Memorandum to the Hon’ble Finance Minister
on ‘Petroleum Subsidies’
May 2005, New Delhi
National Common Minimum Programme (NCMP) of the Government,
inter alia, states:
subsidies will be targeted sharply at the poor and the
truly needy like small and marginal farmers, farm labour
and the urban poor.
Subsidy comprises of:
Subsidised Kerosene for PDS
of subsidies and under-recoveries
petroleum subsidy is estimated at Rs.6573 crores in 2003-04,
up from Rs.5225 crore in 2002-03.
the gross under-recovery on petrol, diesel, LPG and kerosene
was Rs.20,310 crore in 2004-05, which is borne by the
oil industry including upstream producers, mid-stream
firms and downstream companies, and private refiners.
Taking into account the designated announced subsidy and
the import parity cost, the oil companies are losing nearly
Rs 100/cylinder for LPG and Rs 2.5-3/litre for kerosene.
The subsidy under-recovery, however, is set to decrease
in 2005-06 on account of the reduction in customs and
excise duties and drop in international prices.
in the Pricing of Petroleum Products, and in Calculation
major oil sector reform has been the abolition of the
administered pricing mechanism (APM) with effect from
31 March 2002. However, it does not give market forces
the complete freedom to fix the price, as the price
revision has to be discussed with the Government, each
there a subsidy burden?
present system of working out the extent of subsidies
itself is notional on the basis of import parity pricing
of petroleum products and not on the basis of unrecovered
costs, which is the appropriate figure for calculating
government imposes a cess on indigenously produced crude
oil. The Oil Industry Development Act, 1974 based on
which the cess is being charged, states that "the
cess collected under this provision would be made available
to the development of petroleum sector". The cess
was introduced to provide financial assistance to state-owned
oil companies, and is not applicable to private oil
producers. Over the past three decades, the government
has collected Rs.50,000 crore as cess, but only Rs.902
crore has been allocated to the Oil Industry Development
Board (OIDB) that is supposed to disburse the money
to the industry. The balance money has gone to the Consolidated
Fund of India. The cess was doubled in 2002 from Rs.900
a tonne to Rs.1800 a tonne, on the ground of providing
subsidies on LPG and kerosene (the cess was
never intended to cover subsidies). This helped
raise an annual amount of about Rs.6000 crore in 2002-03
and 2003-04. Now that the petroleum sector has been
deregulated and opened for private sector, there is
no justification of continuing this cess at all. The
cess amount now seems to be an implicit arrangement
of meeting the subsidy burden and containing government’s
deficits. Considering the amount of cess, the net
petroleum subsidy seems to be negligible.
is a highly taxed sector. Taxes take different forms
– excise duty, additional excise duty including different
cesses levied to raise funds for specific purposes such
as road construction, and State taxes. The total tax
revenues from the oil sector stood at Rs.110,000 crore
in 2003-04 (Rs.69,000 crore went to the Centre, and
remaining accrued to the states in the form of sales
tax). Compared with other Asian economies, India’s levies
on oil tend to be high. The taxes on crude oil and natural
gas add to the production cost of kerosene and LPG and
inflate their subsidy bill. In addition, a part of the
cost of LPG and kerosene is made up of sales tax and
excise duty. This further inflates the petroleum subsidy
oil companies losing out?
companies charge buyers of both petrol and diesel ‘adjusted’
import parity price. This formula of arriving at the
retail price came into effect after the government dismantled
the administered price mechanism in April 2002. Accordingly,
the customs duty on imported petrol and diesel is factored
in, to arrive at the import parity prices of petrol
and diesel. Incidentally, the country does not import
petrol or diesel as the production is more than the
total domestic demand. So, no customs duties are paid
but this levy is added on to the base price to avail
of the protection that is offered under the policy of
import-parity pricing. It is estimated the oil companies
garnered an additional Rs.9866 crore in 2003-04 on account
of the notional customs duty. This was not paid
to the government, as the amount is not collected from
the consumer as customs duty.
Planning Commission in its mid-term appraisal of the
sector for the 10th FYP has criticised the
pricing methodology based on import parity, which provides
higher margins to the refiners thereby resulting in
oil companies factor in costs incurred on account of
ocean loss, letter of credit charges and port charges.
Again, these are largely notional costs.
2002-03, it was estimated that oil companies made net
profits of around $19.5 on every barrel of oil that
reached the public. These profits are very high as compared
to international standards – most international companies
earned net profits of between $0.62 and $1.38 a barrel
during 1999-2002. Anyhow, the high profits are considered
necessary to build in high margins, as the government
still controls the prices of petrol and diesel and does
not allow the companies to raise rates when crude oil
becomes costly internationally. Further, oil companies
are forced to absorb losses on subsidised cooking gas
and PDS kerosene. Another reason for high profits in
petroleum is due to the monopolistic practices of state-run
PSUs, as per a discussion paper of the Oil Ministry.
significant step towards introducing competition in
the down stream value chain, in the Indian petroleum
sector, was the decanalisation of kerosene (SKO), LPG
and LSHS products. From 1993 onwards, private parties
have been allowed to import, as well as market, these
products at the prices determined by the market forces,
in parallel to the PSU dominated marketing system. The
new entrants are expected to develop infrastructure
for imports of these products, tankers for storage,
LPG Bottling plants, in addition to setting up their
own distribution and marketing network including, transportation
In order to maintain its distinction from the Kerosene
supplied by the parallel marketers, the PDS kerosene
has been coloured with blue dye. Furthermore, the LPG
Control Order has specified that the cylinders, regulators
and valves to be used by the parallel marketeers have
to be distinctively different from that used by the
public sector oil companies. The latter is an anti-competitive
requirement. It reduces the freedom of LPG end-users
in switching from one supplier to the other.
Furthermore, only public sector companies are allowed
to market subsidised petroleum products. While there
may be some genuine, social concerns that Government
has to take care of, the non-targeted subsidies offered
to PSU oil companies in terms of concessional pricing,
distorts the market, making it difficult for private
firms to cater to these segments and also restricts
their ability to compete effectively.
pricing structure of various petroleum products is not
transparently determined. Government’s intervention is
distorting the process of arriving at market-determined
prices. The public-sector companies and the government
are minting money from distortionary policies and practices.
The claim of huge subsidy burden and bleeding oil companies
seems to be exaggerated.
is a strong case for the Government to directly support
the needy people, rather than canalising through oil
PSUs, which distorts the market process. To ensure that
the assistance provided does not destroy the incentives
for self-reliant efforts, the subsidy program should
be temporary, as an interim measure to protect certain
groups from the adverse effects of macroeconomic or
sector adjustment on prices.
subsidy on kerosene, to the extent it is used by rural
households for lighting purposes should be linked with
pricing regime should be dismantled and oil companies
allowed to charge market-determined prices.
the prevailing tax structure. Replace the current ad
valorem duty structure with a specific one. This will
remove the cascading effect of a rise in oil prices.
A price stabilisation fund may be created to check high
volatility of crude prices. The fund could be resourced
from the cess collected under the Oil Industry Development
Remove the anti-competitive provision of the LPG Control
Order. The petroleum sector requires a comprehensive
competition framework rather than stringent regulations.
the Petroleum and Natural Gas Regulatory Board
measures will bring transparency in the determination
of petroleum products, ensure that market forces are
allowed to operate, and facilitate proper targeting
made in the report/background note
APM was abolished in 2002, government continues
to play a major role in determination of prices
of petroleum products.
is lack of transparency in the determination
The system of calculating the extent of subsidies
itself is notional on the basis of import parity
pricing of petroleum products and not on the
basis of unrecovered costs
state-owned oil companies have been permitted
to market subsidised domestic LPG and PDS kerosene.
This has stifled competition by curtailing the
entry of private retailers
intervention in the oil sector is impeding the
market process. There is need to rationalise
government’s intervention in the sector and
target sharply the subsidies at the poor and
the truly needy
pricing regime should be dismantled and oil
companies allowed to charge market-determined
the prevailing tax structure. Replace the current
ad valorem duty structure with a specific one.
This will remove the cascading effect of a rise
in oil prices.
price stabilisation fund may be created to check
high volatility of crude prices. The fund could
be resourced from the cess collected under the
Oil Industry Development Act.
Remove the anti-competitive provision of the
LPG Control Order. The petroleum sector requires
a comprehensive competition framework rather
than stringent regulations.
Establish the Petroleum and Natural Gas Regulatory
that prices of petroleum products are determined
Subsidy on Domestic LPG
made in the report
LPG subsidy benefits largely the higher expenditure
groups in urban areas
marketing of domestic gas cylinders
use of domestic LPG for commercial purposes
of LPG subsidy in a gradual manner, or at least
a substantial reduction in the subsidy element,
may be recommended
has decided to raise the cooking gas price by
Rs. 5 a cylinder every month starting December
the anti-competitive provision in the LPG Control
Order which specifies that the cylinders, regulators
and valves to be used by the parallel marketeers
(private players) have to be distinctively different
from that used by the public sector oil companies.
This reduces the freedom of LPG end-users in
switching from one supplier to the other.
taxes/levies that inflate the cost of providing
cooking gas and inflate the subsidy bill. Facilitate
prices to be determined by competitive forces.
Subsidy on PDS Kerosene
made in the report
a per capita basis, the urban areas receive
a larger subsidy on kerosene
limited availability of subsidised kerosene
in rural areas biases its use in favour of lighting
rather than cooking
kerosene subsidy in rural areas is regressive
as higher expenditure groups receive more subsidised
kerosene than lower expenditure groups
subsidy is prone to misutilisation with about
half of the subsidised kerosene supplies diverted
and never reaching the intended groups. Hence,
it is not affordability, but non-availability
that is restricting the use of clean fuels like
kerosene by poor households.
reaches the consumer through kerosene dealers
appointed by the public sector oil marketing
companies. The companies deliver kerosene to
the retailers (dealers) from their marketing
installation points. However, this arrangement
does not ensure smooth supply of products. This
also leads to leakage of the product for adulteration
cautious approach is justified in the reduction
of kerosene subsidies since about a half of
the rural households use kerosene primarily
to light their homes
an open and competitive market with clearly
defined and well-enforced rules and regulations
for all participants, to expand access and improve
the quality of service
all sales of kerosene through the retail markets,
and encourage small distributors of fuels.
may be issued only to poor ration card holders
with entitlement to purchase kerosene from a
retailer at the subsidised price. This would
discourage direct diversion of subsidised kerosene
to other sectors.
should be involved in monitoring of kerosene
distribution system. They should be involved
in the task of identifying beneficiaries for
coupons. They should be roped in to create awareness
among consumers about their entitlements under
redressal system should be established.
should conduct social audit of the schemes,
and report misuse of funds.
the list of beneficiaries publicly available
and accessible to all
on kerosene should be linked with rural electrification
Remove taxes/levies that inflate the cost of
providing kerosene and inflate the subsidy bill.