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Options to preclude hikes in retail prices for oil

The duty structure and IPP offer scope for a re-look at fuel taxation and pricing policy

A MAJOR PRODUCER: Reliance Industries' refinery at Jamnagar in Gujarat.

THE MONTHS long uncertainty has finally ended with the hike in petrol and diesel prices on September 5. Apart from raising the prices, the Government plans to issue oil bonds worth Rs. 10,000 crore. It has justified the price revision citing the more than 30 per cent rise in international price of crude oil to over $65 a barrel since the last revision of domestic prices in June. The brunt of the increased crude price was so far being borne by the oil companies through huge under-recoveries.

The decision however does not augur well for the Government as the left parties and the NDA plan to go on a nationwide strike. Is the opposition to the oil price rise justified? The answer to the question can be given if one knows how the oil product prices are set. From the consumers' viewpoint, there is a void in their understanding of the oil price mechanism. The case for rational petroleum product prices will strengthen if consumers are made aware of the price fixing process. This article briefly delves into the issue and probes whether price hike was the only option available.

In the supply chain of oil from import to its final destination, namely the consumer, there are six stakeholders — the government importing the crude, domestic upstream companies producing crude, refineries (standalone and integrated), oil marketing companies, State governments and consumers. An increase in crude price can be absorbed at any or all of the levels depending on the option(s) available.

Current practice

At present, the Government pursues an import parity pricing (IPP) policy for select oil products. Under this, the import parity price is what an importer of petrol or diesel would pay to buy from an international refinery, transport them from that refinery, insure the products against losses at sea and land them on Indian shores. Since the entire petrol and diesel consumed in the country are produced within the country from imported and indigenous crude, the import parity prices only imply that product prices at the refinery gate are notional and can provide a high refining margin when global product prices soar. At any point in time, crude and petroleum product prices differ by $10-12 a barrel. With IPP for products, the final impact on consumers can be much higher as the import duty on products such as petrol and diesel is higher (10 per cent) than on crude (5 per cent). Similarly, higher FOB value increases the ad valorem insurance paid, pushing up the retail price.

The retail selling prices (RSP) of petroleum products are built on these notional prices by adding excise duty, freight up to depots, marketing cost/margin, delivery charges from depot to retail pump outlets, sales tax/other local levies and dealers' commission to the basic refinery gate prices. The extent of taxes levied (non-fuel component) at present is very high.

High tax component

The figures show that petrol and diesel RSP comprise a sizable indirect tax component. The share varies from 57 per cent to 61 per cent for petrol and from 35 per cent to 47 per cent for diesel in the four metros. In fact, this is the main bone of contention in the price issue. This burden can be reduced to keep the prices stable. However, it is important to note that the proportion of indirect taxes is high in other countries too. Even the use of IPP for products instead of for crude is contributing to high prices at the consumer end. Quick calculations indicate that if crude is taken instead of petroleum products for IPP, a global crude price of even $60 a barrel can be accommodated with the same duty structure assuming the average refining cost of IOC of 52 paise a litre.

Existing cess rates and actions taken in the past also suggest that avenues exist to avoid a price rise. The ONGC and OIL pay a cess of Rs. 1,800 a tonne on their crude for the development of the oil industry. With the opening of the oil sector, this fund has lost its relevance. Moreover, out of Rs. 57,000 crore collected from the cess so far, less than 2 per cent has been channelled for the industry's development. Estimates suggest that withdrawal of this cess will give a relief of Rs. 5,400 crore to ONGC and the money collected in the past can be utilised to tide over the current precarious situation.

In previous pricing regime, an Oil Pool Account (OPA) was created to ensure uniform and stable prices by balancing high and low input costs. While the private producers and foreign investors are entitled to the global price for their crude oil, ONGC and OIL are entitled to 77.5 per cent of the FOB prevailing international price, whereas the OPA gets 22.5 per cent of the landed cost of crude oil. However, an earlier decision of the Finance Ministry resulted in withdrawal of money from the OPA without compensating it. Reimbursement by the Ministry will also help tide over the situation partly.

Impact on stakeholders

The current duty structure and IPP provide an opportunity to re-look at the fuel taxation and pricing policy. Levying specific duties (on weight basis) can help but this will be resisted as it impacts revenue. Any loss from specific duties will, however, be more than offset by larger revenue through increased oil consumption.

Bringing customs duty on petroleum products on a par with crude oil will reduce the margins on refining operations but the margin on marketing will increase. Pure refiners will also lose because the cut in import duties on oil products will lower the end prices of their products. The lower excise duty on petroleum products will help the marketing companies while the lowering of sales tax will benefit the consumers.

The three main objectives of petroleum pricing/tariff are the Government's revenue needs, the need to keep profitability of the oil companies high and the necessity to keep consumer prices low. As it can be easily seen, these are mutually exclusive and till the recent upswing in international prices, the pricing has fulfilled mainly the first two objectives. There are thus options that preclude any further increase in petroleum products and there is scope for rationalisation of pricing/tariffs. In the worst scenario, when the duty structure is undisturbed and pricing policy not changed, the only silver-lining for consumers will be earmarking the revenue generated for supporting renewable energy programmes.

VINISH KATHURIA

The author is Associate Professor, Madras School of Economics, Chennai. He can be contacted at vinish@mse.ac.in

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