Bank transaction tax – a revolutionary Idea or tax reform mirage

This post was originally published on CRI on 

http://centreright.in/2014/01/bank-transaction-tax-a-revolutionary-idea-or-tax-reform-mirage/#.U5bcKPmSz_g 

Is Bank transaction tax just an idea whose time may never come?

John Maynard Keynes once argued that

The master economist must possess a rare combination of gifts….He must be mathematician, historian, philosopher – in some degree. He must understand symbols and speak in words. He must contemplate the particular in terms of the general and touch abstract and concrete in the same flight of thoughts. He must study the present in the light of the past for the purpose of the future. No part of man’s nature or his institutions must lie entirely outside his regard.

Baba Ramdev, who is a spiritual leader best known for his contribution in Yoga and Ayurveda, seems to have taken a leaf out of Keynes thoughts. Being one of the early Anti-Corruption Crusaders Baba Ramdev has now thrown his weight behind Bank transaction tax and is looking up to BJP to implement should come to power in Centre, Baba Ramdev tried selling bank transaction tax to BJP PM Candidate Shri Narendra Modi during one of the events last week. Whether Baba Ramdev followed decorum of the stage by insisting Shri NarendraModi to endorse or commit to bank transaction tax is to be judged by the political commentators

I respect Baba Ramdev’s efforts to support initiatives of public good and issues of national interest,but idea of single bank transaction tax has not given me much confidence. CRI commentator Rightwing Indian wrote two posts (Part 1 and Part 2). There is an event organised on January 19 2014 in Mumbai to discuss this proposal. I hope my concerns raised in this blog will also be taken in to the account by the Core committee of the event.

Constitutional Challenges and Encroachment on Federalism principle

Bank transaction code is posed as single tax which can replace all taxes imposed by the Central, State and other municipal corporations in India. Bank transaction tax revenue is proposed to be shared between Centre, State and the local government. While Income tax is a centre subject, seventh schedule list II to article 246 of the constitution provides state rights to raise taxes. Each state is responsible for managing its own finances.

As proposed, the finance ministry or RBI will be responsible for determination of Bank Transaction tax; states might or might not have any say in the determination of the bank transaction tax. Fiscal federalism is one of the reasons why GST (Goods and Service Tax) is not yet implemented in India. If Government of India is not able to implement GST due to state pressure, I wonder how BTT will be different. Each state in India is unique and each has its own financial requirements, pegging their finance requirement to the number of bank transactions, takes away the freedom of the state to manage its own financial affair.

States use taxes for a variety of reasons ranging from attracting investments, discouraging consumptions and use of cost effective environment friendly products etc. Now assuming that all other taxes are abolished, states will be dependent on their share of Bank transaction tax which are directly proportional to state’s volume in banking. This is a classic chicken and the egg situation i.e. whether the state GDP encourages usage of banking or increased usage of banking will stimulate the state GDP? If the states are not a part of decision making process on the bank transaction tax we are in a way allowing encroachment on principle of federalism.

Do we have sufficient banks? Is BTT appropriate for new age banking?

Bank transaction tax puts onus on banks to deduct BTT. Backbone of the proposed implementation is a bank. While the number of commercial bank branches per 100000 adults in India is almost same as the world average. But, in comparison with the other developing countries in Europe, Central Asia and Latin America, India has a long way to go.

Within India, bank penetration has not been even across states; Chandigarh has one branch per 3000 adults while Manipur has one branch per 33000 while overall India average stands at a branch per 14000 adults.

Many critics of the Bank transaction tax have highlighted cascading nature of the tax and it provides undue advantage to big corporations, specifically vertically integrated corporations.

In the new age banking, most of us hardly visit banks. Most transaction are done online, a person might be resident of Mumbai but can operate bank account in Pune or Bangalore or anywhere in India for that matter. Bank transaction at a particular branch may or may not have anything to do with the place of business. Hence a purchase made for a manufacturing facility in the remote town of Gujarat might be paid from a bank in Delhi or Mumbai or any other place in India. How would one determine the jurisdiction in such situation?

Isn’t Bank Transaction tax representing socialism?

Arthakranti which has propagated the current proposal of bank transaction tax in their proposal mention

The system can be brought into force without any major change in the constitution. It is truly benevolent and fair system, in line with the basic socialistic philosophy of nation.

If the current taxation systems are perils of socialist policy, why should we adopt one more system which is built on the socialist question – of whether bank transaction tax rates are progressive or flat? Although there is minor progressiveness is embedded in the proposed tax, yet in my opinion BTT remains primarily a flat tax. Under progressive tax regime there is a constant temptation to raise tax on rich to pay and whereas flat tax rate ‘BTT’ is applicable to everyone at the same rate.

Why is ‘Socialist’ mentioned in the proposal? Did Arthakranti refer ‘socialist philosophy’ to please incumbent centre government and state government in Maharashtra? I don’t know. I am not saying that everything associated with socialism is bad but to use it as one of the selling points to appease target audience is certainly not a good idea.

Bank transaction tax is essentially central imposed tax. Why should we view bank transaction tax different than five years central planning imposed on the nation?

Bank Transaction tax and Principles of ideal taxation

Arthakranti in its proposal has mentioned different principles of taxation which they have applied to current taxation system, I didn’t notice those being applied to their own Bank Transaction tax. Hence I take liberty to judge the BTT after applying those principles. Following principles of ideal taxation

Canon of Equity

Every person should have to pay the taxes to the government proportional to his ability.

Bank transaction tax is neither Income tax nor consumption tax. It assumes that person’s banking transactions determines his ability to pay. This might be true but not always. There are many exceptions; to name a few  - loans taken for non-productive usage for example marriage, social gathering, health, education etc.

Under Bank transaction tax loss making business entity has zero respite; Loss making business entity might become history feels Arthakranti. Profit and loss are inherent nature of business; even loss making entity will have to pay BTT. I am kind of bewildered to explain business can make real loss and not an accounting loss. Loss making entities do not have the ability to pay tax but they will not be exempted from payment of bank transaction tax.

Canon of Productivity

According to this principle tax should yield sufficient income to government.

Bank transaction tax is proposed to be distributed in predefined ratio between centre, state and local government. Whether BTT will increase revenue share for each state/local government is to be seen, but with bank transaction tax and abolition of all other taxes, we are certainly talking about limiting option of the states/local government. State government/Local government need flexibility to raise taxation based on need.

At this point, we also have to understand that tax is not only a tool for raising revenue for the government but also a tool to influence consumption, public health, economic conditions, or any such matter. For example government wants to decrease the consumption of tobacco and related products, hence it is charged with heavy indirect tax under the current regime. At the same time, taxes on certain products are either Nil or exempted. Whether these tax exempt products benefits the poor section of the society or saves foreign exchange or generates employment is the government’s prerogative.

Canon of Simplicity

According to this principle, tax should be simple so that tax payer can understand its purpose and implication of the same.

On the first look bank transaction tax looks simple tax without any complication but as people say, the devil lies in the details. What we have seen is the simple high level presentation on the bank transaction tax. What has been surprising is although Arthakranti proposal has been around for a while in the public forum, they have not put up details such as

• State wise/Local Municipal level tax revenue comparison, what we have seen is the high level proposed tax calculation and Mumbai Municipal Corporation. I wish they would have given state-wise and municipal wise tax calculation under proposed Bank transaction tax.
• BTT has been projected as single ‘Ram Baan – Panacea’ replacement to all taxes in the country, it would be good to still list out all taxes in one place to know which of taxes are going to get replaced.
• Model legislation which will bring in bank transaction tax.
• Which existing legislation need to be abolished and which need to be changed at Centre/State/Local Government level.
• Arthakranti has mentioned that there is no need to change constitution, but then why is the constitution proposed to be changed for the implementation of GST.
• If there is no constitution change is proposed, how will the Central government ensure that states and local government will not raise additional taxes?
• There are many businesses where security deposit is taken from customer as part of business practice, should those bank transaction also be subject to Bank transaction tax?
• What about the business houses which act as clearing houses, stock brokers, or any other business which receives money on behalf of their customer?
• What will happen to double taxation agreement with different countries – will BTT be considered as income tax or not? Dividend/Loan or IPO money received from ADR will also be subject to BTT.
• Whether intra bank lending will also attract bank transaction tax?
• How will law enforcement agencies be structured?
• How will law enforcement agencies enforce law? What if people find mechanism to evade this tax?
• Will there be any exemption from Bank transaction tax?

Canon of Elasticity

Elasticity means that tax rate should be capable of downward and upward revision. With BTT, when confronted with economic recession or boom, state and local governments do not have this flexibility to revise tax rates.

Canon of Economy

Canon of economy means Cost of collecting tax should be less than tax. We have not seen any cost estimate to implement and collect bank transaction tax. There will be one time cost to switch from current taxation to bank transaction cost and there will be business as usual cost which needs to be estimated. Without having any estimation it would not be appropriate to say BTT satisfies canon of economy.

Will it decrease circulation of black money or increase it?

Arthakranti fears if high denomination currencies are not withdrawn people might turn to cash transactions once BTT is introduced. Arthakranti has recommended withdrawal of high denomination currency (say above ₹ 50). They have also recommended restricting cash transaction up to limit (say ₹ 2000). Comparison has been made between INR and USD denomination. I guess somewhere during this comparison exercise, we didn’t look at the important point, which is purchasing power of ₹ 50 Note and USD 50 note. I understand that restricting Rs 2000 cash transaction is indicative, but it is important to note the purchasing power of ₹2000.

In the times of bit coin this measure doesn’t inspire much confidence.

In order to evade bank transaction tax, corporate houses may move their payment hub out of India, and might want to switch to offshore banks. I wonder how new tax enforcement authorities will be able to enforce payments to be made out of Indian banks and not from any of the foreign banks.

Conclusion

I don’t think I can conclude on this topic, I foresee many more discussions on this topic. But I hope concerns I have raised above will be taken in good spirit by the proponents of the bank transaction tax. I do believe in rationalisation of taxes. I think it can very well done leverage existing taxation system rather than the complete overhaul.

Bank Transaction Tax: Number Crunching on Top Companies in India

This post was published on CRI on January 29 2014

http://centreright.in/2014/01/bank-transaction-tax-number-crunching-on-top-companies-in-india/#.U5bbzPmSz_g

We have been discussing merits and demerits of the bank transaction tax for a while. What will be the impact of the bank transaction tax on our economy in general is a question most of us have on our minds. To start with I have tried calculating bank transaction tax on India’s leading companies. I have selected companies randomly; data used for the calculation is taken from MoneyControl.com.

Assumption for calculation above:

• This is a static model, I do understand that in dynamic model the calculation may vary a lot. Bank transaction tax is applied on the gross receipt in the bank. In the absence of this information I have derived the Gross bank Receipt highlighted in column F.
• It is assumed that working capital requirement for above operation is funded from internal accruals and there is no working capital loan is taken. Gross bank transaction includes capital receipts to fund expansion meeting working capital requirement etc. I have not included these transactions in model.
• Complexity of global supply chain cycle is not considered for above calculation, I would be happy to discuss impact on above calculations. Cash flow from investing or financing activity is not taken in to account for above calculations.
• Total Income includes Revenue, other income, stock adjustment and excise duty in some cases.
• Profit before tax does not include extra-ordinary items
• Table is sorted based on column G in ascending order.
• BTT rate is assumed at 2%
• All data is for Fiscal year ended 31st March 2013. Opening balance of Sundry Debtors is taken from 31st March 2012.

Inference from Simulation

You may observe that organisation with lowest profit margin ends up paying more tax than organisation with highest profit. Let’s compare tax payable by Cipla and Hindalco. Hindalco made 34.77 crore more profit than Cipla, but under the BTT regime Hindalco has to pay 364.042 crores more tax than Cipla. The difference is due to profit before tax to total revenue ratio, Higher the profit margin a company manages lesser the tax it contributes. Impact of Bank transaction tax on whole supply chain cycle and organisation behaviour is matter of debate.

Simulation at different profit level

For the benefit of simplification one more simulation is done, in this simulation BTT impact at various profit level is measured

You can simulate and change the figure in column C to see effect on column I.

Inference from Simulation

Higher the profit margin of the company the lesser the tax it contributes. An organisation earning Rs 500 at 5% profit margin has to pay Rs 200 in taxes and an organisation earning Rs. 10000 also contributes the same Rs 200.

Conclusion

I would like to draw you attention to a point I made in my last post

Canon of Equity

“Every person should have to pay the taxes to the government proportional to his ability.”

Bank transaction tax is neither Income tax nor consumption tax. It assumes that person’s banking transactions determines his ability to pay. This might be true but not always.

Dynamic model which better represents the subtleties of business cycle could make the above simulation more complex. I would be happy to take those discussion as well. I am presenting a most simplified static model to make my case. Even in simplest model BTT looks unfair to me. In my humble opinion BTT is not a fair taxation system. It simply does not meet the canon of equity. I would be happy to proven otherwise.

I would also like my fellow commentators to give their views on this simulation. Please find the simulation worksheet here

Gas pricing: Kejriwal’s hypocrisy?

This post is published originally on CRI on 22nd Feb 2014

http://centreright.in/2014/02/gas-pricing-kejriwals-hypocrisy/#.U5basfmSz_g

Dear Mr Arvind Kejriwal,

With reference to your letter to Shri Narendra Modi over Gas price issue, I would also like to bring to your notice that there is huge scam in Oil/Crude. I am really surprised. How come an anti-corruption activist like you has not spoken against it?

I hope after reading following details, you will take up this matter and take appropriate action against all Crude Oil Producers in India.

Crude/Oil Production			Figures in BBL & Amount in $ Mln
Year	2007-08	2008-09	2009-10	2010-11	2011-12	Total
India Prodn	245.736	241.272	241.272	271.368	273.744	1273.392
India PVT/JV Prodn	36.648	33.624	37.872	69.696	76.968	254.808
OIL/ONGC (A)	209.088	207.648	203.4	201.672	196.776	1018.584
Crude Oil Price /BBL in $ (B)	79.25	83.57	69.76	85.09	111.89
Cost of Prodn /BBL in $ (C)	33.76	33.76	33.76	33.76	33.76
Profit (D) = (B-C)*A	9511.413	10342.95	7322.4	10351.82	15374.11	52902.69

Note 1: Crude Price is picked up from statistics released by Petroleum Ministry

Note 2: Cost per BBL is cost of production in US based on 2007-09 Data

Sir, as you can observe there is scam of $52 Billion dollars. Both BJP and Congress are silent on this issue; well even you have been silent so far. But it should not be of great concern to you. You have chance of exposing this big scam. This scam is an injustice done to the Aam Aadmi. AAP should pick up this cause and expose the corrupt oil producers of India.

I have listened to your speech at CII. I am quite impressed by your thoughts on gas pricing. When I heard you speaking, “Why should we get gas at market price? From our wells, we should get it at basic cost, plus some profits”, I thought if there is an issue with reference to gas price not being Cost Plus, why there is no issue with crude oil? Crude oil has been sold at market prices for a long time and no one has bothered to comment on it. Hence I calculated $52 billion of scam.

Some of the facts I have noted below are also mentioned in article written by R Jagannathan, I am not sure whether you have read it or not? If not read, do you expect Narendra Modi to also take your letter seriously? But anyways let’s go to some detail:

• Article 21.6 of the PSC provides for sale of gas at competitive, arm’s length price, to the benefit of parties to the Contract and it also provides that the gas price formula/basis have approval of the Government prior to the sale of natural gas to consumers/buyers. I hope you being ex IRS officer understand what arm’s length price means?
• I wondered where you got figure of $2.35 in your article. A friend pointed out that you were referring to legal dispute going between RIL and NTPC. NTPC alleged that RIL has agreed to supply 12 MMSCMD at $ 2.35 for 17 years. This matter is sub judice, I would have appreciated if you would have questioned asp tp why even after close to 10 years there is no movement of the case.
• Supreme Court in another case but with respect to KG basin D6 ruled thatcontractor is free to market gas but it cannot finalise the gas price. Correct question to be asked to our policy makers is why there is a policy flip flop with respect to government’s position on Crude pricing vis-à-vis Oil Price. As you can see yourself there is scam of more than $52 Billion with respect to crude sales. Why are you not demanding Cost Plus price for crude also?
• Planning commission has estimated that in 12th plan more than half of India’s Gas demand is fulfilled by imported gas. I hope you are aware that imported gas is priced on an avg $ 12-$ 15. Why not demand imported gas to be price at cost plus? If they don’t agree, you can always do dharna in front of the respective embassy! 1/4th of production will be produced by PVT/JV. And 1/4thwill be produced by OIL/ONGC. If government wants to decide Gas price keeping in mind interest of RIL, shouldn’t you demand same price for OIL and ONGC? But Sir, I am sorry to disappoint you; new price is also applicable to OIL and ONGC. I know you don’t care for details and references but I do. The following is a quick look at demand vs production estimate under 12th Plan.
  
• R Jagannathan in his article addressed to you has highlighted that higher sales price means higher profit for contactors. As per PSC terms profit earned by contractors needs to be shared with Government of India. So with high price government is going to get a benefit as well, so where is the issue Mr Arvind Kejriwal?
• Do you remember last December you made scam allegation against Gujarat Government and Narendra Modi in particular, did you take the matter to court? If not why have you not cared so far, after all you had all the proof with you! By the way I wrote some details on the same account at that time, I am not sure whether you will be interested to know but in this link you will find my point by point counter to your allegation.

To summarise, will you care to expose Crude Oil producers in India? They get market price for their production. Gas Producers are still getting price fixed by government. You have been consistently making wild allegations against your political adversary without proving anything!

I am not surprised R Jagannathan said “Mr Kejriwal, grow up. Your open letter to Modi is all gas, no economics.”

Bank Transaction Tax – Few more concerns

This post was originally published on CRI on March 3 2014

http://centreright.in/2014/03/bank-transaction-tax-few-more-concerns/#.U5bbGvmSz_g

During June 1935, Bureau of Sugar experiment stations in Australia introduced quite unusual step to control menace of Cane Beetle. Back then conventional method of pest control was found unsatisfactory. They introduced Cane Toad to Australia. Cane Toads were native to Central and South America. More than 102 young were released in northern Queensland.

Since their release, toads have rapidly multiplied in population and now number over 200 million and have been known to spread diseases affecting local biodiversity. Unfortunately, the introduction of the toads has not only caused large environmental detriment, but there is also no evidence that they have had an impact on the cane beetles they were introduced to predate. [1]

I hope bank transaction tax proposal isn’t similar to introduction of Cane Toad. Cane Toads were introduced to predate Cane Beetle. Cane Beetle exists in Australia even today and that to also sufficient numbers. I just hope, in order to control menace of black money, measures like bank transaction tax does not become epidemic like Cane Toad.

Let us look at some additional issues and thoughts pertaining to the bank transaction tax.

Bank Transaction Tax and impact on GDP growth

Do the proponents of bank transaction tax feel that the ‘Current tax regime has not helped the government to raise sufficient revenue to fuel growth?’ I might be wrong, but this is one of the underlying grievance most of us have and this belief very much exists amongst proponents of bank transaction tax. While this might be true, but is the increase in tax revenue in direct correlation to GDP growth? Following is comparison between BRIC nations with respect to tax revenue to GDP ratio.

Data from here.

You might be surprised to know that tax to GDP ratio of China and India are almost similar. Simple point which I am trying to make here is that for better GDP growth, equitable distribution of development, wealth and efficient social welfare, tax revenue is just one of the determinants.

“Bank Transaction tax is simple” is myth

For a layman, proposal looks very simple; however it is far from simple. In the absence of model act, I would take current proposal by Arthakranti as base for my critics. I am of the opinion that the proposal in its current form is prone to legal disputes between tax enforcement agencies and tax payers let me give couple of examples.

1. Role of tax enforcement agencies: -Assumption that tax enforcement agencies will become redundant is misplaced. In my opinion in any taxation system, tax enforcement agencies will always have role to play and bank transaction tax will not be any different.
   There are a few good suggestions been made by my fellow commentator Rightwingdian with respect to revenue sharing between centre, state and local government.However I would like to go back to original proposal by Arthakranti, under which revenue will be shared between centre, state and local government in a fixed percentage.
   I highlighted in my previous post that today most business operates their bank account from a head office or a centralised payment location. Under this scenario state or local government can only maximise tax revenue if they somehow make sure that each economic operations under their local area is cash settled. What does it mean? It means that a local Municipal corporation and state government might want to create law which can force business to cash settle all economic activity. Let me give you an example

Company A has factory in Maharashtra under Pune Municipal Corporation and sales depot in Chennai, Tamilnadu. Goods are transferred from Pune factory to Chennai sales depot, sales to external customer is done via Chennai sales depot and payment for the same is received in Bangalore, Karnataka.

Under BTT as proposed, sales proceed received in Bangalore will be taxed in Karnataka. Centre (India), State(Karnataka) and local government(Bangalore Municipal Corporation) will get tax revenue. What about Maharashtra/Pune and Tamilnadu/Chennai get? Answer is that they get nothing. In order to get their share of revenue what Maharashtra/Tamilnadu can do? They can make law to make sure that all economic activity is cash settled.

Under this arrangement, Chennai sales depot has to pay to Pune factory. And Bangalore payment processing centre of a company has to pay to Chennai sales depot. What are we saying here, this is like a company within a company, this method of accounting is called as profit centre accounting. Most company use this accounting but they does not cash settle balance between profit centres. Profit centre accounting is currently used as management accounting tool.

1. Bank Transaction tax is Income tax or consumption tax?
   My fellow commentator Rightwingdian felt that I should not be comparing bank transaction tax against profit. I agree that Bank transaction tax is not income tax, but at the same time BTT isn’t consumption tax either. In the absence of any form of taxes, it is but natural for business to compare BTT against profit margin. I would also like to highlight that BTT isn’t revenue expenditure, BTT will be charged on Capital receipt and on revenue receipt. Hence it would be inappropriate to compare BTT as revenue expenditure same as audit fees or any such expenditure.
   If we take in to account BTT on capital receipt, effective rate of tax will substantially change. Effective rate of taxation is important barometer for government and business. Coming back to simplicity principle of BTT, most proponents of BTT has argued that they would consider BTT as pass through tax, something like VAT/sales tax. I am asking readers how much that pass through percentage will be. If your answer is 2% or 2.04%, I am sorry to say that your understanding of the business is too simplistic. What we are missing is that BTT paid on capital (Equity, Long term loan, short term loan, bank credit etc.) rose. In order to start business you need capital and this capital is raised from various sources.
   Whenever you raise capital, there is bank transaction associated with it. You may argue that those costs should be considered as cost to the business. I might agree with that argument as well but let’s be honest, what figure of pass through percentage you had in mind? If it was 2% or 2.04%, you clearly are not considering BTT as pass through percentage. Besides BTT paid on capital will be way higher than BTT paid on revenue receipt. Economic research repeated highlighted that taxing capital is counterproductive. It discourages fresh investment and innovations.

Bank Transaction tax and Accounting Principles

It was highlighted in one of the presentation of BTT that BTT does not have any impact on accounting practices. Person giving statement was part of the Arthakranti group. I would like to point out few accounting issues BTT will generate. BTT will not only be charged on revenue receipt but capital receipt as well. Capital receipts includes initial capital introduce by entrepreneurs, short term capital etc.

Accounting standard AS 22 deals with differed taxation, with BTT AS 22 may become redundant or it has to be changed accordingly. BTT will require accounting guidance as to how BTT paid on capital receipt should be treated in books of accounts and annual reports. BTT paid on capital receipt cannot be considered as revenue expenditure, because cost incurred isn’t for one financial year. So how many years bank transaction tax should be amortised?

I would like to apologize to my reader for having used technical references such as accounting standards and issues associated with it, but I could not restrain myself to respond to a sweeping statement such as BTT will not have any accounting policy impact. I would not shy to admit that accounting issue highlighted is peripheral; I am sure required accounting policy changes will be and can be done. Moot point is how many more such issues are yet to be identified and how many of such issues are show stopper. Impact of BTT at different point of supply chain cycle is difficult to estimate, realistic evaluation can only happen if we introduce BTT on pilot mode at any one SEZ (I heard from one of the Arthakranti member that they want to make whole India SEZ by introduction of BTT).

Conclusion

I continue to hold reservation about amateur tax regime like bank transaction tax. I would be interested to look at a watertight proposal of bank transaction tax. As I mentioned earlier in my blog, we should try this concept on pilot basis, let us implement in one or two SEZ. Let us evaluate the results and validate whether tax regime such as bank transaction tax will make any sense and how businesses will react to it.

Oil & Gas Policy for the Next Government

This Post was published on CRI on March 16 2014 
http://centreright.in/2014/03/oil-gas-policy-for-the-next-government/#.U5bbcPmSz_g

Most Countries consider economic growth, environmental quality, and energy security as their main component of the sound energy policy. India like any other country has created ‘India Hydrocarbon Vision 2025′ and subsequently followed up with integrated energy policy report 2006. Every budget year and via five year plans, GOI has tried to provide guidance on various Oil & Gas Policies. Even so, in the last decade the Oil & Gas industry has seen a lot of perplex policy decisions. What we intend to do in following exercise is to list out the expectations which we think might give a fresh lease of life in current Oil & Gas Industry.

In line with industry structure, we will segment Oil & Gas in to following broad categories

• Upstream
• Midstream
• Downstream

Upstream – Exploration & Production

During the period 2002-03 to 2010-11, India’s crude oil reserves increased at a CAGR of 0.27% while the natural gas reserves increased at a CAGR of 6.5%. The reserves growth in natural gas was on account of the significant gas discovery made by RIL in the KG-D6 block on the east coast of India. Although definite progress has been made, in terms of addition to reserves and production, when compared with other peer countries, the rate at which reserves and production has grown has raised many concerns.

There has been low and declining interest in NELP bidding and not enough progress has been made for the blocks that have been awarded under different NELP rounds.

Key Issues

• Lack of Fiscal prudence: In many instances, Indian Oil Companies including National Oil companies (NOC) have bid aggressively to win the licence. There have been multiple instances of cost overrun from the original minimum work program submitted.
• Long delays in clearance of blocks: Getting clearances from multiple ministries such as defence, environment & forest and different state government has caused lot of delays. Dealing with multiple agencies at different stages of the E & P has become cause of major concern for most of the investors.
  
  
• Lack of Market Principle and government interference: NELP was presented as a fiscal regime based on market principles and without direct government interference. NELP’s contract terms are applicable both to Oil & Gas on the same ground. However, contract terms pertaining to gas has caused lot of confusion in the industry. Valuation and utilisation of Oil & Gas produce in India has been major cause of concern among industry participants. Oil producer unless not Oil sold in India gets international prices, however gas production is governed by administered allocation policy which also indirectly gives government to dictate price of the gas to be sold.
  
  
• Inadequate regulatory framework: Although there has been a model NELP production sharing contract which governs all PSC contracts signed under NELP round, model contract still has consistency issues in terms of Gas ownership, pricing and valuation for the purpose of profit sharing. Directorate of Hydrocarbon (DGH) is designated regulator but its involvement in the management committee for finalisation of development plan etc. questions its independence to regulate. Besides DGH is also facing bandwidth issues.
  
  
• Inclusion of all stake holders: Ownership of the hydrocarbon reserves remains with central government, however important stake holders such as state government and land owners in case onshore blocks has been kept out while determining policy. State government needs to be involved in policy decisions to reduce administrative delays and to avoid additional tax on the sales of hydrocarbon products.
  
  
• Unconventional Energy resources: Given the substantial coal resources, India boast of significant Coal Bed Methane (CBM) potentials and opportunity. From its commencement in 2007, four rounds of bidding under the CBM policy have been concluded by the government and a total of 30 blocks have been awarded. So far only approx. 2.6 Billion cubic feet (Equivalent of 73 Million Cubic feet) of net production could have been extracted as against 6 trillion cubic feet of established reserves.
  There has been lot of buzz around Shale gas exploration and its potential, government of India has issued draft shale gas policy in 2012 and ONGC is awarded 1st round of shale gas blocks for exploration. Industry insiders have raised questions on why state oil company is made Guiney-pig for such new initiative.

Expectation

• Adoption of Adjusted concession regime: Boston Consulting group (BCG) carried out study for Ministry of Petroleum and recommended that India should move to adjusted concession regime. Under this regime government share will be based on revenue instead of profit. This will remove lot of administrative hassle and dispute regarding cost recovery. Adoption of new framework should be for all existing PSC contracts. Concurrent system of PSC and adjusted concession regime will only add chaos and confusion to E & P industry.
  
• Clear stand on Gas Utilisation policy: Success of Gas Utilisation policy is directly dependent on pipeline structure; current pipeline structure is definitely inadequate to support Gas Utilisation policy. Ideal condition would be to give total freedom to Gas producer or contractors to choose their marketing representative and decide customer which gives them maximum revenue. Considering Government of India’s plan to move to adjusted concession regime, more revenue contractor earn, government share of royalty and taxes also increase.
  
• Inclusion of state government as stakeholder: Oil & Gas related policy decision has been taken by central government, however in order to expedite various administrative approvals state government should also be made signatories to PSC or adjusted concession agreements. Agreement with state government should be within overall NELP or any other prospective regime adopted by government of India. 
  
• Inclusion of Land owners as royalty interest owner: In many countries land owners gets royalty for the land access right, India should also move to this system of compensating land owners. Nagaland has recently passed legislation to include land owners as royalty interest owners. This system should include both capital payment and regular payment in terms of royalty to land owners. 
  
• Facilitating single clearance window: All existing blocks pending various approvals from different ministry and states should be brought under single clearance window; this possible single window might be DGH. All administrative issues pertaining to strengthen DGH should be resolved, DGH should be made full time regulator in line with SEBI, IRDA etc. 
  
• Leveraging existing accounting & reporting framework: In the area of financial reporting for example DGH should use existing financial reporting requirement as per accounting standards issued by Institute of chartered accountant of India. Currently Institute of chartered accountant of India has issued guidance note in some cases, however Institute should issue additional accounting standard( or provide guidance note on usage of IFRS) to meet global best accounting practice and reporting requirement for Oil & Gas blocks operated out of India.
  
• Unconventional Energy Sources: Land acquisition and technology holds key to success for unconventional energy source, such as Coal Bed Methane and Shale Gas. Shale Gas in US has been great success because they develop technology to make shale gas exploration economically viable and causing minimum adverse environmental impact. US has required rules and regulation to protect interest of land owners and they also made part of the economic boon that might come to explorer/contractor by making land owner royalty interest owner. Government of India should create conducive environment to nurture potential fuel source.
  
• Usage of Technology: Following is possible usage of technology which DGH and related agencies can use
  
  • Budget approval and budget utilisation per each Minimum work program
    
  • Usage of technical information related to 2D, 3D seismic data for further data mining.
  • E-submission of all reporting requirement with fixed due date.
    
  • Inter departmental workflows
    

Midstream

Midstream sector involves transportation (via pipeline, barge or truck), storage and wholesale marketing of crude or refined petroleum products. Infrastructure is important to balance fluctuations between supply and demand. The country’s pipeline infrastructure spans 19,300 km for crude oil, 16,293 km for gas and 15,903 km for products. However, the pipeline density in the country is still among the lowest in the world with onshore natural gas pipeline density being 3 km per 1,000 km2 of area as compared to 50 km per km2 in the USA, China and the UK. Under-developed pipeline remains one of the most important impediments for effective Gas Utilisation policy. The country has close to 13 major and 176 non-major ports. The total volume of traffic handled by the ports during 2010-11 was 850 million metric tonnes (MMT), out of which major ports handled traffic close to 570 MMT. The petroleum, oil and lubricants (POL) traffic handled during the same period was close to 180 MMT. Current penetration of coastal shipping is concentrated in favour of bulk goods like petroleum and coal.

Increased gas availability, improved gas pipeline coverage and gas being one of the priority sectors are the major drivers of the City Gas Distribution (CGD) business in India. The government has aggressive plans to develop CGD network in more than 200 cities across India. Each city would warrant an investment ranging between 65 million USD to 100 million USD. The first round of bidding is complete and the companies have been authorised by PNGRB. In the second round the bids have been received but authorisation is still awaited. The third (8 cities) and fourth (8 cities) rounds of CGD bidding launched by PNGRB are currently underway.

Key Issues

• Lack of coordination: Existing pipeline developer has installed and proposed to install pipeline based on their marketing plans. Gas allocation made to certain sectors could not even be executed because non availability of the required pipeline structures.
• Policy Paralysis: Pipeline policy of 2006 gave pipeline developers to choose customers of their choice and develop the pipeline as per their own requirement and business plans. However in 2009, when government of India announced setting up of ‘National gas highway development authority’ which will be directly funded by it (Centre) to lay a pipeline network across the country, Petroleum and Natural Gas regulator board (PNGRB) was apprehended fearing curb on its power. Last we heard is plan to set up ‘National gas highway development authority’ is put up on back burner.
• Lack of Investment: Unlike upstream and downstream midstream segment has seen zero or little concentrated effort from any of the authority to increase the investment. Whether it is case of additional pipeline development or development of new ports, there is lack of holistic view of how these infrastructure projects needs to be synchronised.
  
• Slow Progress on laying of CGD: Government intend to develop CGD network across 200 cities however initial round of bids has not even covered 10% of the cities. Tariff regulation and lack of financial support makes many project unviable or cause cost overrun. Principle challenges faced by CGD includes right of way and right of use in laying gas transmission and distribution pipelines.
  

Expectations

• Integrated Oil & Gas Infrastructure development: There is need to have holistic view to how individual cluster of Oil & Gas Infrastructure projects needs to be initiated across India. Gas find in Bombay High enabled to create required infrastructure in Gujarat and Maharashtra. Similar Oil & Gas Infrastructure needs to be designed for the Eastern, Southern and Northern India. This planning requires integrated development of Ports, Storage facility, LNG terminal and refinery needs to be planned minimising last mile rail and road connectivity. 
  
• Policy Guidance: Petroleum and Natural Gas regulator board (PNGRB) should be empowered to provide all policy guidance with reference to midstream infrastructure development across the country. Current ambiguity over its role and jurisdiction should be clarified. Today the Government of India assumes all powers in determining the gas price. However, it is felt that looking into the spirit behind setting up the PNGRB and also gradually moving towards a perfect natural gas market) as a regulator, the board should get the power to set prices and also allocate gas.
  
  
  
• More Cities to be brought under CGD: Laying CGD has to be cohesive effort by central government in coordination with state government. If government intends to phase out LPG subsidy, creating CGD network. In order to bring more cities under CGD, policies should be made investment friendly so that entry barrier is removed and more public private participation can be forged.

Downstream

India has emerged as a global refining hub on the back of major refining capacity additions involving massive investments. The domestic demand of petroleum products is expected to grow at a CAGR of 7.5% during the next five years. The projected expansion of refinery capacity from 232 MMTPA (4.66 MMbbls per day) in 2012-13 to 311 MMTPA (6.3 MMbbls per day) in 2016-17 is in line with India’s aspiration of becoming a global refining hub. Though the current refining capacity stands at 3.8 MMbbls per day, the throughput in 2011 exceeded 4 MMbbls per day, indicating more than 100% capacity utilisation. India might be Net importer of crude oil however in recent years it has become petroleum exporter. Much of the pain and chaos in downstream sector remains due to subsidy policy adopted by subsequent governments.

Currently government is facing challenge to remove under-recovery and subsidy mainly for Diesel, LPG, and PDS Kerosene.

Key Issues

• Eliminate Notional Subsidy: There has been lot of misrepresentation over subsidy or under recovery on account of diesel. Government and various agencies have maintained that diesel subsidy has caused lot of drain on government fiscal health. However closer look Diesel pricing under-recovery vs. taxed recovered per litre of diesel sold reveals that central and state tax put together are in excess of under recovery. In the event of removal of under recovery and taxation, there will be further downstream impact on states which rely heavily on taxation on diesel sales to fund their state budget.
• Domestic LPG Subsidy: Putting cap on number of LPG cylinders is adding woes to already crumbled administrative machinery. Questions remains whether dual pricing system will work considering bureaucratic administration and corrupt practice exist on ground. For instance, there are many Piped gas consumer reluctant to surrender LPG cylinders. This leads to inefficient consumption and diversion of LPG cylinder, mostly for commercial use.
  
  
• PDS Kerosene: Kerosene is primarily used in rural household for lightning purpose. Large volume of subsidized kerosene sold is illegally diverted and resold at higher price or used to adulterate diesel and gasoline. 
  
• Interference on fuel pricing: Much of the under recovery and subsidy has accumulated because government of India has continued to set the fuel price. Although it has been decade where multiple recommendation committee and planning commission has time and again said that fuel prices should be deregulated. But Diesel, Kerosene and LPG prices are still regulated by government. 
  

Expectations

• Rationalisation of Taxation & Adopting correct price determination mechanism:There is argument that under recovery and losses by Oil Marketing companies are not actual financial losses but more of accounting or notional loss. Fuels price formula currently based on trade price parity where 80% weightage is given to import parity price and 20% weightage given to export parity price. It is important to note that India might be importer of crude oil but India is also net exporter of diesel. Using export parity price & reduction in taxes such as Customer duty and special excise duty may reduce under recovery to a larger extent. There is also argument to raise price of diesel by raising taxes to make it equal to petrol, however author of this article feel that this might turn out to be counterproductive. Government of day will always be under pressure not to raise price and taxes and will go back to populism and provide further subsidy. Currently most of the refinery are owned by Oil Marketing companies, in terms of profitability refinery operations are profitable and gross refinery margin (GRM) earned by refinery including public sector are more or less at par with average GRM earned in other refinery across world. Considering most of the under-recoveries have been born by oil marketing companies, it makes sense that either refinery should be part of separate legal entity or along with hydrocarbon retail price build up refinery margin earned should also be disclosed.
  
• Domestic LPG Supply: Increasing penetration of LPG and piped natural gas in rural areas should be one of the utmost priorities. Dual Pricing can be implemented easily with piped gases instead of cylinder gas. Co-ordinate efforts along with state government should be made to expand piped gas network. Direct cash transfer with Aadhar enabled bank accounts for BPL households is one of the options to make sure that subsidy is received by segment of society needs most. 
  
  
  
• Creating efficient Cooking fuel for rural sector: Considering rising cost of petroleum and availability of Gas including imported gas, moving rural areas to LPG looks distant dream. Usage Advanced Bio Mass (ABS) cooking fuel should be promoted. Considering health hazard, adverse impact on deforestation and providing efficient cooking fuels this sector needs special attention.
  
• Fix Kerosene Subsidy responsibility with power ministry: Very insignificant portion of Kerosene consumption is towards usage in cooking fuel. Since most of other usage is towards lighting purpose it makes sense that onus of the subsidy should be transferred to power ministry. Irrespective of the responsibility, there should be gradual effort to reduce consumption of the kerosene; direct cash transfer remains one of the options to plug the leakages.
  

References

1. BCG Benchmarking report review of upstream commercial structures and insight from global practice 
   
2. Natural Gas in India: An Analysis of Policy by Anil Jain and Anupama Sen
   
3. Exploring India, Country Insight by PWC prepared for Petrotech 2012
   
4. Exploring India, Country Insight by pwc prepared for Petrotech 2012
   
5. Gujarat — The Model CGD State: Lessons and Expectations by DJ Pandian, IAS, Principal Secretary, Energy & Petrochemical Department, Government of Gujarat
6. Exploring India, Country Insight by pwc prepared for Petrotech 2012
7. India’s Fuel Subsidies: Policy recommendation for reform.