Petroleum Pricing in India

Economists are fond of saying that inflation is a tax on poor. Inflationary pressure in the economy is persistently strong despite measures taken by RBI by hiking Repo rate thirteen times since March, 2010 to curtail prices. Still, inflation persists near double digit mainly on account of the fact that inflationary situation in India can’t be understood only from the demand side as often articulated by government in power. The normal logic offered is that since the nation has been witnessing reasonably high growth despite global economic downturn, people income level is consequently on the rise resulting in demand-supply mismatch. The excessive demand in the economy thus is resulting in demand push inflation.  Supply side pressure including cost-push inflation is generally not factored into such logic though it too has its share in explaining the situation of inflation in holistic way. Deregulation of petrol prices has resulted in its price being hiked five times in last one year. Similarly, prices of diesel, kerosene and LPG too have been raised few times. Such measure certainly adds to cost push inflationary pressure in the economy.

No net losses to public sector petroleum companies   

The hike in prices of universal intermediateries like petrol and diesel has not certainly assisted in controlling price spiral. Hiking in prices of petroleum fuels in India is generally justified in wake of prevailing high levels of crude oil at global level.  Pranab Mukherjee has been on record explaining the need for increase in prices of petrol as, “Our annual requirement of petrol is 106 million ton, of which we produce only 32 to 33 million tons and need to import the rest. The financial health of oil companies is such that they won't be able to import if they are ailing. Their under recovery has increased. The total loss for BPCL and HPCL between April and September 2011 was Rs 12,000 crore. IOC is also in the red. I made a provision of Rs 50,000 crore as subsidy but the under recovery has shot up to Rs 78,190 crore. The average price in 2010-11 was 85 USD per barrel. Today it is 110 USD. So the underecovery is going to be 1.32 lakh crore. This is the problem." Despite all this talk of hit on the financial position of public sector oil companies the upstream pubic sector ONGC net Profit during the half yearly period ending on Sep 30, 2011 for the fiscal 2011-12 is still above Rs. 13,000 Cr, that is more than the combined loss of downstream public sector companies like HPCL, BPCL etc. At the same time it should be understood that high levels of ‘under-recoveries’ of oil companies on the basis of which the argument is generally built on to raise fuel prices are not “LOSS” as generally understood. The pertinent point will be elaborated later but for the time being it would suffice to put forward the position as fortnightly statement from the Ministry of Petroleum and Natural Gas brought out on October 18, 2011 puts it, “under recovery is the gap between the desired price and the actual selling price of petrol. The desired price is not calculated on actual costs.” 

Link between Energy security and Human development measures

Kirit Parekh and other committees set up on the issue of fuel pricing after the release of the report-Integrated Energy Policy in 2006 have argued for deregulation of prices  of petrol, diesel and LPG. They have also argued for better targeting of subsidies for BPL households in case of LPG especially. Fuel pricing in India is intrinsically linked with the question of ensuring energy security for more than 70 percent of the population of the country. Energy security on its part is organically linked with the pertinent task of improving human development measure as the access to energy assists in providing other essentials of life. At present the nation lags on this front.  None of these reports look at how unmet demand and lack of access to modern commercial energy have an impact on inclusive development, and its core components such as, health, education, infant and maternal mortality, gender equality and livelihoods. Greater access to commercial energy remains essential to each of the foregoing elements of inclusive development and an improved Human Development Index (HDI). Despite a period of high sustained gross domestic product (GDP) growth, India’s HDI has slipped eight notches to 134 among 180 countries. India at present sits feebly at 67^th position among 88 countries on Global Hunger Index.  Any reform in pricing of petroleum products must necessarily address taxation of petroleum products by rationalizing it. It will assist in providing access to energy resources for greater masses of the country.  To ensure this it is crucial that fuels are priced in such a way that it is affordable for larger masses of the country. India is an energy deficient country. Per capita commercial energy consumption in India is under 5% that of the US, under 26% that of China and under 22% of the world average.

Petrol pricing in India

With the constant doses of neo-liberal agenda by successive governments in India becoming a permanent feature government of India announced in 2010 that petrol process will be deregulated. This will allow oil marketing public sector companies to set of prices of petrol on their own. In this context it will interestingly to see how prices of petrol are determined in India presently after deregulation of petrol prices. Singapore spot market, not production costs, is driving Indian petrol price presently. The notional loss of ‘under-recoveries’ is also determined from the prevailing prices of petrol in Singapore spot market.

A strange world of petroleum pricing exists in the country. A world where the laws of economics regarding how even prices are determined even in market based mechanism is turned on their heads, where there is no competition between the different players involved and where the price that we pay for petrol (or for that matter diesel or aviation turbine fuel) has no resemblance whatsoever to  their cost of production. The world of petroleum pricing is complex world of assumed prices and their derivative concepts such as “under-recoveries.” The oil companies adopt a bizarre pricing policy that is linked neither to their costs nor to the competition in the market. The prices of the products that they sell in the domestic market are driven by the prices of the same products in the global markets; currently domestic prices are determined by the price swings in the Singapore oil market. This is unlike in any other industry. Let's take the case of steel. The price of finished steel produced by an Indian company will be determined by its cost of raw materials such as iron ore and coking coal, the cost of power used to produce the steel plus other items of cost such as salaries and other overheads. The competition that the company faces in the market will determine how much margin it can add to this cost base. The oil companies simply take the price of petrol in the Singapore market, apply the rupee-dollar exchange rate to that price, add other costs such as freight and import duties and insurance, there comes the price that they should charge domestic consumers. Interestingly, not a litre of the petrol that these companies sell in the market is imported from Singapore; they are all produced here in their own refineries. Now, the problem is that most often the price that they so arrive at have no relation to the prevailing domestic retail price, which is invariably lower. Thus is born the concept of “under-recoveries,” something that is unique to our oil companies.

One should note that they don't call this loss, simply because it is not a loss. A loss will be caused when a company is forced to sell a product below its cost of production. In this case, we have no idea what the cost of production is for petrol or diesel or, for that matter, any petroleum product. Under-recoveries are therefore bogus numbers that bear no resemblance to reality. Yet, pricing decisions for the domestic market are based on these numbers. A careful reading of the statements that the oil companies put out whenever prices are revised will be enlightening. Here is an extract from the latest one released on November 30. “Review of international oil prices and INR-USD exchange rate of relevant fortnight for prices effective 01.12.11 brings out a further downtrend in international oil prices and a further weakening of the exchange rate. Thus, while petrol international prices have moved down significantly from $116/barrel approx. to $109/barrel approx., the exchange rate has deteriorated from Rs. 49.32/USD to Rs 51.50/USD. The combined impact of the two factors is an over-recovery of Rs. 0.65/litre. It has therefore, been decided to revise the petrol prices downward by Rs.0.65/litre (excluding state levies) w.e.f 1st Dec. 2011.” Simply put, what this statement from Indian Oil Corporation says is that petrol prices have dropped in the global markets and despite the depreciation in the rupee, there is still room to reduce the domestic retail price. Of course, it goes without saying that if there is a rise in petrol price in the Singapore market and the rupee continues to depreciate, domestic prices will be revised upwards. The question is: why should we in India pay for petrol a price that has no resemblance to either the cost structure of Indian Oil (or Hindustan Petroleum or Bharat Petroleum) or to competition in the market? Prices in Singapore dance to various tunes ranging from fundamental reasons such as consumption levels by countries in the region or shutdown of refineries or pipelines to market-related reasons such as levels of speculation and money flows into the commodities market. How are we in India affected by these when we do not import a litre of petrol or diesel from Singapore? A senior official in a leading oil company concedes that this model is flawed and interestingly, says his company is all for a cost-plus pricing structure with competition between the three oil retailers — Indian Oil, Hindustan Petroleum and Bharat Petroleum. The collusive pricing policy of the oil companies is an anti-competitive practice and has come under the radar of the Competition Commission in the past. When governments says it is suffering huge deficits due to ‘under-recoveries’ it is basically putting only half truth in public domain. Petroleum sector in India is having highly skewed tax structure. It would be cleared from the break up of petrol and diesel prices as is given in table below. The tax component is almost half of the total retail price in case of petrol and one-third in case of diesel. 

 It is to understand that that there are no net subsidies in the petroleum sector even inclusive of the erroneous “claimed” under-recoveries. For example, the total tax receipts of government from taxes levied on petroleum sector was Rs 1,61,798 Cr in financial year 2008-09 in compared to combined figures of subsidies and under-recoveries to the tune of Rs 1,05,980 Cr. Thus, the total tax collected from the petroleum sector by the central and state governments is a multiple of the combined fiscal subsidies and the claimed under-recoveries. It’s like saying that what the government is giving away to people with one hand it is taking away from the other.

  

Parikh committee recommends that the subsidies on LPG should be restricted to BPL category. It is basically twisted way to state that whatever little subsidy is still there should also be done away with. This is because how many BPL households in India use LPG? In any event are all above the poverty line (APL) families so prosperous that they can do without subsidies?

Comparison with other countries

There is yet another myth that permeates the Parikh Committee and indeed most government propagated discourse that prices of petrol and diesel is low in India. Petrol and diesel prices are made up of the base price for the fuel and the taxes/levies imposed by the central and the state governments. Even if one agree with the Parikh Committee that the international price of a traded commodity such as oil and oil products should prevail. The problem is that the committee completely ignores the fact that the taxes, that are domestically imposed, must reflect the purchasing power parity (PPP) of the host country. If one see the comparative figures one will find that petrol prices in India is among highest in the world if compared on purchasing power parity with other countries

Attempt to benefit private refiners in pretext of deregulation

India is dependent on imported crude oil to the extent of 80% even to meet domestic needs. Yet, India has promoted surplus refining capacity that exceeds domestic demand by some 35%. The value addition in refining is minimal with raw material (imported crude oil) accounting for over 90% of the product price. The surplus refining capacity was created on the back of multiple subsidies disbursed selectively. The surplus refining capacity was justified on the pretext of promoting export-oriented refineries. And due to this indeed petroleum products have emerged as India’s largest export in recent years– an activity known for yielding small, and sometimes, negative margins? But what India has been exporting is not added value but the subsidies to the refiners funded by Indian taxpayers. Such subsidies over the years from government exchequer to firms like Reliance only succeeds in turning public expenditure to private profit in the pretext of promoting exports. In light of this, the government decision to regulate petrol prices is bad for the country and worse for the aam aadmi. Bad for the country because this effort at deregulation appear to be driven by the desire to allow private sector refiners, originally set up for export of products, an entry into the domestic market under the garb of liberalising price of petrol and diesel. This would be detrimental to the public sector refiners in the current context.

Thus the government should immediately role back its decision to deregulate petrol prices to control prevailing price spiral which is hitting the poor masses of the country badly. It should also work on rationalizing tax structure on petroleum products especially in the context that cascading effect of such high level of indirect taxation on universal intermediaries like diesel and petrol will increase inflationary pressure further at the cost of aam aadmi of the country.

By Saurabh Naruka