Awaiting a petro product tariff regime rehaul

Among the more interesting issues that the finance minister would be addressing in this Budget would be the tariff regime for petroleum products. At the one end, the public sector oil companies have been complaining that the subsidies on LPG and kerosene are not being compensated by recoveries from petrol and diesel, and that price increases are held up for government approval, resulting in substantial losses for these companies. There have been arguments that the existing tariff regime can be softened to reduce the burden on the consumer, and the report of the committee set up by the Prime Minister to address this issue is eagerly awaited.

The Administered Price Mecha-nism for petroleum products was put in place in 1977, a bureaucratic snakes and ladders game that created an oil pool account into which the surpluses from petrol and diesel would go. And after deductions for losses in LPG and kerosene, the balance would be ladled out in careful doses to the constantly hungry companies, who would continue to ask for more. Over the years, a spaghetti bowl of unreconciled claims emerged and the government was forced to issue designated bonds to the companies in 1997 to reconcile the account. The mechanism could work only while international crude prices were stable, for any major volatility would upset the fabric of reimbursement, given the complexities of the product exchanges between the companies.

The decision to give up the APM regime, taken in 1997 and to be implemented by 2002, was a good one. However, the implementation was short-lived, with the government in 2004 again seeking to intervene in price determination. With crude oil prices remaining high, consumer prices lagged behind, with consequences for the balance sheets of the oil companies. The committee now constituted is to recommend measures to tackle this problem.

At the core are several different issues that are interconnected?the tariff regime for oil and products, the methodology of arriving at prices, and the subsidies on some of the products.

At present, customs duties on crude are at 5% and on most products at 10%. Given that products are not imported, this provides a substantial refinery margin to the producers, in excess of $15 a barrel. This is a profit that refiners and marketing companies make at the stage of refining. Even if products and crude were to be brought down to the same level of import duties of 5%, there would be no effect on customs revenues, and the refining margins would still be around $ 5 a barrel. This would result in a reduction in product prices of around Rs 1.50 a litre.

Product prices are determined by the companies on the basis of import parity, that is to say, the landed cost of the imports plus transportation and marketing. As a quarter of the crude is sourced indigenously, it is learnt that the committee is examining the option of allowing only 80% of the products to be priced on this basis. This would benefit those refineries that export more, at the expense of public sector refineries. An alternative would be to look closely at the margins and add-ups to costs that the marketing companies provide for, and ensure a reasonable return on sales or capital employed. A comparison in terms of efficiency would be consumer prices net of duties, compared with international prices.

Consumer prices are also determined by the excise duties paid by the refiners. The regime of ad-valorem excise duties was given up last year in the face of high product prices, and currently, petrol attracts a duty of 8% and Rs 13 a litre while that on diesel is 8% and Rs 3.25 a litre. It is rumoured that the ad-valorem content would be removed, and there would be a specific duty of around Rs 15 a litre on petrol and Rs 5 on diesel. The specific duty would reduce the cascading impact of a rise in product prices, while ensuring no loss of revenue to the national exchequer when prices drop. The effect could be to reduce the consumer prices by about half a rupee.

On subsidies, there is lack of clarity, with the new petroleum minister stating that LPG and kerosene prices would not be increased, while the industry (and perhaps the committee) is seeking to recommend an increase in both. At the core is a dilemma of choosing between the consumer and the oil companies. My sympathies here are entirely with the consumer.

China, in spite of a huge oil demand, is still maintaining less than market parity on petroleum product prices. The concerns are that in a growing economy, the underlying inflationary effects might get exacerbated by maintaining parity with the world.

In India, the oil companies pride themselves on being at the top of the ladder in terms of market capitalisation and profitability, and the private companies are declaring profits, hand over fist. There is no contradiction in making these firms share some of the burden of adjustment and to protect the customer. I am fully with the Left in protesting against the proposed increases?why should ONGC make over a billion dollars, especially when it is producing less oil than last year?

A rational approach could be to equalise customs duty on crude and products, arrive at a reasonable fixed excise duty regime for petrol and diesel, and remove cartelisation of prices between the three retailers, and especially the basis of import parity price fixing. The customer would benefit by at least Rs 2.50 a litre. The regime would also leave revenues protected, though ultimately, crude and products should attract zero customs duty.

The writer is a former finance secretary and economic advisor to the PM