The Indian Economy Blog

June 3, 2008

Upsetting Oil Pricing Conundrum

Filed under: Energy,Growth,Politics — Pragmatic @ 11:31 pm

Earlier post on the subject: Oil Pricing in India

Vikram S Mehta, chairman of the Shell Group of companies in India, provides the structure of the price build up for petrol and diesel by the public sector companies in India.

Indian Oil Corporation (IOC) calculates inter alia the landed import duty paid price of petrol and diesel every fortnight. This calculation is based on a formula that is linked to international prices. IOC’s landed price of petrol in Mumbai for the second fortnight of May was, for instance, Rs 38.1 per litre and for diesel Rs 48.8 per litre. The marketing companies had to, in other words, pay this amount to the refiners to buy the products. Next, the Central government imposes an excise and educational cess on the purchase cost. In May, this was Rs 14.4 per litre and Rs 0.4 per litre for petrol and Rs 4.6 per litre and Rs 0.1 per litre for diesel respectively. The total cash required by the marketing companies to purchase petrol and diesel in May was, therefore, Rs 52.9 per litre for petrol and Rs 53.6 per litre for diesel. The companies then sell these products at the ministry of petroleum mandated price of Rs 49.7 per litre for petrol and Rs 35.6 per litre for diesel (Mumbai prices). As such, they lose Rs 3.2 and Rs 18 for every litre of petrol and diesel sold respectively.

That, however, is not their total loss. They have to also pay sales tax to the state governments. In Mumbai, this tax is Rs 10.6 per litre and Rs 7.1 per litre for petrol and diesel respectively. Thus, the total cash loss suffered on account of the sale of 1 litre in Mumbai is Rs 13.7 and Rs 25.1 for petrol and diesel respectively. This is, in other words, the amount by which prices would have to be increased at the retail outlet for the companies to simply break even on a cash basis. Such a hike is, of course, out of the question.[Indian Express]

Many in the public domain believe that the imbalance can be redressed by reducing the central and local taxes to make the public sector oil companies profitable. However, it is actually not about reducing the taxes to bring the prices down. That is just an indirect way of maintaining the subsidies. On one hand, the balance sheets of the oil companies might look healthier and higher profits might allow theme to disburse handsome dividends. On the other hand, the government revenues would come down and higher revenue deficits will bring the finance ministry into the FRBM dragnet. It is not a Morton’s fork but a Hobson’s choice for the government — to link the retail rates of petroleum products with the market rates.

In case of most other commodities, the high consumer price checks demand. This helps restore the supply-demand balance. As prices are not linked to the rising market rates, oil demand is not checked commensurate with the price change. It obviously creates an asymmetry in the supply-demand balance and can be only restored at much higher prices. By then, it might be already too late for the Indian economy.

Now let us look at two sensible, yet asynchronous, viewpoints on resolving this pricing conundrum. In the same piece, Vikram Mehta prescribes the policy framework for a comprehensive petroleum policy.

First, we should accept that high oil prices are here to stay. This does not mean we will not see sharp declines from present levels. What it does mean is that we will not see prices stabilising at levels significantly below a triple digit number. Second, we must create a mechanism that leads to a ‘graduated’ reduction in subsidies, an orderly alignment of domestic prices to international levels and a more efficient disbursement of financial support to the poor. Third, we must reverse ‘dieselisation’. And finally, we must recognise that the sine qua non of energy security is a robust and competitive domestic petroleum and energy sector.

Fellow blogger Atanu Dey has a much simpler, but more innovative solution to offer to redress this perverse subsidy for the rich.

The basic economic truth is that there is really no such thing as a free lunch. Today’s subsidy comes at a cost that will only grow larger the longer the delay in pricing petroleum products at full cost. It is fairly simple to remedy the situation. Raising the price at the pump is the simplest but the most politically risky. The UPA government knows that and will definitely not risk losing power even if raising prices is for the larger benefit of the economy.

But those subsidies have to be reduced, if not totally abolished overnight. A start could be made immediately to reduce the subsidy to the rich while continuing it for the poor. A mechanism for doing so would be to impose a tax on car owners which would reflect the full cost of the petrol they use. Depending on the size of the engine and average fuel consumption, an annual fee could be assessed which has be paid to maintain registration. So if a particular make and model of car typically consumes, say, 1,000 litres of petrol a year, the tax could be Rs 10,000.

This type of a mechanism would leave all two-wheelers, three-wheelers, and buses untouched. Since it is usually the common man who uses public transportation, the common man would continue to enjoy the subsidy.[Deeshaa]

One can only wonder if Rs 200,000 crore in oil subsidies, nearly 2% of India’s GDP, is not alarming enough for the government to pay heed to such sensible opinions.

11 Comments »

  1. The idea of eliminating or reducing the subsidy for rich is quiet innovative and superb but the way of implementing may lead to unnecessary increase in the black market of oil and other means of availing.

    Comment by Ajay Reddy — June 5, 2008 @ 3:54 pm

  2. [...] Cross posted at The Indian Economy Blog [...]

    Pingback by Pragmatic Euphony » Blog Archive » Upsetting oil pricing conundrum — June 5, 2008 @ 4:55 pm

  3. The suggestion by Atanu Dey that “So if a particular make and model of car typically consumes, say, 1,000 litres of petrol a year, the tax could be Rs 10,000.” sounds pretty outrageous. Car models per se do not consume typical quantities of petrol in a year but its the amount of usage by the owner. This would unnecessarily punish big car owners even if their usage/consumption of fuel is limited.

    Comment by Aditya — June 6, 2008 @ 10:06 am

  4. We must not forget that the money for Govt. subsidies ultimately is being paid by all Indians. It is not manufactured out of thin air. And thus either directly or indirectly we are all paying the price. Further more the effect of the rising oil prices is being felt by us regardless of what we pay at the pump. The Government is paying for the oil( via oil bonds) thus increasing money supply and that I believe leads to higher inflation.

    Comment by Tee Jay — June 6, 2008 @ 10:41 pm

  5. I liked your suggestions a lot. However, the Government is caught i a catch22 situation. If it increases rates, it faces the vent of the public. Otherwise it makes some Rs. 2 Lac Crore loss(almost 2-3% of the GDP) which is what no developing country can surely afford. Nevertheless, all opinions should be heeded!! Keep it up for the good post.

    Comment by Chirag — June 7, 2008 @ 10:56 am

  6. If the government decides to reduce or say eliminate the sales and excise taxes on oil products, the cost for the marketing companies will reduce and revenue for government will also reduce. But that does not result in increased fiscal deficit for government as the subsidy given to marketing companies (thru oil bonds) will also reduce, which is the expenditure for the government and so the deficit will be balanced upto some extent.

    Now, rather than taxing all car owners fixed amount per month, I would suggest the government to track the usage of oil per month and charge the price of oil as per marginal schedule. Cars can be given a unique card ( as it has a registration number), which should be made mendatory for oil purchases and thus government can track car owner’s monthly usage of oil. Government can impose different rates for different ranges of usage ( such as electricity charge). This process will ensure that the car owner who is driving more knows the eexcess costs aligned with it. And the owners who drive minimum are not penalized just for the reason of owning a car. Now thats what I call the absence of free lunch.

    Comment by Shiv Desai — June 12, 2008 @ 1:23 pm

  7. Gleaming from the blogs – there is no social responsibility.

    a) To hell with the nation,
    b) make sure that the price doesn’t go up
    c) even if it does make sure my lifestyle is not impacted.
    d) do all that to somebody else.

    Change your life style. Reduce your carbon footprint on this world. Ration your consumption. As long Indians keep aping the west, you will inherit all the problems of the west. Indian Cities need bicycle trails and not more high speed roadways like the west.

    Comment by goldwinner — June 13, 2008 @ 9:25 pm

  8. The idea of taxing owners of four wheelers sounds good from an qeuity point of view. BUt it is unlikely to make much an impact on the fiscal deficit. Assuming about 10 million vehicles (which is probably too high an estimate) on the road and even assuming an annual tax of about Rs.5K per year, that would about 5000 crores of revenue – not much when compared to the large hole we are staring at, is it?

    And dont even think of charging vehciles based on their consumption, that would just throw up another flourshing sector of beuraucratic corruption.

    I am just guessing here, but i think a large part of the oil consumption comes not from private vehicles, but for industrail use and public transport. So there is no way out but for the latter two to share a good part of the burden.
    Clearly, this whole fiscal problem is a structural one with the govt depending on the oil industry for a disproportionate share of revenues. And the solutions would neccssarily be textbook solutions, not “out of the box” ones – widen the tax base, tone up the tax administration, improve the tax/gdp ratio and so on. Areas where there are clearly quite a few low hanging fruits. Till that happens, we will have to make do with these price increases relucutantly taken to stave of fiscal disaster.

    Comment by sai aravindh — June 14, 2008 @ 2:48 pm

  9. Beuraucratic corruption can be a hindrence to a process of marginal charge of fuel based upon consumption but that problem can be easily sorted out. As Petroleum Distribution is an indutry with Few major players and almost an organized sector, which is a big relief in implementation of a process.

    It is easy to track the purchase of petroleum by a distributing company. The distribution of the same among states and districts by the company. This step has to be taken to the bottom level till each petroleum. All petrol pumps can be interconnected with an satellite which can transfer the real time data about the quantity of oil the customer has purchased in a month. The purchases by a petrol pump can be tracked again authentic sales (with unique id of vehicle) and the difference among them can be charged to petrol pump at the highest bracket. This will eliminate the corruption at the level petrol pump. Petrol pumps can be given some margin for the evaporation of oil.

    This process will lead to initial capex for the distribution inductry but can provide the long term solution. If the Indian think tanks take this approach seriously, they can create much more robust model.

    And the increased tax rate leads to lower economic activity and lead to higher rates of unemployment which can be fatal for the second most populous country.

    Comment by Shiv Desai — June 19, 2008 @ 10:27 am

  10. Im a regular reader of this blog and could hardly believe Atanu Dey suggested what he did !

    Its an open invitation to corruption every babu in this country will be queuing up to monitor car fuel consumption.
    Its impractical, untenable and unviable. Its also a waste of precious resources.

    Why are we as a country so keen to penalise ? Why not incentivise ?

    Theres an old saying you get more flies with honey than you do with vinegar. Lets make energy efficiency a National Mission . Its not very hard to do and once it takes off can be a win-win situation .

    Here are my suggestions.

    a. Bussing the citizen.

    i. Allow duty free import of a/c electric buses (like those used in airports overseas) by say a Mall-Theatre-Restaurant.

    ii. Have a free shuttle service run b/w the mall and various points like railway stations, bus stops, taxi stands or even buildings.

    iii. Malls could offer a home delivery service of all shopping that cannot be carried in 2 hands or above a certain purchase price for all those who opt to be bussed. Considering their proximity to each other, most malls can combine shuttling (like many airport hotels share a common coach service esp. in Europe ) and linking . So MallA can have its shuttle run upto a midway point from where a MallB shuttle can take over. Its all logistics management.

    iv. Slowly but surely, people are going to jump at it . Most malls have inadequate parking or at a price but with monthly shopping bags being as large as they now are, personal transport is a given.

    v. Home delivery can be instituted thru postal vans, courier companies or even the railways. A DTDC or Gati would probably see great value in it.

    vi. Cost of the service can be rebated from the service tax paid by malls on rental income. It can be arrived at on a negotiated formula.

    vii.The naysayers will say that people will use this as a freebie and it maybe misused. That will happen and there can be a way to link it to a mall bill or just use RFID judiciously.

    b. Renewable energy

    i. US Companies like Nanosolar and First solar are commercially producing solar panel sheets.
    ii.The govt of India should buy up an entire years production and then supply these sheets for free to the ubiquitous glass and steel buildings that now dot our country to be affixed. Sticking them on govt buildings might be even better.

    iii.The energy produced from these panels should be used for all lighting and airconditioning needs.

    iv. The savings made by all buildings opting for this could be returned to the govt as an energy tax which would solely be used to procure more such renewable energy products and distribute them to residential buildings.

    v. Our national energy bills will reduce enough to bring money to peoples pockets welcome anytime but esp. in these inflation ridden times and the govts. Import costs will come down with it.

    Our politicians love giving free water, free power , free tvs so why not ask them to give something free that will eventually help the country ? And talking of politicians maybe the Govt could put a limit on the number of pilot cars and hangers on in pvt cars who get right of way when they accompany mantrijis be it for an inauguration of a power plant or a roadside chowk ?

    Finally, this requires some out-of-the-box thinking and it requires political zeal. For all our sakes, I hope someone in Delhi or the state capitals has it !

    Comment by s anand — July 13, 2008 @ 9:50 am

  11. Wrt to the subsidy to the poor and extracting the real price from the rich, it always has a possibility of increasing black marketing and adulteration. The problem in India in general is not that we don’t have a law, the problem is that it’s not implemented and the law in India is an ass, it just depends who rides that ass!!

    Comment by rahul — July 16, 2008 @ 3:52 pm

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