The Hindu Business Line : No soft options to stem the barrelling oil crisis

The same old “package” of reduction in taxes and duties, issuance of oil bonds and higher subsidy sharing by the upstream oil companies will not work this time around. Only increasing the retail prices of petroleum products will.

Will the Government go the extra mile?

Raghuvir Srinivasan

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The Government’s options are fast running out with every passing day of rising oil prices. Sooner than later, it will have to bow to the market and increase retail prices of petroleum products especially that of transportation fuels. The last time that retail prices were tinkered with was in February, when global oil prices were at $95 a barrel. Today, oil trades at $133 a barrel. Surely, retail prices fixed then cannot hold now after crude oil prices have risen 40 per cent.

That the Petroleum Minister, Mr Murli Deora, has already met the Prime Minister, Dr Manmohan Singh, twice in two days tells the tale. But sadly, despite these meetings at the highest level what we now hear is more of the same when it comes to options before the Government to handle the crisis.

It is the same old “package” of reduction in taxes and duties, issuance of oil bonds and higher subsidy sharing by the upstream oil companies, Oil and Natural Gas Corporation (ONGC) and Oil India Ltd (OIL). The option of increasing the retail price seems to be the least favoured one, but economically speaking it should rank at the top of the weaponry to combat the crisis.

Options other than an increase in retail price may have worked when oil was at sub-$100 a barrel. Indeed, successive governments have employed options such as oil bonds successfully at many stages of the journey of oil prices from around $30 a barrel in the early part of this decade, to now. But those options may not work in the current context given the unbelievably large disconnect between what should be the prices of products such as petrol, diesel, cooking gas and kerosene and what they actually are now (see tables).

Let us examine each of the options that the Government is considering now to see why there may not be an alternative to increasing retail prices.

Reduction in taxes and duties

The Petroleum Ministry is pitching for a reduction in the large component of taxes and duties in retail prices of transportation fuels. For instance, taxes and duties account for about half the retail price of petrol and 27 per cent that of diesel in Delhi, where local sales taxes are among the lowest in the country. The proportion of taxes will be higher in cities such as Mumbai, Kolkata and Chennai where local taxes are higher than in Delhi.

Interestingly, despite the sharp rise in crude oil prices, the basic price of Euro III grade petrol at the refinery gate, exclusive of taxes, is only Rs 21.93 a litre. But excise duty, education cess and local sales tax add up to Rs 22.37 a litre (Delhi prices)! So, the governments’ (Central and State) mark-up is more than 100 per cent in the case of petrol.

In addition to the taxes and duties on products is the 5 per cent customs duty on crude oil itself. Considering that it is on ad valorem basis, the Centre is reaping a windfall in customs duty earnings for no special effort on its part. This has obviously caught the eye of the mandarins in the Petroleum Ministry who are now gunning for abolishing the duty on crude altogether.

The Central Government earned a whopping Rs 71,000 crore in 2006-07 from taxes and duties on petroleum products and crude oil. The windfall earnings sticks out like a sore thumb in these turbulent times for consumers and oil companies and is, therefore, a prime target for reduction. But the question is: Will the Finance Ministry accede to the demand?

It may not be easy to convince the Finance Minister, Mr P. Chidambaram, to reduce duties given that they constitute a big chunk of the overall indirect tax revenues of the Government. Only in the last Budget, Mr Chidambaram had switched to specific excise duty from ad valorem on petrol and diesel.

Even assuming that the Finance Ministry agrees to a reduction in taxes, it may not make a major difference to the consumer because sales tax accounts for a large chunk of the retail price of petrol and diesel. And sales tax is the preserve of the respective State governments.

Herein lies the crunch. Will the Centre be able to persuade State governments to reduce local taxes? After all, total earnings of all State governments from taxes on petroleum products was Rs 62,000 crore in 2006-07, only slightly lower than what the Centre earned by way of duties on these products.

Therefore, it is clear that tax/duty reduction can only be of minor benefit and that is after assuming that State governments will agree to reduce local levies.

Oil bonds

This strategy has been employed repeatedly by different governments in the last decade and is a convenient off-Budget finance option for the Government. But the problem with this option is that it has been overdone. There are already bonds outstanding to the tune of Rs 67,000 crore and together with fertiliser bonds they are assuming worrying proportions for the fisc. Some estimates suggest that these bonds could add 1-1.5 percentage points to the fiscal deficit.

Besides, oil companies are none too happy with bonds, especially because they don’t have SLR (statutory liquidity ratio) status which robs them of liquidity. Again, bonds do nothing to help the working capital position of the oil refining and marketing companies. They may artificially bolster the revenues and earnings of these companies but they certainly don’t boost the cash flows.

Thanks to the impact of all those bonds issued in the last two years oil companies are now big borrowers in the market. Total borrowings of the three big refining and marketing companies — Indian Oil, Bharat Petroleum and Hindustan Petroleum — is estimated at close to Rs 70,000 crore as of March 31, 2008, almost double that of the previous year.

Soon, these companies may be forced, if they already are not, to put their investment plans on the backburner which does not augur well for the long-term prospects of the country’s oil economy.

Sharing of burden

Upstream oil companies already share a third of the under-recovery burden, which is estimated at Rs 77,000 crore in 2007-08. ONGC coughed up a little over Rs 17,000 crore in 2006-07 as its share of the under-recovery burden. Interestingly, this was more than its net profit of Rs 15,642 crore for that year! The company realises roughly just half of the prevailing global crude prices for every barrel of its production, thanks to the subsidy and other royalties and duties.

For the first nine months of 2007-08, ONGC’s subsidy share of Rs 13,528 crore is almost as much as its post-tax profit of Rs 14,074 crore. With such a huge drain on its finances, how can ONGC, supposed to be the flagship exploration and production company, invest in exploring for oil or even for developing the fields that it has already discovered, such as the KG Basin deepwater gas fields?

Granted that ONGC is a cash cow but there is a limit to which even it can be milked. The under-recovery for the current fiscal is estimated at Rs 2,00,000 crore assuming current level of oil prices. It is inconceivable how ONGC and OIL can cough up an equivalent share again without a deleterious impact on their finances.

No choice but to raise

The choice, therefore, is very clear. Retail prices have to be raised and raised steeply to correspond to the global uptrend. A reduction in taxes and duties, if it happens, may help in reducing the price increase but there is no alternative to an increase itself.

The subsidy level has reached ridiculous proportions on products such as cooking gas and kerosene, especially. The subsidy on cooking gas at Rs 305.95 is more than the current retail price of Rs 294.75 (Delhi price) for a domestic cylinder!

Similarly, in the case of kerosene, the subsidy of Rs 28.72 per litre is three times the current retail price of Rs 9.09 per litre. Interestingly, the prevailing retail price of kerosene was fixed when crude oil was at $35 a barrel and it included a subsidy even then! Today, crude oil costs $100 more per barrel but kerosene prices are rooted where they were.

Clearly, this state of affairs is not sustainable and the Government cannot toy around with the fortunes of such a basic infrastructure sector as oil. There are enough arguments to justify why cooking gas prices need not be subsidised, and reams have been written on it.

There are also enough arguments why retail prices of transportation fuels need to be fully linked to the market, the most important being conservation of fuel and energy efficiency.

The current crisis presents the Government with an opportunity to wipe the slate clean by going for bold reform and freeing prices of petroleum products. Will it? That’s literally a million dollar question.

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