbai-based investment analyst forecasts that margins would remain buoyant at least until 2007. Other refineries belonging to Bongaigaon Petroleum and Refineries, Chennai Petroleum Corporation, Kochi Refineries and Mangalore Refineries and Petrochemicals posted increases of more than 50 per cent in net profit in 2004-05 when compared to the previous year. The oil marketing companies, on the other hand, were hit hard with the net profit of BPCL, HPCL and Indian Oil Corporation declining between 30 and 73 per cent in 2004-05.
Dipankar Mukerjee believes that the windfall profits of the refineries has been caused by the pricing structure that has replaced the APM. The Petroleum Ministry is also reported to be making moves to get RIL to participate in the effort to cut the losses of the oil marketing companies. The revenue loss of the public sector undertakings in the April-June 2005 quarter is reported to be about Rs.4,300 crores for petrol and diesel, and Rs.5,000 crores for LPG and kerosene. Indian Oil Corporation, the country's biggest oil company, will for the first time close a quarter with losses of around Rs.1,000 crores even if upstream companies - the Oil and Natural Gas Corporation, Oil India and Gail India - share IOC's under-realisation. The company will lose Rs.3,000 crores on kerosene and LPG during the quarter while its losses on petrol and diesel will be Rs.2,000 crores. IOC has already asked the government to direct upstream companies to share 50 per cent of the revenue loss in the April-June quarter. Reliance does not suffer from any of these problems because its marketing presence is rather limited; in any case its backward linkages to oil prospecting and exploration enable it to preserve margins. Of course, the fact that it does not have to supply LPG and kerosene at subsidised prices, unlike its PSU competitors, has also helped. Critics of the fuel price hike have argued that there is a strong case for transferring resources from entities which have made super profits because of the anomalies in the pricing structure.
Successive reports of the Standing Committee of Parliament have called for the establishment of a price stabilisation fund, using the cess that the ONGC and Oil India Ltd. pay at the rate of Rs.1,800 a tonne to the government. Although the government has collected more than Rs.50,000 crores as cess, very little has gone towards the development of the oil industry, which was the primary reason cited for the collection of the cess when it was introduced about three decades ago. Most of the money collected has gone into the Consolidated Fund of the government.
The Left parties have suggested that annual collections from the cess of about Rs.5,400 crores could be used to establish the stabilisation fund. Moreover, the government could also have avoided paying export subsidies to the tune of Rs.1,200 crores to private refiners, notably Reliance. These measures would have enabled the government to avoid placing the burden of a hike in prices on the consumers.