India?s three state-run oil marketing companies, Indian Oil Corporation, BPCL and HPCL, could be in big trouble this fiscal under the weight of their combined under-recoveries of over Rs 1 lakh crore unless hard decisions are taken to hike the prices of their products or alternatively, to change the fiscal deficit target, warns petroleum secretary S Sundareshan.

He told FE in an exclusive interview: ?Oil prices are very high. If the average price for the whole year (2010-11) is $80 a barrel, under-recoveries would be extremely high and I would project it at over Rs 1 lakh crore. This is something which is really disastrous for the oil marketing companies and is a burden they cannot bear.?

Significantly, unlike in 2008-09 when OMCs were compensated chiefly through oil bonds worth Rs 71,292 crore, the government balance sheet will have to reflect a very large oil subsidy burden in 2010-11. This is because finance minister Pranab Mukherjee has pledged not to resort to issue of oil bonds, an off-budget instrument, as far as possible. The minister is in favour of compensating OMCs through cash payments, which have to be promptly budgeted for. The externality of oil prices is, therefore, a grave threat to the budget plan for a lower fiscal deficit of 5.5% of GDP this fiscal.

Of course, the increase of every cent above $80 in oil price would exacerbate the OMCs? situation and make it that much for difficult for the country to reduce its net external indebtedness.

Brent crude price for June settlement was ruling at around $85 in various global markets on Wednesday. The average price of Indian basket of crude stood at $76.6 in January 2010, the latest monthly figure available.

Projected under-recoveries for 2010-11 are 122% higher than 2009-10?s relatively moderate figure of Rs 45,000 crore, but equal to the all-time high of Rs 1.03 lakh crore in 2008-09, a year which saw oil prices skyrocket, and reach a record $147 in July 2008. During the six years from 2003-04 to 2008-09, OMCs reported under-recoveries of close to Rs 3 lakh crore and a third of that was in 2008-09 alone.

In 2008-09, the Indian basket crude price averaged the highest in any year at $82.7, up from $79.5 the year before, the second-highest in history, and, of course, way above $26.8 in 2000-01 or $22.4 in 2001-02 (see chart). OMCs?s under-recoveries (the notional losses on account of selling petroleum products below cost) are managed through a combination of measures: oil bonds, burden-sharing by upstream companies ONGC, OIL and GAIL India through price discounts to OMCs and some absorption by OMCs. The three upstream companies took a collective hit of Rs 32,000 crore in 2008-09 and Rs 15,000 crore in 2009-10 for compensating OMCs for the revenue loss from selling petrol and diesel below cost.

The Kirit Parikh group to recommend a sustainable system of pricing petroleum products proposed in its report in February this year that petrol and diesel price be de-regulated. It also recommended a 20% reduction in PDS kerosene allotment, along with a price hike of Rs 6 per litre, and raising LPG price by Rs 100 a cylinder. The group said that if these measures are implemented and product prices at the international parity are applied, then under-recoveries in 2009-10 (Rs 45,000 crore) would come down by 67% to a manageable figure of over Rs 15,000 crore.

Since this year?s under-recoveries will be much higher at the projected average crude price of $80 or above, the subsidy bill would be much higher even if the government implements the group?s recommendations. And few expect that the government would have the gumption to take the politically difficult option of implementing Parikh?s recommendations in toto. So, the most part of the burden would be on the fisc, while upstream companies would also share the onus. Finance ministry officials told FE that OMCs could also be expected to absorb a portion of the under-recoveries. Even after all the compensation and burden-sharing by the upstream sector, the combined net profit of IOC, BPCL and HPCL declined 60% between 2004-05 and 2008-09.

The composition of the Indian basket of crude represents the average of Oman and Dubai for sour grades and Brent for sweet grade in the ratio of 63.5:36.5.