Price hike in the pipeline

Duties and levies of the governments account for over half of the retail selling price of petrol. - SONDEEP SHANKAR/BLOOMBERG NEWS

The Central government is clearly waiting for the Assembly elections to be over to increase the prices of petroleum products.

OUTSOURCING an intractable problem to an "expert" committee is often the preferred choice of governments. Doing this enables governments to maintain the pretence of obtaining an independent, objective assessment, while actually pursuing a predetermined but controversial course.

The United Progressive Alliance (UPA) government has repeatedly threatened to increase fuel prices but has been restrained by its Left allies. The government can now cite the recent report of the Committee on Pricing and Taxation of Petroleum Products headed by C. Rangarajan, Chairman of the Prime Minister's Economic Advisory Council, to justify its trigger-happy intentions.

It would appear that the sharp increase in international crude oil prices, from about $40 a barrel in late 2004 to the current level of more than $60 a barrel, leaves the government with no other option but to increase prices. But arranging the facts in this manner only obfuscates matters. Obviously, if the prices of petroleum products are to be kept in check, because they are a basic raw material for the economy and in order to protect consumers, other options have to be considered instead of pleading helplessness in the face of buoyant prices in the international market. The Rangarajan Committee, instead of correcting systemic anomalies, merely attempts to fine-tune a badly flawed regime.

The overarching importance given to the mantra of "revenue neutrality", a critical ingredient of fiscal fundamentalism, tied the hands of the committee in its search for a solution. The government's excessive reliance on the petroleum sector for revenues explains its unwillingness to consider options that would be obvious to many. In 2004-05, almost one-fourth of the customs duty collections amounting to Rs.56,000 crores came from the petroleum sector; moreover, 43 per cent of all excise duty collections, amounting to Rs.1,00,720 crores, came from levies on the petroleum sector.

There is much truth in the "no gain without pain" principle. If consumers - or the economy at large - are to be given relief, the government needs necessarily to forgo revenue collections. The "revenue neutrality" principle closes this option. Although customs and excise duties have been cut in the last few years, the increase in prices and the increase in the consumption of petroleum products have resulted in the government mobilising an increasing proportion of its revenue from this sector. Indeed, the perverse logic of the situation is such that the government would actually welcome an increase in prices simply because it would gain more revenues.

The Rangarajan Committee points out that the sharp increase in the prices of "sensitive petroleum products" such as liquefied petroleum gas (LPG) and kerosene, distributed through the Public Distribution System (PDS) has resulted in subsidies climbing to "unprecedented levels". The panel observes that the subsidies on these two key cooking fuels amount to Rs.26,000 crores-Rs.15,000 crores for kerosene and Rs.11,000 crores for LPG. Since the government finances only 13 per cent of the LPG subsidy through its Budget, the burden of the subsidy has fallen on public sector oil companies. The panel observes that this not only leads to a fiscal problem but affects the vitality of the publicly owned companies involved in oil exploration, refining and marketing. Since oil prices are unlikely to soften in the near future, the panel said "an immediate adjustment of prices and subsidies is an immediate imperative".

Targeting, that familiar device of choice of the subsidy-bashers, is recommended as a means of slashing the subsidy on kerosene, the main fuel of the poor. Making only those families below the poverty line (BPL) eligible for subsidised kerosene would result in the kerosene subsidy being slashed by about 40 per cent.

In fact, the hardline stance of the committee is surprising and potentially controversial. It mandates that the Planning Commission's controversial criteria for the identification of BPL families, instead of those based on enumeration by State governments, will prevail in identifying families that will be able to avail themselves of the kerosene subsidy. This is sure to raise a controversy.

The committee also views the removal of the LPG subsidy as an "urgent imperative". It suggests that "an immediate one-time" hike of Rs.75 a cylinder is necessary and that this needs to be followed up by regular revisions to close the gap between subsidised and actual prices, now amounting to Rs.171 a cylinder. It reckons that its suggestions on targeting and cutting subsidies will reduce the bill by almost Rs.11,000 crores.

Most people would be aghast if they understood how petroleum prices are actually set in India. India is self-sufficient in refining crude oil for conversion to petroleum products. Since the dismantling of the administered pricing mechanism (APM) in 2002, prices are determined using the import parity principle. This is a purely notional price, arrived at on the basis of the assumption that petroleum products are imported. The notional price includes the free onboard price, ocean freight, insurance, exchange rates, customs duties, losses during transit, and port charges. Further, the retail selling price that consumers pay includes the cost of transport from the depot to the retail outlet, the marketing cost, the margins of the oil companies, State-specific taxes and duties, dealers' commissions and other charges. As the accompanying graphic shows, taxes, duties and levies of the Central and State governments account for more than half the retail selling price that consumers pay for fuels.

The Parliamentary Standing Committee on Petroleum and Natural Gas, which evaluated the import parity system of pricing, observed in its report of August 2005 that it "artificially inflates the price of petroleum products." It pointed out that the system was "irrational and far-removed from reality" because prices were arrived at on the basis of "assumed costs". It urged the government "to scrap the method" and adopt "a more realistic method". The import parity principle, in effect, enables Indian refining companies to import inflated prices which bear no relation to the actual cost of production in the country. The sharp increase in international crude oil prices has enabled Indian refiners to earn a bonanza.

However, the oil-marketing companies, particularly the public sector companies Hindustan Petroleum Corporation Ltd (HPCL) and Bharat Petroleum Corporation Ltd (BPCL), are at a disadvantage because they have small refining capacities. The biggest gainer was obviously Reliance Industries, whose stand-alone refinery with a capacity of 33 million tonnes a year is the biggest refinery in India.

The notional method of pricing petroleum products obviously overstates the "losses" of the public sector oil companies. It is important to differentiate between losses and "under-recoveries" of the oil companies. The latter is purely notional since they relate to the notional price that the companies could charge if they were free to do so. Actual losses, on the other hand, are real. The confusion deliberately created by the free interchange of the two terms in much of the financial media makes the situation appear far more alarming than it actually is. The Rangarajan Committee estimated that the "under-recoveries" of the oil companies will amount to Rs.39,704 crores in 2005-06. But the actual losses amount to only about Rs.3,000 crores, mainly confined to three public sector oil-marketing companies, HPCL, BPCL and IBP.

Reliance enjoys several advantages that are not available to the public sector companies. First, since it does not have to sell subsidised LPG or kerosene through the PDS there is no question of making losses on such operations. Secondly, it does not have to pay cess on crude oil unlike public sector oil exploration companies such as the Oil and Natural Gas Corporation (ONGC) and Oil India Ltd. In fact, the recent Union Budget increased the cess on crude from Rs.1,800 a tonne to Rs.2,500 a tonne. Simple calculations show that the cess at the new level amounts to $7.77 a barrel. This implies that the cess that ONGC, the principal oil exploration company in India, will have to pay is about 13 per cent of the international price of crude oil, a margin that would wreck any commercial undertaking. One wonders what would happen if the cess is hiked to Rs.4,800 a tonne, as has been recommended by the Rangarajan Committee. Since the New Exploration Licensing Policy (NELP) spares private oil exploration companies from the cess, an increase in the cess skews the field even more for ONGC vis-a-vis the private players.

Thirdly, Reliance, unlike the public sector oil companies, exports nearly one-third of its refined output and in doing this enjoys substantial tax benefits. For instance, the parliamentary committee's report showed that the government spent nearly Rs.2,700 crores in 2004-05 on advance licence benefits, a subsidy for exporters. Reliance, by virtue of being by far the biggest exporter of petroleum products - it exported one-third of its output in 2004-05 - was the biggest beneficiary of this subsidy: it received almost 60 per cent of the subsidy that was paid by the government to exporters of petroleum products. Kerosene and LPG consumers can well ask why the government wants to cut subsidies on the major cooking fuels ruthlessly when the biggest private exporter is provided incentives to export.

Dipankar Mukherjee, a member of the Parliamentary Standing Committee and widely regarded as the Left's expert on the petroleum sector, asks: "Why has the government ignored the recommendations of the parliamentary committee? Is it of a lesser value than the Rangarajan report?" He pointed out that the three main "stake-holders" - public sector oil companies, the government and consumers - found no representation in the Rangarajan Committee. "The imprint of the Finance Ministry can be clearly seen in the committee's outlook and its recommendations," he observed.

It is obvious that political compulsions, particularly forthcoming elections in several States, have restrained the Finance Ministry acting immediately on the panel's recommendations. But consumers can be sure that when these are out of the way, and when Parliament is not in session, prices will be set ablaze again.