Now that the government has committed to compensate the oil marketing companies in cash rather than through issue of oil bonds, the finance ministry wants a change in the way under-recoveries of OMCs are calculated. The idea is to rationalise the outgo.

The under-recoveries are currently calculated on a trade parity basis, that is, by reckoning the freight on board (FoB) price of petroleum products in global markets. Under-recovery is the gap between government-allowed retail price and a notional price (excluding taxes) calculated assuming that finished petroleum products supplied in the country are actually imported.

The finance ministry feels the practice of adding some cost elements, like letter of credit opening charges and ocean losses to FoB price of petroleum products, should be dispensed of. This is because the FoB price already comprises these cost elements and adding them again would be redundant.

The finance ministry has already conveyed its views in this regard to the petroleum ministry, according to official sources.

A switch over from oil bonds to cash subsidy means the government has to find the resources immediately for compensating retailers? under-recoveries unlike oil bonds which merely transferred the present problem to the future.

The finance ministry wants to ensure that the under-recoveries of public sector fuel retailers, which are partly met from the exchequer, are directly relatable to their financial hardship on account of selling fuel below cost.

?It is an act of tying our hands (against spending). If we are free to issue bonds, we tend to do it indefinitely. But when it comes to giving subsidy in cash, we will have to make a cut in expenditure somewhere else. That introduces a discipline,? a finance ministry official told FE on condition of anonymity.

The final petroleum product sold in the country are actually obtained from refining mostly (97%) imported crude. For the last few years, the weighted average of 80% import parity price and 20% export parity price of finished petroleum products is followed. Experts had earlier pointed out that this calculation is not a correct reflection of the actual economic hardship that public sector retailers suffer on account of selling them at government-set prices.

The BK Chaturvedi Committee on the financial position of oil companies had pointed out that the refinery gate prices of petroleum products calculated as per this formula is often higher than the actual prices of finished products in international markets. The committee had also pointed out that the starting point of calculating trade parity price?the FoB price of petroleum products at international markets also comprises certain costs, such as letter of credit opening charges and ocean losses. Despite this, trade parity price is calculated by again adding some of these costs to the FoB price, the panel had indicated.

(Under-recovery is distinct from the actual loss or profits made by a retailer as it does not include the subsidy given as well as income from other streams such as freely-priced jet fuel).

A more recent committee on the sustainable pricing of petroleum products chaired by Planning Commission member Kirit Parikh, however, did not study this issue in detail, a member of the panel told FE.

Faced with the tough call of cutting spending somewhere else to compensate oil retailers, the finance ministry now wants a more accurate assessment of the economic suffering of retailers. It is expected to discuss the matter with the petroleum ministry, which expects the finance ministry to agree to an extra Rs 18,000 crore as subsidy to oil retailers this fiscal.

Finance minister Pranab Mukherjee agreed to only Rs 12,000 crore for the fiscal although the petroleum ministry estimated an under-recovery of Rs 20,000 crore for the three quarters ending December and around Rs 30,000 crore for the whole fiscal.

?There are different options (to deal with under-recoveries)? One could be to replenish the subsidy through supplementary demands for grants. The other options could be to raise fuel prices or to let oil marketing companies to take a hit,? the finance ministry official said.