Last January Finance
Ministry announced that they want to reduce Rs 18000 Cr of Subsidy Bill by
moving to export parity price for Diesel prices.
Every time there is price rise in the
petroleum products, there are more or less similar reactions from people,
media, and economists of our country. For many of us subsidy word is taboo,
when we ask private citizens who are either economist or intellectuals or folks
on twitter, all that we hear is that subsidy is bad and government should
reduce it as soon as possible.
We have been fed by government as to how much
subsidy been given by government on different petroleum products. However while
discussing subsidy on these petroleum products, no one really put a focus on
net contribution from petroleum sector to government exchequer and real reason
why government who is supposed not to interfere in setting up of petroleum
price continues to do so even after 10 years since moving away from APM
(Administered price method).
Following is quick summary of net
contribution government of India received from petroleum sector
Year
|
Net Contribution in Cr
|
Crude Price
|
Crude Consumption
|
2004-05
|
36249
|
39.21
|
120171
|
2005-06
|
23143
|
55.72
|
122353
|
2006-07
|
22506
|
62.46
|
131668
|
2007-08
|
1254
|
79.25
|
140699
|
2008-09
|
(32735)
|
83.57
|
145511
|
2009-10
|
25716
|
69.76
|
148415
|
2010-11
|
24427
|
85.09
|
156913
|
2011-12
|
(43312)
|
111.89
|
163494
|
Total
|
57248
|
Table 1: Net
contribution to Government exchequer
Net contribution to government exchequer has
always been positive, except for year 2008-09 and 2011-12. However it would be
unfair to club all the petroleum products under one bracket, government does
not offer subsidy on all petroleum products, but to certain products only viz.
Petrol, Diesel, LPG, Kerosene.
Figures
in Cr
Year
|
PDS SKO
|
LPG
|
Petrol
|
Diesel
|
Total
|
2004-05
|
9480
|
8362
|
150
|
2154
|
20146
|
2005-06
|
14384
|
10246
|
2723
|
12647
|
40000
|
2006-07
|
17883
|
10701
|
2027
|
18776
|
49387
|
2007-08
|
19102
|
15523
|
7332
|
35166
|
77123
|
2008-09
|
28225
|
17600
|
5181
|
52286
|
103292
|
2009-10
|
17364
|
14257
|
5151
|
9279
|
46051
|
2010-11
|
19485
|
21772
|
2227
|
34706
|
78190
|
2011-12
|
27352
|
29997
|
0
|
81192
|
138541
|
Total
|
153275
|
128458
|
24791
|
246206
|
552730
|
Table 2: Under recovery
by marketing company
So how does this net contribution to
exchequer being positive and ever expanding subsidy both fit together? This is
where we have to understand how petroleum products are priced in India and in
world at large.
Oil economy and its
importance in the world are unquestionable. Americans have been accused of
waging war to secure oil reserves and Arabs have been accused of becoming slum
dog millionaire. Oil production and consumption both has been cause of sorrow
and happiness for economist and government servants managing policy decisions.
Different countries have followed different fuel pricing formulas based on
various factors such as size of the country, geographical location, weather,
per capita income, industrial requirement, Import/Export requirement, balance
of payment issues…..list can go on.
What are the objectives of
Indian government governing fuel pricing policy and why should government
intervene at all in the market and set petrol prices? Vision and policy on
petroleum products can also be reference from http://www.petroleum.nic.in/vision.doc
, however I would like to bring something interesting to your notice. Expert committee under Chairmanship of Shri Kirit
S Parikh has observed in 2010 following
1)
To protect poor consumers so that they may afford kerosene for lighting
2)
To provide merit goods to consumers such as clean cooking fuels like natural gas,
LPG and kerosene to replace use of biomass-based fuels such as firewood and
dung.
3)
Another reason is to insulate the domestic economy from the volatility of the petroleum
prices on the world market. It is feared that complete pass through of
increase in world oil prices may cause inflation which may persist even when
oil prices come down.
4)
However major objective of the policy is to have efficient and competitive oil
economy that promotes efficient use by consumers, appropriate choice of
fuels among substitutes and a proper choice of technique
It is also interesting to note that Mr Kirit
Parikh was also instrumental in writing Integrated Energy policy in 2006 where
he discussed different methodology used in petroleum product pricing
·
Import Parity price
·
Export Parity price
·
Trade Parity price
Determination of petroleum price has never
been easy subjects world over, different countries have tried above methods or
variants of methods at different period and have evolved their petroleum
product pricing to suits requirement of country.
Chronology of petroleum products pricing in
India is as follows
·
Import
Parity Pricing (IPP) in pre-1975 era (Damle; Talukdar; and Shantilal
Committees)
·
Oil
Prices Committee (OPC, Krishnaswamy, 1974) – cost plus basis (also called
administered price mechanism or APM): crude oil cost + refining cost + 15 %
return on capital employed (RoCE)
·
Oil
Cost Review Committee (OCRC, Iyer, 1984) – revised the RoCE element to
weighted average of (a) cost of borrowing and (b) 12 % post-tax return on net
worth
·
Oil
Pool Accounts maintained by Oil Co-ordination Committee (OCC): Crude Oil
Price Equalisation (COPE) Account, Cost and Freight (C&F) Account,
Product Price Adjustment (PPA) Account
·
Dismantling
of APM, closure of oil pool Market Determined Pricing Mechanism (MDPM) – From
April 1, 1998, moved to adjusted import parity pricing for controlled (MS,
HSD, SKO, ATF, LPG) products. Prices / markets decontrolled for industrial
products (Naphtha, FO, LSHS, Bitumen, Paraffin)
·
MS
and HSD deregulated in 2002
·
Trade
Parity Pricing (TPP, Rangarajan, 2006) for MS and HSD (with weight of 80 %
IPP and 20 % Export Parity Price (EPP))
·
Continue
with TPP (Parikh Committee, 2010) for HSD, market determined pricing for MS –
Government takes an in-principle decision to move to market determined
pricing both at refinery gate and retail level for HSD at an appropriate time
|
Source: GOI 2006, GOI
2010a .Above information is compiled by M.
Mukesh Anand in paper Diesel Pricing in India: Entangled in policy maze
for National Institute of Public Finance and policy.
It is most important to note observation made
by Mr Kirit Parekh on setting up petroleum prices
“If prices are to be fixed by the government, that has to be based on some principle.
Prices can be
fixed based on pre-determined formula, which is derived from principles like
import parity
(IPP), trade parity (TPP), or export parity (EPP). This approach is also
fraught with major deficiencies. The formula often involves elements of
cost-plus. In an industry, which is continuously changing, a prescriptive and biased
cost-plus pricing formula requires continuous monitoring and periodic
adjustments in certain components of the formula. For instance, there is no
single or unique formula for import parity which is applied globally”
Although we have been importer of crude oil
but at the same time, over a period of time India has added extra refining
capacity which has helped India to become Net exporter of petroleum products.
For the year 2011-12 except crude oil and LNG, India has surplus export over
import[ii].
Coming back to price determination methods
lets us go through quick definition & Issues associated with it
Import Parity Price: Import parity pricing (IPP) is the policy of
pricing locally refined petrol on the basis of the cost of importing refined
petrol. IPP is simply the landed cost of obtaining refined product from
overseas refiners. When evaluating pricing, it is important to note that prices
at all stages of the petrol supply chain are heavily influenced by the landed
price of imported petrol into India, whether or not the petrol sold is actually
refined in India or imported. IPP based formula can be expressed as follows
IPP based price = bench mark price +
Quality premium + Shipping cost + Wharfage +Insurance & Loss + Custom Duty
|
Benchmark price is taken at Arab Gulf.
Impact of IPP based
formula pricing
Use of IPP based formula pricing has
downstream impact for petroleum product pricing all the way in supply chain. As
highlighted before India is net exporter of the petroleum products, IPP formula
is dependent on buy-sell arrangement entered into between oil marketing company
and refiner and importer. Although most of PSU Oil Marketing firm has their own
refinery, they still buy from each other in individual states based on the own refinery
capacity and market demand. Such buy-sell arrangements are generally on
bilateral basis and period of contract sometimes are anything between 6 months
to 12 months.
Just to give you example, Reliance and Essar
has stopped selling petroleum products out of their petrol pump but they
continued to supply to Govt PSU. One fifth of diesel sold through IOCL, HPCL,
BPCL is supplied by Reliance and Essar[iii]
Key Implication of such buy-sell arrangement
is that buy-sell arrangement which in turn impact IPP is based on notional cost
of imported product instead of actual cost of refined product from domestic
refinery. Refiner do not pay Arab Gulf benchmark price or incur cost associated
to quality premium, ocean freight, Insurance, or any such associated cost, but
all these components are paid on actual basis, based on the long term buy-sell
contract between refinery Oil producing company and Oil Marketing company.
Assumption for Import Parity Price is 1)
Domestic refiner has little motivation to refine unless it gets import price 2)
Buyer may not pay more for local production than imported one 3) Imported
products is alternative and there is no constraints on availability.
Till 2006 government continue to use Import
Parity Price formula pricing, however post Dr C Rangarajan committee report
government has adopted trade parity price formula with 80% weight to Import and
20% to Export.
While recommending trade parity principle
committee has also made following observation
Effectively government of India has adopted
trade parity price from 2006 our subsidy bill was 49387 Cr with Crude oil price
at 62.46 and at year end 2011-12 with crude price of 111.89 our subsidy bill
has gone up to 138541 Cr. Crude consumption was 131668 BBL in 2006-07 and
163494 BBL in 2011-12.
Export Parity Price: Export parity pricing (EPP) is the policy of
pricing refined petrol on the basis of the Value of product sold at a specific
location in a foreign country, but a valued from specific location of exporting
country. EPP is simply the CIF (Cost Insurance and freight) value of refined
product from overseas refiners minus freight and insurance cost. EPP based
formula can be expressed as follows
EPP based price = bench mark CIF price -
freight – Insurance
|
* I am yet to look at the finance ministry
export parity price calculation circular. Above calculation is generic concept
If you think that increase diesel price to
end customers like you and me is going to decrease subsidy amount, let’s look
at how much tax you and me pay and how much under recovery OMC incur. Finance
ministry wants to reduce diesel subsidy alone by 18000 Cr by bringing export
parity price on diesel. Increasing Retail selling price is bottom up measure to
reduce under-recovery and opting for export parity price is top down measure to
reduce under recovery to Oil Marketing.
Description
|
Diesel/Litre
|
LPG
|
SKO Kerosene
|
Retail Selling Price
|
48.15
|
410.66
|
14.96
|
Custom duty @ 2.58
|
1.13
|
Nil
|
Nil
|
Special Excise Duty
|
3.56
|
Nil
|
Nil
|
VAT
|
5.6
|
Nil
|
0.71
|
Total Tax included in Retail selling price
|
10.29
|
Nil
|
0.71
|
Under Recovery to Oil Marketing company
|
8.64
|
439.07
|
33.43
|
Net Contribution to Government
|
1.64
|
Nil
|
(32.72)
|
Trade Parity Price
|
44.29
|
N/A
|
N/A
|
Import Parity Price
|
739.30
|
45.69
|
|
Price Charged to dealers
|
37.90
|
373.41
|
12.95
|
Export Parity Price
|
42.49
|
N/A
|
N/A
|
Under recovery at Export parity price base
|
4.59
|
N/A
|
N/A
|
Total Under recovery for FY 2011-12
|
81192
|
29997
|
27532
|
Under recovery to Oil Marketing company is
calculated as difference between dealers price at depot minus trade parity
price/Import Parity price/Export Parity Price as the case may be.
In argument against export parity price, like
import price parity price, EPP is assumed cost to refiners or oil marketing
company. This is not actual cost of production to refiners or Oil Marketing
Company. Besides net contribution from 1 Litre of Diesel to government is still
1.64. That’s what I call Notional
Subsidy, we can very well see that subsidy (Under recovery to OMC) of Rs 8.65
on diesels is not really subsidy. If government really wants to put fewer
burdens on common man, it can very well remove all taxes on diesel and still
have net contribution to its exchequer. But it does not do that, may be it
impacts their tax to GDP ratio negatively. Off course out of Rs 10.29, Rs 5.6
is towards to VAT. VAT is part of state tax exchequer. As many say although
it’s called as VAT but in essence its nothing but sales tax, as there is input
credit is allowed for custom duty paid, which in a way impacts Gross refinery
margin. Proposed GST legislation might still leave out petroleum out of its
purview
Government is not same situation as far as
SKO (PDS kerosene) is concerned. Let me quote Report of expert group under
chairmanship of Mr Kirit Parekh in 2010
“The primary objective
of subsidizing kerosene is for lighting purpose. In the absence of electricity,
kerosene has, for long, been the only source of lighting (apart from more
expensive vegetable oil-based lamps).”
“Since kerosene subsidy
is going largely for lighting, the allocations should be reduced as more and
more BPL households are connected to the electricity grid. Such connections
under the RGGVY are subsidized and continuing kerosene supply to such household’s
amounts to double subsidy.”
“Only 1.3% of rural
households use kerosene for cooking. Among the poorest four deciles, less than
1% used it for cooking but 60% used it for lighting. As BPLhouseholds meanwhile
are connected to electricity grid under Rajiv Gandhi Gramin Vidyutikaran Yojna
(RGGVY), the percentage of BPL households using kerosene for lighting would
have been reduced substantially by now” (This data was collected in NSSO survey
2004-05)
Apart from highlighting
issue of double subsidy, it is important to note PDS kerosene is mainly for
lighting purpose. This ideally should have been addressed with appropriate policy
statement and implementation of the same in power ministry. There is additional
catch, “distribution of PDS kerosene has developed an inverse relationship with
the income levels of states, which needs to be rationalized. For instance, the
average per capita kerosene allocation in high income States in 2007-08 was
14.1 litres which was 41% higher than that of the low income States.”
We have spent Rs 153275
Cr since 2004-05 on subsidising PDS kerosene, which apparently is used not for
cooking but for lightning purpose. I wonder how many power plants could have
started with this money. (Power policy is different topic may be my next blogJ). In ideal world GOI
should build more power plants which in turn should reduce consumption of
kerosene, but when you look at the news such as this you understand why this
item never been removed from subsidy list (http://www.thehindubusinessline.com/opinion/columns/p-v-indiresan/perverse-policy-on-kerosene/article1162092.ece
and http://articles.timesofindia.indiatimes.com/2007-07-12/nagpur/27953279_1_kerosene-adulteration-racket)
On LPG front we have
seen in last year, government’s effort to put cap on number of LPG cylinders
customers can use and all the drama over who are eligible and not eligible for
cap of LPG cylinders.
Mr Kirit Parekh in his
report did mentioned that any effort to ration or limit number of cylinders at
subsidized price without “smart cards” will indirectly promote inspector raj
rather than effectively reducing subsidy. This is text book example of what
recommendation was and exactly opposite was done by government. Government’s
approach to reduce subsidy on LPG seems to put under UID scope and try to
provide LPG cylinders to BPL families at discounted rate.
Just to summarise for especially
for the readers like me J who
doesn’t want to read through ABC of Fuel pricing policy & Notional Subsidy
here is quick summary
·
Net contribution from Petroleum products to government to exchequer has
generally been positive except for year 2011-12 and 2008-09
·
India might be Crude Oil Importing country, but it is petroleum product
exporter country.
·
Import parity price or trade parity price is not really suitable for
India because it increase notional cost for price calculation base.
[i] http://articles.economictimes.indiatimes.com/2013-01-28/news/36596639_1_petrol-and-diesel-import-parity-export-parity
