Business Today

Two cheers for oil reforms

Subsidies on LPG and kerosene are not only desirable but can also be made viable, argues Kirit Parikh.

Puja Mehra | Print Edition: July 25, 2010

The deregulation of petrol, and eventually diesel, prices is certainly desirable as it will liberalise the energy sector. This was the most important of all the recommendations we (five-member expert group, headed by former Planning Commission member Kirit Parikh, to advise on a viable and sustainable system of pricing petroleum products) had submitted to the government. Decontrolled petrol and diesel prices boost the energy security of the country.

The energy sector will become fully competitive when diesel prices get fully decontrolled. To get there, the government could have raised the prices to the market-determined level while cushioning the impact to consumers by lowering the excise duty on diesel by Rs 1.75 per litre. The earlier non-market mechanism for setting prices had eliminated competition by driving out private companies from the retail business.

The under-recoveries reported by the public sector oil companies could have overstated their losses due to administered prices as they are based on assumed notional costs of distribution and transportation, etc. A lot of the fat in the system would disappear with complete deregulation as companies could begin to use hedging, stocking and long-term contracts resulting in smoother and, perhaps, even lower market prices.

The government took the cue from the Kirit Parikh Committee's recommendations, but has to do a lot more.
Petrol & DieselComplete de-regulation; market determined prices at the refinery gate and the retail level; additional excise duty on diesel car owners.Complete de-regulation immediately for petrol and in the works for diesel (immediate hike of 5%).
LPG & Kerosene
  • Continue to subsidise the clean cooking fuel but rationalise allocation.
  • Increase LPG price by Rs 100/cylinder and thereafter periodic increases in line with per capita income.
  • Increase kerosene prices by Rs 6/ltr (current price at Rs 9/ltr), and thereafter periodic increases in line with nominal agri GDP growth.
  • Price of LPG raised by 11.2% (Rs 35/cylinder) and kerosene by 33.3% (Rs 3/ltr).
  • Prices of both fuels continue to remain administered.
Under-recoveriesZero for auto fuel; link burden of rest of subsidies borne by ONGC and OIL to global price of crude through a formula.Will shrink by about Rs 20, 000 crore to about Rs 55,000 crore overall. Losses on LPG and kerosene will reduce marginally.
SubsidiesGovernment’s share would be capped at Rs 20,000-23,000 crore at all crude levels.Subsidy-sharing formula not announced yet.

We (Kirit Parikh Committee members) were asked to suggest a viable and sustainable system of pricing petroleum products, but the dilution of the recommendations on LPG and kerosene will not make the fuel subsidies viable, which is disappointing. There is a strong case for subsidising LPG since it is a clean fuel and also kerosene as it is used for lighting in most rural households. These subsidies are socially desirable.

But, to stabilise the impact of these subsidies on the Budget, we had recommended a formula that capped the share of their burden on the government at Rs 20,000 crore a year irrespective of the global crude prices. This formula makes the subsidies viable by linking the prices of fuels to the income growth of those who consume them. So, for instance, the quantum of the subsidy under this formula comes down if agricultural incomes rise. Efficient targeting also helps: Allocations to states could be reviewed periodically in accordance with the number of households below the poverty line hooking up to power grids.

The government still hasn't clarified how the subsidies will be funded and by whom; when under-recoveries on account of LPG and kerosene by oil marketing firms will be eliminated and if it will continue to issue oil bonds to compensate them. Even if it chooses to bear a larger share of the overall subsidy than our recommendation of Rs 20,000 crore, the government should pass on more of the cost of fuels to consumers, if it wants to make the subsidies sustainable.

Right now, the burden of the subsidies is borne largely by taxpayers, which doesn't exclude the poor since there is no escaping the regressive indirect taxes. I am hopeful that a big chunk of the under-recoveries will stabilise when the burden that is absorbed by Oil and Natural Gas Corporation and Oil India Ltd is linked to global prices of crude through a profit-sharing formula the firms themselves have suggested.

— Kirit Parikh is a former member of the Planning Commission

(As told to BT's Puja Mehra)

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