Diesel Price Deregulation: A Few Months to Go

Manish
Kumar &
Surobhi Mukherjee


There is no doubt that the newly elected government will
favour deregulating the price of diesel as well as other petroleum products in lieu of subsidies or grants to the
oil sector. At least on this issue both governments (NDA as well as UPA) are of
the same view, despite the fact that under-recovery on diesel touched record
low at Rs 2.80 per litre on 2nd of June ’14 .(
www.pib.nic.in).




Since
January 2013, Oil Marketing Companies (OMCs) were allowed to increase the price
of diesel by 40-50 paisa per month on until under-recovery on diesel vanishes completely.
It is postulated that in coming few months the diesel price will be left open
to free market if the same pricing trend continues and other macro indicators
do not change. This article focuses on two aspects- first; the validity of
arguments which favour price deregulation of petroleum products and the second;
the possible gains and losses of such an outcome.


Deregulation is promulgated in response
to huge losses made by OMCs or “under –recovery” faced by the oil-sector and as
a result of these the government is facing added fiscal burden
. – How far this is true?


 “Under-recovery” is not congruent to loss
(Sethi, 2010, and Dasguta & Chatterjee, 2012). It is the gap between
desired price and administered price. Apart from the actual cost, desired price
includes many other elements like cost & freight charges, import and custom
duties etc. which just inflate desired price and, in turn, produce “under-recovery”.
These factors amount to overestimating the actual loss, given the fact that
India doesn’t import petroleum products but only crude-oil. In fact India’s
refining capacity of crude oil is more than its domestic demand and is exported.
Because of this over-estimation, under-recovery is cited as ‘loss’. Reported
under-recovery is far greater than the actual loss. Apart from 2008-09 and
2011-12, the average gap between under-recovery and loss has been around Rs
17000 crore.



As far as
questions of financing under-recovery are concerned, almost 50% of it is absorbed
within the sector and remaining 50% is financed by government.
 



Another interesting point worth noting is
regarding, how the “loss” is understood. For this we need to understand the
structure of the oil-sector. There are 14 Public Sector Under-takings (PSUs)
under the Ministry of Petroleum and Natural Gas. Out of these, six of them are
involved in major businesses. On the basis of their financial performance, these
6 companies are further classified as up-stream and down-stream companies.
ONGC, GAIL and OIL are up-stream companies. Their prime businesses involves
extraction and purchase of crude oil (ONGC also undertakes refining but its
share in the total is very small). IOCL, BPCL and HPCL are down-stream
companies involved mainly in refining and retailing (IOCL also purchases crude
but its share is very small).


The
down-stream companies are the loss making bodies in the oil-sector. But there
are no documentary estimates of actual loss. So by looking at the profit and
loss accounts of these three retail units and by taking into consideration the
external elements we can arrive at a figure of loss which is different from the
claimed under-recovery. There are three external elements in the profit &
loss account – grants by government, subsidy as per scheme, and discount by
up-stream companies. Grants are given to down-stream companies against their
claim of under-recovery. Since June 2010, there has been no under-recovery on
petrol. In the case of diesel, partial deregulation is allowed (as mentioned
above) since January. Only two petroleum products i.e. PDS kerosene and LPG have
not yet witnessed any deregulation in their prices till now (but there is a
limitation on number of subsidised LPG supplied to households). Subsidy as per
scheme is also given to down-stream companies only for these two products.
Other than the government a part of under-recovery is also financed by
up-stream companies in terms of discounts on crude-oil prices.


Now it is
true that if we remove all these three external elements of financing
under-recovery then the profit of down-stream companies turns out to be
negative i.e. IOCL, BPCL and HPCL are making losses. Here three important
points need to be noted.


1.    Product-wise
disaggregation of cost of production is impossible since the refining process
is very complicated. Actually different products are recovered at different
levels of the same production process. So any claim of product specific loss
has always some degree of imperfection.

2.    Since
product specific loss calculation is almost impossible, we have to look at
aggregate loss. For this purpose we need to look at the whole production
process. IOCL, BPCL and HPCL primarily refine crude oil and sell it to
retailers. Here we need to be cautious as production process of petroleum
products doesn’t start from refining but from extraction of crude. So any
calculation of aggregate loss must include the whole production process. India
imports around 80% of its crude oil demand and the rest is extracted
domestically. So in the Indian case 80% of the production process starts from
importing crude oil and the rest 20% from extraction. For the purpose of
arriving at a figure of aggregate loss we have to include all companies of the
oil-sector. After adding these, loss vanishes and we find that in fact the oil-
sector as a whole earns profits, even with the present structure of taxes and
duties, for most of the time, in last seven years.

Even
if we consider the loss of OMCs, there should still be some analysis of the
government’s claim of fiscal burden. Here we should note that Tax+Duties earned
by the government (central as well as state, although states’ share is very
small) from the Oil-Sector is far greater than the under-recoveries and
subsidies (Sethi, 2010) and through the same way government earns huge revenue
from OMCs as well. So the claim that the government is facing a huge fiscal
burden is wrong.
    Almost
half of the under-recovery is financed by government of India so it is possible
that post deregulation, government exchequer will save some money. The
remaining half of the burden is shared by up-stream companies so these
companies will also get rid of this “so called” burden and finally some part of
the burden is absorbed by OMCs, henceforth after complete removal of under
recovery these companies need not to do so. Apart from these, OMCs will also
get rid of cash flow problem, which is caused by delay in payment by
government. But the above benefit can’t be said significant as part of under
recovery shared by up-stream companies is very small in comparison to its
profit and that’s why for most of the year even after absorbing this cost,
sector as a whole makes profit. A similar argument could be constructed for
government as amount incurred for financing under recovery is very small in
comparison of what government gets from the sector or OMCs in form of taxes,
duties and royalties.        

Then the
questions arise, if government or oil-sector is not going to be benefited
appreciably then who are going to be possible beneficiary from this move and on
what cost?

Apart
from the PSUs there are some private players engaged in retail business. Essar
and Reliance are two big names in this area. Currently Essar has 1400
operational retail outlets and also ready to add 1600 more (Business Standard
Oct. 2013). Reliance has currently 1450 retail outlets out of which 280 are
operational at present. Given their potential they can enter and expand their
retail business after complete removal of under-recovery. These private
companies have also huge refining capacity. Essar and Reliance account for 80
Million Metric Tonne Per Annum (MMTPA) out of 215.07 MMTPA of all India
including PSUs and joint venture i.e. around 37% (Refinery Map of India, PPAC).
Currently Reliance and Essar are primarily exporting petroleum products but
after price deregulation selling in the domestic market would be easier.

This
policy move will help private players to capture a significant portion of
market which is currently in PSUs hands on one hand and on the flip side this
will influence common man’s budget, with inflation on course (Patnaik, 2011). The
stake of balance between powers is such that the newly elected government would
definitely ensure the interest lies with the former.



References:

Dasgupta,
Dipankar and T. K. Chatterjee (2012): “Petroleum Pricing Policy: A Viable
Alternative”, Economic and Political
Weekly
, Vol. XLVII No. 46

Patnaik,
Prabhat (2011): “Raising Price to Curb Inflation”, People’s Democracy, Vol. XXXV No. 29

Sethi,
Surya P. (2010): “Analysing the Parikh Committee Report on Pricing of Petroleum
Products”, Economic and Political Weekly,
Vol XLV No. 13

Business
Standard (July 2nd 2012): “RIL to reopen 50 fuel pumps in Gujarat”
http://www.business-standard.com/article/companies/ril-to-reopen-50-fuel-pumps-in-gujarat-112070200058_1.html 

Business
Standard (October 18th 2013): “Diesel decontrol hope puts Essar in
high gear on fuel retail”
http://www.business-standard.com/article/companies/diesel-decontrol-hope-puts-essar-in-high-gear-on-fuel-retail-113101700829_1.html

Manish
Kumar (
[email protected]) & Surobhi Mukherjee ([email protected]) are M. Phil research scholars at
Centre for Economic Studies and Planning, Jawaharlal Nehru University.