A crude demand for royalty

Written by Uttam Gupta | Updated: Jan 7 2014, 08:28am hrs
While administrative and judicial bodies are expected to aid the process of economic reforms, they sometimes tend to obstruct the smooth conduct of business.

A case in point is the decision of Gujarat government to collect a royalty of 20% on the discount given by Oil and Natural Gas corporation (ONGC)an upstream central oil & gas PSUon the sale of crude to downstream oil PSUs.

The decision has been upheld by the Gujarat High Court, which has ordered ONGC to pay dues worth R5,0006,000 crore retrospectively from 2008.

ONGC is already groaning under the debilitating effect of having to share burden of under-recoveries on the sale of oil products. In the last decade, it shelled out a massive R2,16,000 crore and is now left with a meagre cash balance of R6,000 crore (as on March 31, 2013).

Faced with a huge shortfall in reaching its target of proceeds from disinvestment in PSUsso far it has not got even 5% of R40,000 crore it targetedthe government is also eyeing ONGC, besides other PSUs, for giving special dividend. It is looking for money where it does not exist!

What a pathetic situation for a Maharatna central PSU which has been generating huge surpluses year after yearthanks to its low cost of production and much higher price realisation tagged to international price of crude oiland yet, is terribly short of internal resources!

Now, this liability of R6,000 crore would completely wipe out whatever cash is available with ONGC. No wonder, despite strong fundamentals, ONGC will have borrow massively to meet its capital expenditureR35,000 crore per annum.

Is the royalty on discount justified Can obsession with revenue be pushed to a point wherein the government collects levy even on an amount that is not received by producer

Some the basic facts, first. Until the dawn of the 21st century, petroleum products in India were covered under an administered price regime (APR).

Downstream oil PSUs, viz. Indian Oil Corporation, Bharat Petroleum Corporation Ltd and Hindustan Petroleum Corporation Ltd were required to sell diesel, kerosene and LPG at prices below the cost of production and distributionapart from this, till 1997-98, supplies of naphtha, fuel oil and low sulphur heavy stock (LSHS) to fertiliser industry were also made at concessional price.

The losses on sale of these products were cross-subsidised by surpluses generated from sale of naphtha, fuel oil, LSHS, aviation turbine fuel (ATF) to other industries at prices much higher than costs.

These inflows and outflows were administered through the Oil Pool Account (OPA). Depending on the international price of crude versus price matrix of various products, OPA ran in to net surpluses or deficit at different points of time.

In 2002-03, based on recommendations of Vijay Kelkar Committee, the NDA government dismantled APR. Even as it continued the sale of diesel, kerosene and LPG at low prices, it bowed to the pressure of paying subsidies directly from the Union budget.

The objective was to make these subsidies transparent and focussed. This was also a precursor to a phased program for progressive elimination in a time bound manner. But, this euphoria was short-lived.

The new government under UPA was never serious about reducing subsidies. Yet, it was keen on avoiding stress on the budget. Therefore, it came up with the ingenious idea of directing ONGCbesides Oil India Ltd (OIL)to offer discount on supply of crude to downstream oil PSUs, a policy which continues till date.

According to the Oil Field Act (OFA), ONGC is required to pay a royalty of 20% on the market value of the crude oil it extracts from oil blocks/fields to the state government.

From 2004 onwards, ONGC, in all fairness, started paying royalty to the state government on the crude price net of discount. However, the latter insisted (a belated thought, though) that the royalty be paid on the pre-discount price which the High Court has now allowed.

Charging royalty on the discount/subsidy amount is completely illogical. A levy can be collected only on sale price. Subsidy is clearly not a part of sale realisation. Therefore, it cannot be subject to tax. Doing so will have astounding implications.

Consider the market price of crude to be $100 per barrel. The sale price post-discount is $40 per barrel. Now, if a royalty of 20% is imposed on the market price, this will translate to $20. This translates to an effective royalty rate of 50% (20/40)!

The implications of this for OFA itself need to be carefully evaluated. How can the state administration charge royalty at a rate higher than what is prescribed under the Act

Any levy inevitably increases the cost of supply. This makes no sense as that is reimbursed as subsidy by the union government. Now, if authorities collect levy even on the subsidy amount (the discount given by ONGC), it would be preposterous

The action by the Gujarat government has precedent. In 1988, Tamil Nadu, AP and Kerala raised demand for sales tax on subsidy received by fertiliser manufacturers under the erstwhile retention price scheme (RPS) with a retrospective effect, e.g., from 1982-83 to 1987-88, in the case of Tamil Nadu.

As in oil, the Union government controlled the selling price of fertilisers, keeping it at a low level. The cost of production and distribution being higher, the excess amount was reimbursed as subsidy. This was to compensate producers for loss they would have incurred due to the low price.

Subsidy is not a part of realisation from sale and therefore, imposition of sales tax is illogical. Indeed, the high courts in AP, Kerala and Uttar Pradesh held that demand for sales tax on subsidy was untenable. Those judgements were upheld by the Supreme Court.

Sales tax authorities in Gujarat too had raised the demand for tax on subsidy. However, the state governmentthrough a circular issued under Gujarat Sales Tax Act (1969)directed officials not to press for the same. While other states corrected the wrong through judicial intervention, Gujarat did it on its own.

Why then, with regard to royalty on the discount given on the sale of crudewhere underlying fundamentals are the sameis the state government in a reverse gear with the High Court giving its stamp of approval

This wrong must be corrected at the earliest and ONGC saved the ignominy of eroding its internal resource base that has to be kept robust to enable support for its investment plans, which in the long-term are essential for Indias energy security.

The author is a policy analyst