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may 15, 2010 vol xlv no 20 EPW Economic & Political Weekly18

The Logic of the Expert Group Report on Petroleum Prices

Kirit S Parikh

The article explains the logic behind the Parikh Committee recommendation on petroleum prices. Based on considerations of who would bear what burden, the recommendations would lead to a viable and sustainable pricing policy, which would be workable over a wide range of international oil prices, which would meet the various objectives of the government, and which would limit the fiscal burden on the government and keep the domestic oil industry financially healthy and competitive.

Surya P Sethi’s comments (“Analys-ing the Parikh Committee Report…”, EPW, Vol XLV, No 13, 27 March 2010)

on pricing of petroleum products are misplaced, inconsistent and create much misunderstanding. Hence, I write this to explain the logic of the report of the Expert Group on Petroleum Prices (Parikh et al 2010) and to show the errors in Surya Sethi’s comments. We first look at the background of the oil sector.

Consumption, Production and Imports

In 2009-10 India produced 35.1 mt of crude oil, mainly by public sector companies, Oil and Natural Gas Corporation (ONGC) and Oil India Corporation (OIL), and imported 158.9 mt of crude oil. With an installed re-fining capacity of 178.0 mt of crude oil per year it produced 178.9 mt of oil products of which 50.7 mt were exported. India also imported some oil products and the total consumption was 138.2 mt with nearly 80% of domestic consumption based on imports. Net oil and product imports amounted to $59,364 million, which con-stituted 31.4% of total export earnings in 2008-09.

Oil product pricing can thus have sig-nificant impact on the Indian economy. The four major oil products, petrol, diesel, kerosene and LPG for which the commit-tee was asked to suggest a viable and sus-tainable pricing policy, constitute 60% of oil product consumption in the country. The prices of other products have already been freed and are market-determined.

Under the present policy the govern-ment does not permit public sector oil marketing companies (OMCs) to pass the full cost of imports on to domestic con-sumers of major oil products, i e, petrol, diesel, d omestic LPG (i e, LPG used by the households) and PDS kerosene (i e, Kerosene sold through public distri-bution system of the government). The con-sumers of these products thus receive large

subsidies. The OMCs sell them to the con-sumers at government-determined prices. However, they purchase them from refin-eries at import parity prices or at a weighted average of import parity and export parity prices for some products. The difference between the cost price and the realised price represents the under-recoveries of the OMCs, which were financed partly by the government through issuing bonds, and partly by up-stream public sector companies ONGC, OIL, and GAIL through price discounts. The OMCs also absorbed a part of the u nder-recoveries themselves. Table 1 (p 19) shows the purchase and sales price for these products. The under-recoveries depend on the total volume of products consumed and are shown in Table 2 (p 19).

These policies have a number of conse-quences. They put stress on government’s finances. They reduce the cash surplus of the upstream public sector oil companies restricting their ability for exploration of domestic fields and acquisitions overseas. As the oil bonds are often not issued to OMCs on time, they create cash flow prob-lems for the OMCs who borrow from the market, which increases interest pay-ments and reduces their surplus. Since only the public sector OMCs are provided financial support, the private sector companies have withdrawn from oil marketing. It also has reduced competition in oil marketing. Subsidising domestic consumers also does not provide incen-tives to economise on the use of petroleum products. Rather, as prices have remained low and personal incomes have increased, the demand for petroleum products such as petrol and diesel recorded double digits growth, higher than the GDP growth. Continuation of the present policies is not viable, particularly once oil prices rise again.

A Viable and Sustainable Policy

The committee was asked to suggest via-ble and sustainable pricing policy, which we defined as one that is workable over a wide range of international oil prices and which meets the various objectives of the government. Also, it should limit the fiscal burden on government and keep the d omestic oil industry financially healthy and competitive.

I thank Basudev Mohanty and Jyoti Parikh for their comments on an earlier draft.

Kirit S Parikh (kparikh@irade.org) is with the Integrated Research and Action for Development and was chairperson of the Expert Group on Petroleum Prices.

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The committee’s recommendation are viable and sustainable as it reduces the burden on the central government’s budget to around Rs 20,000 crore and it remains at that level even when the world price of crude oil becomes as high as $140 per barrel.

The first thing to recognise is that any change in policy puts burden on someone or the other. The committee’s recommen-dations are based on consideration of who bears what burden. Our recommendation puts little burden on the aam aadmi and are good for the country.

The Burden of the Recommendations

Petrol Price: The committee recom-mended that “petrol prices should be market-determined both at the refinery gate and retail levels”. That means the price at which refineries sell to the OMCs

and the price at which the OMCs sell to con sumers at their retail outlets should be market-determined.

Freeing petrol price is a no-brainer as the vehicle owners are relatively better-off people and there is no reason to subsidise them. Also petrol consumption has little forward linkages and will not cause much of an impact on other prices. With full pass through, even at a crude price of $80/barrel, an average

two-wheeler driver would spend around Rs 50 per month more.

Diesel Price: The committee also recom-mended that “the price of diesel should also be market-determined both at the refinery gate and retail levels”. The con-sumers of diesel are agriculture (12%), passenger cars (15%), trucks (37%), buses (12%), industry (10%), power generators (8%) and railways (6%).

Diesel use by passenger cars, many of which are expensive sports utility vehicles (SUVs), should not be of much concern as the owners can afford to pay more for diesel and should have little forward link-age and cascading impact on prices.

The Commission on Agricultural Costs and Prices (CACP) takes into account the cost of diesel while fixing Minimum Sup-port Prices (MSP) for agricultural produce. Thus, there would be no additional burden on farmers when diesel price increases. Higher price of diesel, however, will en-courage farmers to use diesel and water more efficiently. This is desirable as there is lot of overexploitation of groundwater in the country with serious consequences for the productivity of land.

The immediate increase in diesel price would be around Rs 2.5/litre. Use by trucks, buses, railways, power generation and industry would increase costs and would have some impact on prices. This would be moderated as higher diesel price would encourage freight movement by railways instead of trucks as railways use one-fourth to one-fifth as much diesel as trucks per net tonne kilometre. Industry and transport operators may not be able to fully pass on the cost increase to consumers as they function in competitive environ-ment. Thus, the impact of higher diesel price is not likely to be more than the

Table 1: Domestic Prices of Petrol, Diesel, Kerosene and LPG (derived from different levels of prices of the Indian basket of crude oil)

InternationalPrices IndicativeRetailSellingPrice(atDelhi)

CrudeOil(IndianBasket) Petrol Diesel Kerosene LPG Petrol Diesel Kerosene LPG

($/bbl) ($/bbl) ($/bbl) ($/Mt) (Rs/Litre) (Rs/Litre) (Rs/Litre) (Rs/Cyl)

60 66 70 72 538 43.75 32.23 23.82 455.42

70 77 81 83 595 47.71 36.08 27.29 495.41

80 88 93 94 652 51.66 39.92 30.76 535.42

90 99 104 106 709 55.61 43.76 34.23 575.42

100 110 115 117 765 59.56 47.61 37.70 615.42

110 121 127 128 822 63.51 51.45 41.18 655.42

120 132 138 140 879 67.46 55.29 44.65 695.43

130 143 149 151 936 71.41 59.13 48.12 735.43

140 154 161 162 993 75.37 62.98 51.59 775.42

150 165 172 173 1,049 79.32 66.82 55.06 815.42

Retail prices (as of 29.1. 2010, when price of Indian basket of crude oil was $71.53/barrel) 44.72 32.92 9.23 281.20The product prices of petrol, diesel, kerosene, and LPG have been derived through regression equations of crude and product prices in international market during January '07 to December '09. The equation, Y = a + bX, in which Y is product price and X is crude oil price, gives the following estimates.

Coefficients Petrol Diesel Kerosene LPG

a 0.41 2.31 3.93 197.31b 1.10 1.13 1.13 5.68 Exchange rate considered at Rs 47 per US dollar. Indicative retail selling prices of PDS kerosene and domestic LPG are after netting off fiscal subsidy at current level of Rs 0.82/litre for PDS kerosene and Rs 22.58 per cylinder for domestic LPG.Source: Parikh et al 2010.

Table 2: Under-recoveries of OMCs and Compensation by Upstream Companies and the Government (Rs crore)

2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 Total

PDS kerosene 3,751 9,480 14,384 17,883 19,102 28,225 92,825

Domestic LPG 5,523 8,362 10,246 10,701 15,523 17,600 67,955

Petrol - 150 2,723 2,027 7,332 5,181 17,413

Diesel - 2,154 12,647 18,776 35,166 52,286 1,21,029

Total under-recovery, of which: 9,274 20,146 40,000 49,387 77,123 1,03,292 2,99,222

Upstream sharing 3,123 5,947 14,000 20,507 25,708 32,000 101,285

Oil bonds - - 11,500 24,121 35,290 71,292 142,203

Absorbed by OMCs 6,151 14,199 14,500 4,759 16,125 - 55,734Source: Parikh et al 2010.

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impact of no change in present policies and would improve economic efficiency.

Kerosene Price: Kerosene is highly sub-sidised at Rs 9/litre, a price that has not been revised since 2002. The price in neighbouring countries is three times this and so is the price of diesel. Thus a lot of PDS kerosene gets d iverted to adulterated diesel and to smuggle to neighbouring countries.

The committee recommended that “the issue price of PDS kerosene be raised by Rs 6/litre and should be revised every year in step with per capita agricultural GDP at nominal prices”.

The households in the poorest decile in rural areas, who use 3.5 litres of kerosene per month, spend 2% of their total e xpenditure on kerosene. Incomes of the rural people have increased since the k erosene price was last revised in 2002. Taking increase in agricultural income as a lower bound on the increase in rural incomes an increase of Rs 6/litre of kero-sene was suggested. This would keep the share of kerosene expenditure in total consumer expenditure at the same level as in 2002.

The tabulations from the National Sample Survey data given in an annexure to the expert group report clearly show that kerosene and electricity provide lighting to more than 99% of households in the country and PDS kerosene is accessed by 78% of rural households. Similarly, LPG is consumed by more than 70% of urban households in the top 50% of households. In urban areas PDS kerosene is used by 10% of the households for cooking where-as 57% of households use LPG for cooking. Sethi’s assertion (“When Bold Is Not Beautiful”, Times of India, 8 February 2010) that “two-thirds of the households cannot pay for even PDS kerosene” is not founded on facts.

The committee also recommended that “the distribution of PDS kerosene across States should be rationalised”. The distri-bution is highly uneven and varies from 14 litres per capita for high income states to 10 litres per capita for low income states. Also, there is a continuous decline in the percentage of households using kerosene. There is, therefore, significant scope to rationalise allocation of PDS

kerosene across states. NSSO data sug-gests that the norm of 5 litres per house-hold per month should be more than ade-quate for lighting. Most of the households use only 3.5 litres per month. State-wise allocation should be based on the number of BPL households without electricity in r ural areas and u rban households using kerosene for cooking. Since electricity supply may be erratic, a smaller alloca-tion, say 2 litres per month, may be made for electrified BPL households. The alloca-tions can be based on NSSO survey data and revised when new data becomes available. Even if we use the 2005-06 data, this should r educe the PDS kerosene by 20%, on all-India basis. Subsequent progress of rural electrification, LPG and piped gas availabilities is expected to r eflect much larger reductions in next NSSO surveys.

The Integrated Energy Policy (IEP) r eport had recommended entitlements at subsidised prices for kerosene and LPG. The expert group endorses that but realises that this is best accomplished through a unique identification (UID)/smart card system. The UID platform would be avail-able in a couple of years. Meanwhile, it has suggested price increases that limit the burden on consumer’s budget below the levels it has been in the past.

LPG Price: The committee recognised that LPG is a merit good as use of biomass-based fuels create much indoor air pollu-tion and health problems for women and children. Targeted subsidised LPG should be provided to the poor once the UID platform is available. At present, LPG is largely consumed by the relatively richer sections and it recommended to “Revise the price of LPG from its level in 2004 level by the percentage increase in per capita income of urban population, which is the main consumer of LPG and increase the price of 14.2 kg LPG cylinder by at least Rs 100 per cylinder.”

The increase in LPG price of Rs 100 per cylinder could also be looked upon as a decrease of subsidy from Rs 285 per cylinder to Rs 185. A large subsidy still remains. It is also worth asking who the beneficiaries of this subsidy are. Table 3 shows that 60% of the subsidy accrues to the richest 30% of population.

The poorest 40% in rural areas get only 0.6% of the subsidy. It is, however, true that some burden will fall on the middle class. However, the suggested price increase is less than the increase in per capita income of the urban popu lation since 2004 when the price of LPG was last set. Rationing to six cylinders per year as suggested by an earlier committee would have been cum-bersome, put a similar financial burden, e ncouraged inspector raj and would not have curbed diversion.

The burden of suggested price increases falls on the actual users of petroleum products and not, as Surya Sethi claims, on the aam aadmi who bears the burden of inflation caused by the present policies of managed prices.

Level Playing Field

Sethi supports the need for a level playing field and pricing reforms but by implica-tion suggests that our recommendations are piecemeal and do not provide such a field. He is wrong. The report of the IEP Expert Committee (Planning Commission 2006) which I chaired and Sethi also signed as convener, argues for market- determined prices at both the refinery gate and retail level. This is exactly what the expert group recommends for petrol and diesel. There is nothing piecemeal about it. Sethi says that along with full competition pricing of petrol and diesel at the refinery gate and retail level should be implemented with trade parity pricing. This makes no sense as once the price is competitively determined there is no scope for fixing price at “trade parity” or at any other level. In fact in a competitive market in an open economy, the price will be at the trade parity level. Trade parity means export parity price for a product that is exported and import parity price for a product that is imported.

The committee has also recommended that “Public sector upstream oil companies like ONGC and OIL should be asked to share part of their profits from production from

Table 3: Who Gets LPG Subsidy (% of total)

Households Rural Urban

Poorest 40% 0.6 11.4

Middle 30% 3.5 24.4

Richest 30% 20.9 39.1Based on NSSO survey data for 2004-05.

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blocks allocated on nomination basis, which did not provide for profit sharing”.

The blocks allocated under the new exploration licensing policy (NELP) require profit sharing or production sharing with the government. Asking ONGC and OIL to do so for their pre-NELP blocks is provid-ing a level playing field. In any case the formula suggested requires less of these upstream public sector undertakings (PSUs) than what the government got through concessional pricing in the past. It would thus increase the financial position of these PSUs.

Do Indians Pay More?

Sethi argues that Indians pay one of the highest prices for petroleum products in the world in purchasing power parity (PPP) terms. For a product that is largely imported, pricing based on PPP is not the right thing to do. We pay for petroleum imports in real dollars and not in terms of PPP dollars.

In fact, the retail price of petrol in India is substantially lower than that in France, G ermany, Italy, Spain, UK and Japan but

higher than in Canada and US. Retail price of diesel in India is lower than the price in all these countries. The differences are largely due to substantially higher share of taxes in retail price in these countries.

The US, China and Canada have lower levels of taxes but all these countries have a larger share of domestic production in petroleum consumption. Also the low pe-troleum price in China should not be viewed in isolation. China has a very dif-ferent pricing system.

When we compare retail prices of these four sensitive products, petrol, diesel, LPG and kerosene, with our neighbours, prices

of petrol and diesel in India are quite com-parable (see Table 4). We also see that prices of LPG and kerosene are much

lower in India, creating much incentive for smuggling across our porous borders. Thus part of our subsidies reaches con-sumers in the neighbouring countries.

Would Private Refineries Benefit More?

Sethi argues that the committee’s recom-mendations will benefit private refiners and also suggests that refinery capacity of export-oriented units created on the back of selective subsidies should be taxed for windfall gains. If petroleum prices are market-determined as recommended by the committee, a refiner buys crude at the international price and exports products abroad at international prices and there would be no windfall gain to a refiner, public or private. When crude price i ncreases, the refiner’s inventory cost i ncreases and there is an increase in the gross refining margin. Net refining margin would increase only when there is e xcess demand. Such increase is not c omparable to windfall gains that accrue to oil producers. Permitting an export- oriented unit to sell

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The WRC encourages institutions/academics and other stakeholders who are involved in teaching and undertaking research on themes related to social sciences to send in their proposals (not exceeding Rs. 75,000/- per proposal) for the above mentioned programmes to Hon. Director, Western Regional Centre, J P Naik Bhavan, University of Mumbai campus, Vidyanagari, Mumbai 400098 on or before 20th June, 2010.

Table 4: Price of Petroleum Products (January 2010) (Indian Rs/Litre or Cylinder)

Petrol Diesel LPG Kerosene

Pakistan 35.59 37.48 577.79 33.21

Bangladesh 49.68 29.54 533.74 29.54

Sri Lanka 46.62 29.59 654.26 20.67

Nepal 48.52 36.31 704.27 36.31

India 44.72 32.92 281.20 9.23

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in the domestic market does not mean that one does not levy taxes that are collected from others when they sell in the domestic market. With such taxes there is no ques-tion of favouring private refiners.

Sethi is concerned that public sector re-fineries would not be able to compete with more modern and more efficient private sector refineries. He would prefer that we protect the inefficiency of public sector r efineries and let the aam aadmi pay for it! In any case the new public sector refineries should be as efficient as private ones and the old ones would have written down their investments. They should be able to compete effectively.

Tax Reforms

Sethi says that the expert group should have considered issues of taxation. Gov-ernments of most countries tax petroleum products and rely on it for revenue genera-tion. India is not an exception. Also, petro-leum product taxes cannot be revised without considering the entire tax system. Moreover, the empowered group of state finance ministers is working out a system of goods and services tax (GST). Sethi a sserts that taxes must reflect the PPP of Indian rupee. This is not valid. Taxes should reflect the incidence on different members of the s ociety and their paying ability. They should also promote energy use efficiency in the system. The expert group has given these considerations most weight.

Sethi suggests that petroleum taxes should be reduced and at the same time lauds the finance minister for emphasising “the need to bolster government revenue”. He suggests we should reduce taxes on p etroleum products and raise taxes on the top 2% to 5% of the country’s population. Raising petrol prices, as suggested by our committee, does raise revenue from the richer population of the country that owns motorised vehicles. Higher tax on petrol compared to diesel can be justified on the ground of taxing the rich who own motor-ised vehicles. It does not make sense to exclude from such taxes those who drive diesel-driven passenger cars, many of which are diesel guzzling sports utility vehicles (SUVs). That is why the committee has recommended additional excise on diesel-driven passenger cars comparable

to what petrol-driven car owners pay in taxes as follows:Additional excise on a particular category of cars =

(Rate of Excise on Petrol – Rate of Excise on Diesel) × (Petrol consump-tion per year by an average user of that category of petrol cars) × [{(1+r)/r} × {1-1/(1+r)̂ 10}]

where r is discount rate and 10 years is a ssumed lifetime.

Those who buy a diesel-driven vehicle because they drive much more than an a verage petrol car owner would still find it worthwhile to use diesel-driven cars. The level of suggested increase in excise duty has been determined so that such users are not discouraged.

Are the Recommendations Inflationary?

Sethi says the recommendations are bad for the aam aadmi. On the contrary, I a rgue here that the impact of the commit-tee’s recommendations on the poor and on the inflation level should be no more than that of present policy and most likely smaller over some months.

The first thing to recognise is that we import 80% of our crude oil in hard cur-rency. The cost of the petroleum products must be borne by someone or the other. Who bears this cost, what impact it would have on price levels and on whom the eventual burden falls will depend on the policy meas-ures used. What alternatives do we have?

When the crude price increases on the international market and it is not passed on to the consumers, the cost will have to be borne by the OMCs. Since private OMCs would get out of a business if they make losses, it will be left to public sector OMCs to supply petroleum products at prices b elow their costs. If the OMCs are asked to bear the losses, they would go bankrupt. It would seriously compromise our energy security. Thus, the government finances the losses.

The government can finance them by raising taxes, cutting down expenditures, borrowing from the market or printing money. All these have consequences for price levels and economic growth both of which affect people’s real incomes.

Consider first the option of raising taxes. As per the budget of 2009-10, total tax

revenue was expected to be some Rs 6,40,000 crore of which Rs 2,65,000 crore are expected to be from indirect tax-es. If the losses on petroleum product are covered by raising indirect taxes, the bur-den will fall on all the people and the poor would bear a larger burden relative to their income because indirect taxes are generally not progressive since progres-sive taxes collect little revenue. While in-come tax can be progressive, raising addi-tional Rs 30,000 crore over the estimated amount of Rs 1,07,000 crore from income taxes will raise the tax rate by some 30% and a tax at a high rate often gets evaded. The burden of corporate tax which is ex-pected to generate Rs 2,57,000 crore may also fall in part on consumers in the form of higher prices.

Suppose the government finances u nder-recoveries through cutting down expenditure. Such cuts are often put on public investments or in public pro-grammes. If investment in irrigation is r educed or outlays on programmes of Bharat Nirman are reduced, the burden falls on the poor.

If, on the other hand, deficit financing through market borrowing is done it has its own consequences. Interest rates will increase, borrowing costs will increase, investments will go down and production costs will increase. This will increase prices also. With higher fiscal deficit, the country’s credit rating will go down and costs of international borrowing will also go up. Financing under-recoveries by issuing bonds to the PSUs is really financ-ing by borrowing money. Financing under-recoveries by printing money would have a direct inflationary impact.

Thus, no matter what is done when crude price increases, domestic price increase is inescapable. The impact of the committee’s recommendations should be examined in terms of who bears the burden.

References

Parikh, Kirit S et al (2010): Report of the Expert Group on a Viable and Sustainable System of Pricing P etroleum Products, Government of India, New Delhi, February, http://petroleum.nic.in/report-price.pdf

Planning Commission (2006): Integrated Energy Policy: Report of the Expert Committee, Government of India, August, http://www.planningcommission.nic.in/reports/genrep/rep_intengy.pdf

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may 15, 2010 vol xlv no 20 EPW Economic & Political Weekly24

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