Column : The case for cash transfers as oil subsidy

Written by Ashok Khemka | Ashok Khemka | Updated: Mar 28 2010, 02:48am hrs
The under-recoveries of OMCs in the last six years from 2003-04 to 2008-09 were Rs 3 lakh crore, 48% of which was compensated for in the form of oil bonds by the government, and another 37% by upstream oil PSUs in the form of subsidised oil prices. The under-recoveries are only estimates benchmarked to the import or trade parity prices of oil and are not additional revenues, which would have accrued to the OMCs if the prices were purely market determined in a perfectly competitive domestic oil market without the intervention of the government. The bottom line is that the bill for half the difference between the trade parity price of oil and the average domestic administrative price was footed by the government in the form of oil bonds. This subsidy promoted over-consumption by the current generation and the bill for redeeming this over-consumption will have to be picked by our future generations, giving rise to inter-generational equity concerns. The selective financing of the under-recoveries of public OMCs also led to the closure of private OMCs, causing a setback to the competitive structure of the domestic petroleum products market.

To address these concerns, the Kirit Parikh report recommends freeing up the markets for petrol and diesel and making them totally market driven. The price for PDS kerosene is recommended to increase from Rs 9 to Rs 15 per litre and the quantity allocation of kerosene for PDS is recommended to be reduced by 20% by making it available to non-electrified BPL households at 5 litres per month and to electrified BPL households at 2 litres per month. The report also recommends a fixed quantity of LPG at a subsidised price is proposed to be increased by a flat Rs 100 to households beyond which the market prices would operate. The report estimates the annual sales volume to be 11.7 billion litres of PDS SKO and 788.3 million domestic LPG cylinders. At an international crude oil price level of $70 per barrel, the under-recoveries of public OMCs financed from the government budget (as per the suggested formula) is estimated at Rs 19,780 crore. The maximum amount needed to be financed by the government at the international crude oil price of $100 per barrel is estimated at Rs 23,340 crore. The difference will be borne by the upstream oil companies who were allotted blocks on nomination basis with the levy of a windfall profit tax of up to 80% for prices exceeding $90 per barrel. In effect, upstream oil companies will be able to take a maximum price of $78 per barrel, plus 20% of the incremental crude oil price above $90 per barrel, which will adversely affect the investments in the E&P sector. For example, at a crude oil price level of $200 per barrel, upstream oil companies will be able to receive half or $100 only, with the balance $100 going to subsidise the under-recoveries of the OMCs. At a price of $300, the upstream oil companies keep only $120, with the balance $180 going to the OMCs to part finance their under-recoveries. It does not require much rocket science to guess as to how workable such a formula would be in case crude oil prices shoot up.

The objective to bring about stability in domestic petroleum product prices is itself flawed. Administrative price fixation by the government may provide a semblance of stability in the short run, but any desirability of stability in fossil oil prices with finite global supply in the long run is a chimera. The experience of Peru, which ran a deficit of $1.5 billion in its price-smoothing fund during 2006-08 due to demand and supply imbalances, cannot be ignored. There are major problems with the setting of administrative prices like efficiency in usage, consumers choice of alternative fuel substitutes and choice of techniques. There are certainly alternatives to setting administrative prices to encourage the consumption of merit goods, like SKO and domestic LPG, that have positive social and environmental externalities amongst poor BPL households.

The total under-recoveries to be financed jointly by the government and the upstream oil companies due to the policy of encouragement of consumption of merit goods like PDS SKO and domestic LPG is estimated in the report at Rs 21,440 crore, at international crude oil prices of $70 per barrel. This is further estimated to rise by Rs 630 crore for each dollar increase in international crude oil prices beyond $70. With roughly six crore BPL households in the country, the direct cash transfer equivalent is nearly Rs 3,600 per year or Rs 300 per month at average crude oil price level of $70 for each BPL household. This cash transfer would increase by Rs 105 per year or Rs 8.75 per month for each dollar increase in crude oil prices beyond $70. Direct cash transfer would not only prevent distortion of the energy markets, but also promote consumers choice amongst various alternatives, efficiency in oil usage, besides promoting producers efficiencies through innovations and competition. Bold thinking is called for to do away with a fossilised mindset and to bring about true reforms in the energy markets.

The author is a civil servant. These are his personal views