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Friday, May 23, 2014

Petroleum Pricing Policy in India


Petroleum product pricing in India is frequently seen as a black hole of subsidies. Economists and oil companies complain about the impacts those subsidies have on public finances, financial performance of oil companies and demand-side management. However, on closer analysis, the issue of petroleum product pricing in India is more complex than the one-way flow of subsidies that is mostly reported. The artificially low prices of petrol and diesel, however, do not reflect the realities of the high crude and refined product prices. These low prices offered to the public are subsidized by the government through the issuance of oil bonds, which are given exclusively to public sector fuel retailers in India.
The price of fuel in different countries is affected by many factors. Few major ones could be the cost of buying finished product in the country (country supplies usually cheaper than importing product), excise and tax rates levied by the Government, Government subsidies for fuel, Currency fluctuations or stability of the respective country, etc.
India was traditionally operating under an Administered Pricing Mechanism (APM) for petroleum products. This system was based on the retention price concept under which the oil refineries, oil marketing companies and the pipelines were compensated for operating costs and were assured a return of 12% post-tax on net worth. Under this concept, a fixed level of profitability for the oil companies was ensured subject to their achievement of specified capacity utilization.
But then in 1997, the Indian government took a strategic decision to deregulate the oil sector and dismantle the administered price mechanism (APM) existing in the Indian oil industry in three phases by the end of March 2002. It was broadly known as “APM dismantling”.
Since then, the Indian oil industry had been undergoing a transformation stage from administered price mechanism to market-determined price mechanism. During this period of transition, the government also cleared the oil pool deficit by completely abolishing it and transferring the deficit and to the general budget. The government has repaid most of the oil companies' outstanding through the payment of oil bonds. It also reduced the subsidies on petro-products.
With the dismantling of APM from April 2002, oil companies stand exposed to the vagaries in the international prices of crude oil and products. Hence, their profitability is now governed by different set of factors. Post-APM dismantling, import of oil, mainly from the Gulf countries, has become a serious threat to domestic players.
Currently, the refinery gate prices of petroleum products are computed based on the Import Parity Principle. In the computation of import parity prices, the principal elements are the FOB price, customs duties, ocean freight and a few other associated items. These elements, except for the FOB price, are not relevant in computing export parity prices.
So how does India differ from the rest of developing Asia?
Up to this point, the story of India’s petroleum product pricing appears a typical reflection of fuel subsidies throughout developing Asia and many other countries. Governments force public sector companies to indirectly subsidize consumption while simultaneously insolating the fiscal position of the government to the extent possible. However, conventional wisdom and economic theory show that consumption subsidies that keep commodity prices artificially low distort economic decision making. Subsidies result in higher consumption and distort the choice between fuel alternatives that might have positive social and economic externalities but are not subsidized. So how does India compare with its neighbors on petroleum product pricing?
Comparison of Retail Price in Selected Asian Countries


Source: Rangarajan Committee Report

Indian retail prices for petrol and diesel are surprisingly among the highest in South-Asia and other developing Asian regions, even exceeding prices of more developed economies. Still Indian companies are incurring huge under-recoveries on the sale of products due to the range of taxes and duties levied on the petroleum products. The complex and opaque system of taxes, charges, duties etc makes it difficult to arrive at a net position of the actual subsidies in the system.
International Comparison of Tax Proportion in Retail Price

Source: Rangarajan Committee Report

Thus, there is still need to review the pricing of sensitive petroleum products (petrol and diesel) to provide relief to consumers as well as corporate and also to rationalize pricing in the context of exports of the order of 20% of production of these products.

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