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.

Fuel Pricing Policy & Notional Subsidy

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 ·         Recently Finance ministry has proposed to use Export Parity Price from[i]

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

[ii] Petroleum Statistics for year 2011-12 http://petroleum.nic.in/petstat.pdf

[iii] http://www.business-standard.com/article/companies/pvt-oil-cos-may-not-sell-fuel-to-psus-if-pricing-model-changes-113031700101_1.html