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Indian fuel subsidies suffocating refiners

Indian fuel prices must rise immediately or the country's downstream companies could face bankruptcy. But they probably won't, Yeshi Seli reports from New Delhi

PETROLEUM products prices must be raised immediately or India's oil-marketing companies could face bankruptcy, according to a government committee. India's public-sector oil-marketing companies will make large losses this year after selling refined products at below cost because of government price controls.

That prospect has intensified the downstream industry's appeals for the government to relax price controls. A government committee set up in December to find solutions to a problem that discourages downstream investment and has in the past forced companies to shut down retail operations has called for immediate price rises. But this recommendation seems unlikely to be implemented: similar committees have said the same in the past, but the government has avoided taking action because price rises would be unpopular. Indeed, the proposal has already met political opposition.

The committee, headed by Kirit Parikh, a former member of India's Planning Commission, says the gasoline price should be raised by Rs3 a litre ($0.07/l), diesel by Rs3-4/l, liquefied petroleum gas (LPG) by at least Rs100 a cylinder and kerosene by Rs6/l. The committee has also recommended an Rs80,000 excise duty on diesel-powered vehicles to reduce the gap in taxation between diesel and gasoline. At present, diesel vehicles have a substantial advantage: gasoline duty is Rs13.5/l, compared with just Rs3.6/l for diesel. Over 10 years, a gasoline car driven 8,000 km a year at an average speed of 13.5 km an hour would cost an extra Rs81,000, the panel said.

The companies will receive some relief. Duty increases introduced in February are expected to generate nearly Rs190bn, which will fund some of the public-sector losses on fuel sales. A basic duty of 5% on crude oil has been levied, an excise duty of 7.5% on gasoline and diesel, and an excise duty on gasoline and diesel of Rs1/l. In Delhi, gasoline and diesel cost Rs44.72/l and Rs39.92/l, respectively.

Refiners squeezed

However, India's state-owned oil-marketing companies continue to be squeezed. Indian Oil, Hindustan Petroleum and Bharat Petroleum are expected to lose a combined Rs456bn ($9.9bn) this fiscal year. At present, they are selling gasoline at a loss of Rs4.72/l, diesel at a loss of Rs2.33/l, kerosene loses Rs18.06/l and domestic LPG Rs287.59 a cylinder.

Taxation on these fuels also remains high. Cutting taxes would reduce losses for oil companies without causing large price rises for consumers, but local state governments and the central government are reluctant, because fuel taxes are important sources of revenue.

Meanwhile, private-sector companies such as Reliance Industries, Essar and Shell have been unable to expand their retail operations because, unlike their state-owned counterparts, they do not receive subsidies. In 2008, Reliance shut down its retail operations when the price of crude rose to nearly $150 a barrel. Shell and Essar also shut some of their retail outlets (PE 4/09 p20), although, with crude at around $75/b, they have all resumed operations. In total, the country has around 34,000 retail outlets in operation.

The committee has not quantified how price rises would affect inflation – another reason why the government is reluctant to allow higher prices – but Parikh has said the effect would be similar whether the increase is funded through fiscal deficit (by providing subsidies instead of allowing the retail price to increase), or a direct price increase.

Failed reforms

Previous attempts to reform India's subsidy system have failed. In 2006, the C Rangarajan committee recommended the elimination of the subsidy on cooking gas (LPG) and restricting the sale of kerosene to only poor families. Two years later, the BK Chaturvedi committee made a similar recommendation. But neither set of recommendations was adopted through fear of adverse political reaction.

In 2002, the government introduced a system designed to replace the administered-pricing mechanism. Oil firms revised products prices every fortnight, adjusting them according to fluctuations in the price of crude. But the process was followed for a few months only. Gasoline and diesel prices were last adjusted in June 2009; the price of LPG was increased in 2008, but lowered last year. The kerosene price has not been revised since 2006. Kerosene, the cheapest cooking fuel in South Asia, is available for Rs9.22/l in Delhi, Rs34.89/l in Pakistan; Rs30.53/l in Bangladesh; Rs21.26/l in Sri Lanka; and Rs34.35/l in Nepal.

There is likely to be a marginal increase in gasoline and diesel prices over the coming weeks, but it is unlikely to be sufficient to ensure the long-term economic viability of oil-marketing operations in India. "We will weigh all the pros and cons," says oil and gas minister Murli Deora. "And then decide on when and how much would the increase in fuel prices should be."

India imports nearly 80% of its crude requirement. Prices in the $75-85/b range are tolerable, but a substantial increase – to over $100/b, for example – would cause severe difficulties for marketing firms.

The government compensates the three state-owned marketers for half of their revenue losses on fuel sales with oil bonds. Upstream companies, including state-owned Oil and Natural Gas Corporation and Oil India, cover another third of their losses by selling them crude at a discount. In 2008-09, upstream companies paid over Rs310bn to the three oil-marketing companies. Separately, the government provided over Rs0.72 trillion in subsidies.

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