The Hindu Business Line : Increase in prices of auto fuels

The recent decision of the Union Government to increase the prices of petrol and diesel does not come as a surprise given the steep rise in the global crude price, currently hovering around $100/barrel. The decision has been taken after months of deliberation and discussion.

This increase comes in the backdrop of the huge losses sustained by the Oil Marketing Companies (OMCs) ever since crude began its upward price spiral in the second half of 2007. It has been reported that currently the OMCs are losing more than Rs 200 crore per day because of increasing under-recoveries on sale of petroleum products.

This, coupled with the rising subsidy burden of LPG and kerosene (distributed through the PDS), has significantly shrunk the margins of these companies.

The Government believed that the situation could not be left as it was and that it warranted an increase in the retail prices of auto fuels. But was this the only option available to the Government?

Over the years, the Government has been trying to tackle this problem in a number of ways, other than by increasing the prices of auto fuels.

The first is by issuing oil bonds to OMCs to compensate for the under-recoveries on sale of petroleum products.

While this option has been exercised by the Government quite frequently in the past, the move is no longer seen by OMCs as a remedy due to the problems faced by them in liquidating these bonds, often resulting in sale of these bonds at a discount.

Further, OMCs can monetise only 25 percent of the total bonds in their portfolio during a quarter, resulting in higher borrowings by them to meet their working capital requirements.

It is also argued that issuance of these bonds worsens the fiscal deficit situation for the Government.

Another way of reducing the burden of under-recoveries on the OMCs is extending discounts to the OMCs from the upstream companies.

However, there are natural limitations on the extent of burden that can be passed on to upstream companies.

Rationalising taxes

This leaves us with the last option, which is using ‘taxes’ as a tool to control the prices. Taxes constitute a significant portion of the total cost of petroleum products (including auto fuels).

As per an estimate, currently, the entire gamut of taxes, right from Customs duty on crude, to excise duty on auto fuels, and including entry taxes levied on movement of petroleum products, make up more than half the price of petrol, and nearly one-third the price of diesel.

Excise duty constitutes a major part of the price of petrol and diesel. The duty is levied on petrol at 6 per cent + Rs 13 per litre on petrol; and 6 per cent + Rs 3.25 per litre on diesel.

Further, States are levying VAT, which is usually levied at the rate of 20 per cent or more for auto fuels. Some States also levy entry taxes on crude oil as well as auto fuels, which add to the overall tax cost.

In the above backdrop, there are many who believe that the Government could have opted for reduction in duties and taxes; particularly the ad valorem portion of excise duties and Customs duties on import of crude.

Analysts argue that in a tax-free world, a crude price of $90 per barrel corresponds roughly to a petrol price of about Rs 26 per litre, while a crude price of $150 per barrel would correspond to Rs 41 per litre, assuming moderate refinery and retail margins.

These prices are still way below the prevailing retail prices of petrol. Therefore, there certainly appears to be a long-term cushion against increasing oil prices, provided the Government can find ways to offset the lost revenue once it lowers taxes.

Lost revenues

From the Government’s perspective (Centre as well as States), it means foregoing part of the assured tax revenues.

The stakes appear to be very high, considering that the taxes on auto fuels consist of nearly one-third of the total indirect tax revenues.

It is also widely believed that during times of persistent price increase, the ad valorem levies further aggravate the burden for the OMCs or the end-consumer. It is argued that ad valorem levies result in the Government benefiting through higher tax yields at the expense of the consumer.

Does it call for removing the ad valorem component altogether and replacing it with an increased specific levy at both the Centre and the State levels?

In fact, this move was recommended by the Rangarajan Committee on Pricing and Taxation of Petroleum Products way back in February 2006, much before this crisis emerged.

Perhaps it is time to formulate a long-term strategy on this issue, which may be a combination of all the above measures discussed.

It would be interesting to see if the Government comes out with some concrete proposals in the forthcoming Budget, particularly on the tax and duty structure on the petroleum products.

It also remains to be seen whether petroleum products would be covered within the ambit of GST regime, proposed to be introduced from April 1, 2010.

(The authors are Director and Manager, respectively, Indirect Tax, KPMG.)