Subsidy bill from oil firms to pinch despite reforms

Written by Aftab Ahmed | Pranav Nambiar | Updated: Nov 13 2013, 05:44am hrs
In our third and final part of the series on the finance ministry's strategy for subsidies this fiscal, we delve on petroleum product subsidies. Payment obligations the ministry is likely to roll over in the coming years in relation to 3 major subsidies oil, fertiliser and food could be as high as R1.17 lakh crore.

The pricing reform that is underway for petroleum products coupled with a relative respite on the import cost of crude may keep PSU oil retailers' under-recoveries (and Budget oil subsidies) for FY14 significantly below last year's record level of R1.6 lakh crore. Yet, the government is likely to push at least R30,000 crore in subsidy costs in the coming years, besides retaining a heavy onus on upstream oil firms whose share of the subsidy burden has risen sharply in recent times.

Last year, a bill of R45,000 crore due for payment was not footed by the government even as it had to revise the budgeted subsidy amount to R96,879 crore (in addition, the OMCs are asking for additional arrears payment of R20,000 crore on account of interest costs suffered due to delayed release of subsidies, losses on oil bonds, a demand the finance ministry feels is not obligatory).

This year's under-recoveries are currently estimated to be around R1.4 lakh crore.

The budgeted subsidy amount for the year is R65,000 crore, 32% less than the revised estimate for last year. Most likely, the budget estimate for oil subsidies won't see a major revision as the finance minister P Chidambaram presents an interim budget early next year.

The final under-recoveries' amount for FY14 would depend on the rupee's movement in the rest of the year and global crude oil prices.

Official sources said in worst-case scenario, R40,000 crore in oil subsidies may be rolled over to future budget. In that case, inclusive of the subsidy bills on food (R43,000 crore) and fertiliser (R34,000 crore) likely to be left unpaid, an amount of R1.17 lakh crore would be rolled over this fiscal.

Analysts fear the phased deregulation of prices of diesel (the subsidy obligation on which is the highest) may falter as the country approaches general elections. This will also reduce the government's ability to reduce the subsidy bill from OMCs.

The government and upstream oil firms compensate oil retailers IOC, HPCL and BPCL on a quarterly basis for selling diesel, LPG and kerosene at discounted prices. While the upstream companies' compensation is in the form of discounts on sale of crude oil are timely, the government has consistently delayed its share of payments.

The R8,000-crore compensation for the April-June quarter this year, for instance, was released only in mid-September and the R8,772-crore compensation for the July-Sept quarter was sanctioned only on November 7, the payment is yet to be made. The R45,000 crore in arrears from the previous financial year was paid only in May. We have partly paid for Q1, we will release some more funds in December, a finance ministry official told FE on condition of anonymity.

Similar payment delays were seen since 2009-10, denting the profits of oil retailers. A weak rupee, poor gross refining margins, inability to increase domestic prices have also added to the financial woes of the oil retailers. Indian Oil Corp (IOC) reported a 82.5% drop in net profits for the July-September quarter owing to foreign exchange losses and the government not fully compensating for oil subsidies. Sources said that there was an average delay of around 180 days between the incidence of under-recovery and receipt of compensation by the government through budgetary support during 2012-13.

To fill the delay gap in subsidy payment, companies draw the amount from banks at an interest rate, which is typically around the base rate of the banks.

At present, the minimum base rate of a bank stands at 10% for State bank of India, which is the largest lenders to these PSU. PSUs have also suffered losses from oil bonds, which were earlier issued by the government to compensate the OMCs for losses. This practice was discontinued from 2009-10 and the government shifted to a cash disbursal mechanism for paying subsidy thereafter.

But a demand letter from OMCs seeking compensation for losses suffered on these bonds has reached the finance ministry recently. Between 2009-10 (when government cash compensations were first introduced) up to 2012-13, the government has paid over R2.5 lakh crore in cash compensations.

Between 2005-06 to 2008-09, the government issued oil bonds worth over R1.42 lakh crore. Analysts said that issuance of bonds was discontinued as oil companies made losses on selling them in the open market and were subject to risks of interest rate movements.

In 2012, the government took a decision to deregulate petroleum product prices in phases and align them with market prices in a phased manner. This has so far only partly been achieved. While petrol prices have been freed up, industry insiders argue that artificial control still continues.

Also dual pricing for diesel has kicked off, where bulk consumers including the railways, defence units, state transport undertakings and industries are paying market price. Retail consumers on the other hand are are seeing small increases of about 50 paise every month. Thanks to the rupee's fall, the under-recoveries on diesel haven't come down as much as the government desired from the level in January 2013, when the practice of periodic price hikes began.

The number of subsidised LPG cylinders has also been limited to 9 per household. The government has also adopted the direct transfer of subsidies on kerosene and LPG to ensure that the subsidy goes to the beneficiary and also bring down the subsidy burden. Even after the reform measures, the under-recovery on diesel stands at R9.58/litre, kerosene of R35.77/litre & LPG of R482.50/cylinder.

Chidambaram had in May stated that his government planned to contain under-recoveries to R 80,000 crore in 2013-14 (from R1.6 lakh crore in FY 13). This was made when the rupee was at 54 to the dollar and the Indian basket crude oil prices was trading at around $ 100/ barrel levels. With the rupee now falling to around 63 to the dollar and the crude oil prices at $ 105, under-recoveries could touch around R1.4 lakh crore.

According to the petroleum ministry, every dollar increase in crude oil prices will add R4,000 crore to the overall under recovery, while every one-rupee fall against the dollar will increase it by R8,000 crore.